Approach to Writing Mains Answer on 25-11-2020

Topic : Banking and Liberalization

Qn. Do you think corporates should be given license to start banking operations? In the backdrop of RBI’s recommendation to allow corporates to be given bank licenses ,what are the risks associated with this recommendation ? (250 words )

Why this Question ?

The Question has been asked in the backdrop of the recommendations of the Internal Working Group (IWG) of the RBI to grant license to corporate houses to start their banking operations.

The two parts of the question are inter related. It is depending upon the risks that are brought out as a part of the answer, individual opinion whether one thinks corporates need to be given banking license or not has to be brought out in the answer.

Introduction:

Since it is a 250 word answer, an apt introduction to the question could be to the length of about 40-50 words.

The introduction can be common and can address both the aspects of the question since both the aspects are inter related.The introduction can point out to any statistics related to the low levels of usage of formal channels of banking in the rural areas and to different sections of the population.

The introduction for the question could be:

“India has seen a spurt in the population brought into the formal system of banking. Around 80% of Indians have a bank account in India.

However out of these accounts half of them are inactive. This shows that there are certain barriers that prevent frequent interactions between the account holder and the banks.Various steps towards liberalizations in the banking sector have benefited a large section of the society. In this context, the Internal Working Group of RBI had recommended that the corporate houses be given the license to start banking operations in India ”

Content:

The recommendation of the IWG has raised eyebrows regarding the wisdom of these recommendations. It is well known that the corporate houses, who are always in dire need of funds can end up having access to cheap credit if they are allowed avenues in Banking operations.Such a move carries with it several risks that can even threaten the stability of the banking sector in India.

Risks associated with the recommendations :- 

  1. Inter Connected lending – lending at favourable rates to one’s own enterprise.
  1. Economic shocks – The operations of the Bank being exposed to the other commercial operations of the corporates and hence any downfall in the profits of the other business can severely affect the sentiments of the shareholders.
  1. High scope for money laundering – Difficult for enforcement agencies to track the different methods employed by the corporates to launder ill gotten wealth through banking
  1. Crony lending – Providing cheaper credit becomes the discretion of the corporate and not on the basis of need and repayment capacity assessment.
  1. Credibility of RBI at risk – The confidence that investors have on the economy is a result of the independence displayed by the regulatory body RBI. If the RBI sets itself on the path to regulation of the affairs of these corporates, RBI itself can come under tremendous pressure from these corporates and this can damage the reputation of the

Corporates if allowed entry would show tremendous interest in acquiring weak PSB’s rather than really creating a network of banks across India.

Conclusion:

While it is noteworthy that the IWG has recommended further liberalization of the banking sector it should also be borne in mind that even in the USA which prides itself on the liberal tendencies, corporates are not allowed in Banking operations. Even the Raghuram Rajan panel (2008) had recommended against the entry of corporates in banking sector operations.

Hence it is not prudential to allow corporate houses operate banks until regulatory & enforcement architecture becomes strengthened so that the risks pointed out are all mitigated.