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BW Businessworld

The Saintly Promoter

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The Reserve Bank of India has conducted a long-drawn and detailed process of consultation over the licensing of new banks. It began by issuing a discussion paper last year which raised a number of questions and listed a series of alternative answers to them. The range of options it gave created the impression that the Reserve Bank had an open mind and was really seeking guidance on what to do. The options it has chosen are, however, so one-sided that they make the consultation process look like a sham: if the Reserve Bank wanted such a costive solution, why did it have to go through the ritual of consultation?

The present process, which will presumably end with the award of some bank licences, began with an implicit assumption that the Reserve Bank was open to giving licences to all sections of the society and had no preferences amongst them. The recent draft guidelines are, however, so closely focused on those whom the Reserve Bank calls promoters that the rest of the people have obviously slipped out of its mind. It may have good reasons to let them do so. Some were briefly explained in last year's discussion paper: for instance, cooperative banks and regional rural banks have failed and are best confined to the waste bin. Perhaps the Reserve Bank's concentration on promoters arises from the extremely high initial investment of Rs 500 crore that it has set; to produce this kind of money, the applicants would have to have made made big money somewhere else. But this preference for big money is debatable. There is the model of the local bank, lending to local business with which it is intimately familiar, which was highly successful before bank nationalisation sent it into the waste bin. Just the fact that it was wantonly exterminated is not an argument for ignoring it.

Amongst promoters, the Reserve Bank has promoters of non-bank financial companies particularly in mind. But it would not let the NBFCs be converted into banks. They must be bifurcated into their rural and urban businesses; only the former would be eligible for a bank licence. This reflects a commendable concern for rural banking, in which even government banks do not have a great record. One could understand if the Reserve Bank insisted on a certain proportion of business coming from rural areas, or a certain number of rural branches being opened. But insistence on completely rural banking right at the outset is like killing the calf before it is born. The reason why rural banking has failed is that it is a loss-making business. If the Reserve Bank had used its considerable profits to build infrastructure for rural branches, to provide them with buildings, electricity and security for example, they would have found many promoters.

It is not as if the Reserve Bank is particularly enamoured of promoters. It wants them only to start the bank. Once they have done so, it wants them to sell off their shares and go home. The Reserve Bank is very sure about whom it does not want to run banks, but it has not thought about whom it wants to run them. The government has traditionally fractured ownership of businesses in the hope of preventing foreigners or promoters from controlling them. The ministry of commerce and industry is still very fond of ordaining percentages of share ownership. But businesses have been controlled by someone or other; usually, those whom the government wanted to exclude have found a way of obtaining control. The Reserve Bank should learn from the failed experiment, let controllers take ownership honestly and hold them responsible for good management.

The Reserve Bank is acutely aware of the possibility that promoters would try to keep control and make profits in concealed ways; so it wants them to report to it and to lay out all their secrets before it all so often. It is understandable that it does not want to trust them, and does not want to be accused of negligence. But in its obsession with preventing control, it has ignored incentives. Reading the Reserve Bank's guidelines, it is difficult to imagine an honest, rational entrepreneur applying for a bank licence. If it has its way, a bank licence has to be the path to some selfless social service with no chance of profit. It is not as if there is no profit in this line; it will be made by those who inherit the management of the banks from the promoters. The inheritors could be the promoters themselves if they practised enough subterfuge. Although the Reserve Bank may not see it that way, its guidelines could be read as an invitation to hoodwink it. And even if it later discovers their tricks, it will have to leave the banks to them for lack of alternative management — or nationalise the banks.

(This story was published in Businessworld Issue Dated 26-09-2011)