Bank licences to corporates soon

India will soon allow corporate houses to open banks despite misgivings within the Reserve Bank of India (RBI) as well as the International Monetary Fund that it could lead to risky loans if newcomers succumb to the temptation of lending to their related firms.

The government wants to reform a sector dominated by often lethargic state banks and which only reaches half the country’s households. Ultimately, it hopes issuing banking licences to corporate groups — India’s biggest conglomerate, the Tata Group, is reported to be interested — will provide fresh impetus for an economy that has struggled to close the gap with emerging market star China.

Final rules, expected soon, have been delayed over disagreement between the government and central bank on whether the traditionally more financially volatile sectors of property and brokerages should be allowed to apply for licences, which the RBI opposes.

Opponents of the new measures worry the reform, driven by the finance ministry, could backfire if risky loans from one branch of a company to another go bad and trigger a broader crisis. “It will be like one person is cooking and the same person is eating it,” said one critic, VK Sharma, chief executive of LIC Housing Finance.

“Most of the time if they need money they will go to their own bank, and it will be difficult to regulate that,” Sharma said. His firm, an arm of state-owned Life Insurance Corp of India, plans to apply for a banking licence.

The RBI regulates banks and has the final say on how the rules are shaped and implemented, but is not statutorily independent so takes the government’s views into consideration. “We are not at all happy with this,” a central bank official said, echoing similar comments from several other RBI officials, on allowing corporate houses into banking. They declined to be identified given the sensitivity of the matter.

The RBI is not alone in its caution. Regulators in the United States and South Korea do not allow industrial houses to set up banks; Australia, Canada, Britain and Hong Kong allow them to, but with restrictions on ownership and voting rights. Even the IMF has urged caution, saying in a report on India last month the risks may outweigh the benefits.

“The basic issue is the possibility of self-dealing,” said Anand Sinha, the deputy RBI governor in charge of banking operations. “This is a risk which everybody recognises across the world, so that is why we have prescribed many safeguards.”

Sinha said final rules would be issued soon. “When there is consultation, obviously you have to take into account the other side,” he said on the sidelines of an event on Friday. Part of India’s rationale for allowing companies to open banks is to extend “financial inclusion”, something the state-dominated banking sector has been slow to address.