Batting for big businesses

Aunindyo Chakravarty

Senior Economic Analyst

If people said it like it is, then the RBI’s latest report on bank ownership would have been called ‘how I took your money and gave it to big corporates.’ Instead, it is being heralded as a ‘watershed’ and a ‘breakthrough’ in banking reforms. Because, in India the best way to make any new economic policy palatable to the public is to call it a ‘reform’.

Experts fear if a corporate begins losing money in its core business, the stress could spill over into its banks.

The report, which is a set of recommendations by an internal team of the RBI, has many technical details about bank ownership, but three crucial proposals stand out. The first is that big business should be allowed to own banks. The second says big corporates who own non-banking financial institutions, that lend but cannot take deposits, should be allowed to convert them into full-fledged deposit-taking banks. The third related is that the limit on shareholding by a bank-promoter should be raised from the current 15 per cent to 26 per cent.

To understand the full import of these ‘reforms’, we need to first look at what banking means in modern economies. Banks are intermediaries through which capital flows in an economy. The money that you and I save, would lie unutilised in our homes if there were no banks to take deposits and pay us interest on it. Banks channel our private ‘unproductive’ savings to those who produce things and provide services.

Our savings become the base on which banks generate credit and lend to ‘producers’. This money is used to buy machines, raw materials and pay for the labour power of workers. Once our money enters the production process run by someone else, it generates profits for them. A part of it comes back to us as interest.

So, the banking process is the life-blood of modern economies, converting inert masses of money into active productive capital. Understandably, whoever controls this capital flow is in an advantageous position. They can mobilise money for their projects and have an advantage over competitors, who might be strapped for cash.

Before Indira Gandhi nationalised Indian banks in 1969, many large banks were controlled by big corporates who used that to lend money to their own businesses or to affiliates. The economic commentator Vivek Kaul has given us some numbers on this. Quoting a report published in 1967, Kaul shows that about a quarter of all loans at that time were directly or indirectly linked to bank directors.

Bank nationalisation changed that to a certain extent. The government, representing the public, now decided how credit would flow. For the first time, farmers began to get loans, and savings was directed towards developing the ‘priority’ sectors. Big industrial houses had to live with a financial field that was becoming less skewed towards their interests.

Things changed again from the mid-1980s, when the Rajiv Gandhi government began to incentivise private entrepreneurship. Before that, the government believed it had to control crucial sectors directly through public sector companies. The government infused capital into them, and ensured they got credit. PSE debt was also effectively underwritten by the state, which made it much more secure.

The 1991 Rao-Manmohan reforms accelerated privatisation. Over the next two decades, private companies began running big infrastructure projects which were earlier in the government’s domain. This required large amounts of capital. Some of it was raised in the stock markets, but the bulk of the new investments were financed by bank credit. Interestingly, most of it came from the much-maligned public sector banks. Public money, like in government-owned banks, became the basis on which to create massive financial assets for private profit.

We all know what happened to this irrational exuberance of credit. India’s public sector banks were saddled with a mountain of bad loans, because private projects failed to make money. In most cases, the private companies who had taken these loans lost very little. They had ‘gold-plated’ or overstated how much the project would cost. A project that needed Rs 1,000 crore was shown to require Rs 1,250 crore. If the promoter could get 80 per cent of that projected cost as a loan, they would get the entire Rs 1,000 crore as credit. They wouldn’t have to put up even a penny in equity. So, if it failed, they had absolutely no skin in the game.

India’s entire bad loan crisis has been created by such loans to big corporates. Whether it is IL&FS, Yes Bank, PMC Bank or Lakshmi Vilas Bank, each of these have fallen into deep trouble, because they had given big loans to connected corporate houses. Much of this happened right when the RBI was supposedly taking strict steps to curb bad loans. If despite such vigilance, the central bank failed to detect what was going on in these banks, how does it expect to regulate what big corporates will do if they are allowed to open their own banks?

What is interesting is that all experts the RBI’s committee consulted, ‘except one were of the opinion that large corporate/industrial houses should not be allowed to promote a bank’. The experts believed that Indian companies have poor corporate governance norms, and it would be easy for them to circumvent regulations that stop them from lending money to their own businesses. They also felt that if a corporate began losing money in its core business, the stress could spill over into its banks.

India’s entire bad loan crisis has been created by such loans to big corporates. At best, this reveals a mindset that believes that big enterprises are the best suited to deliver high growth. It shows that India’s central bank has no problem with concentration of financial and economic power in the hands of a few big players. There is one more reason to believe that this report is pro-big business, and that is the recommendation to raise the cap on how much equity a promoter can hold. This not only opens the door for big corporates to control capital flows, but to concentrate that power directly in their hands.

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