Banks’ fintech challenge – /iStockphoto
In this age of fintech and blockchain, corporates entering banking space is inevitable. But the regulator must be ready
The report of the Internal Working Group of the RBI has generated a healthy debate. But why do economists not practice what they preach when they are inside the government?
Laws governing Indian banking and non-banking space are so weak that scams and failures (PNB, PMC, IL&FS, YES Bank, Dewan Housing, and LVB) have become regular occurrences. Why is the RBI not able to detect a single scam? Why does the system not have an in-built checks? The entire system — law, competition, institution, regulation — needs an objective relook.
Why do the RBI’s guidelines not distinguish between ‘residents’ and ‘citizens’ in ownership? The IWG suggests: residents (as defined in FEMA Regulations) and Indian citizens (as defined under Citizenship Act, 1955).. entities in private sector owned and controlled by ‘resident Indian citizens’ (as defined by FEMA Regulations).
There are many recommendations by IWG to Indianise banks such as 26 per cent ownership by promoters. A key question is: whether India should have Indian capital or 74 per cent FDI in banking? Depositors are often befuddled about the ‘real’ owners of their banks.
The problem of archaic laws
The IWG has brought into light the archaic law, which is unable to detect scams even without corporate entry. It has referred to the US Federal Reserve Act’s Section 23A and 23B that regulate connected lending. Our banking regulations are no comparison as evidenced by Section 6 (n) and (o) of the Banking Regulation Act, 1949.
It is intriguing that IL&FS could create hundreds of subsidiaries without the RBI not detecting them. So is the case with PMC Bank’s IT-linked fraud. Where is the law to prevent such frauds in future? Why should the perpetrator not be subject to special law/deterrent punishment? The system should have in-built penalty for the wrong doers — not through the IBC, the NCLT or the DRT.
The UK, Germany, France and most major countries permit corporate entities to own banks and vice versa. The US and Japan have maintained a policy that separates banking and commerce to prevent misallocation of credit, anti-competitive effects, exposure of deposit insurance and taxpayers to greater risks from commerce, and additional supervisory burdens on regulators.
However, this separation is being reconsidered both in the US and Japan. With challenges of fast-changing fintech products, block chain technology, machine learning, artificial intelligence, big data analytics and many multinationals investing in next generation banking, it is a matter of time before on-line banking and e-commerce transform banking through synergies between the two, reducing information costs.
But are Indian banks ready? A big bank like PNB could not even link Core Banking Indian IT Solution to SWIFT – International IT Solution. So banks cannot survive without huge IT investments.
In the US, former Comptroller of Currency Keith Noreika proposed in 2017 that the US re-examine the historic separation of banking and commerce.
He said the US “is the only country” with such separation, and “it’s not the best thing to put all your eggs in one basket.”
In fact, the Gramm-Leach-Bliley Financial Modernization Act of 1999 in the US had already liberalised banking. It mandates new financial holding companies (FHCs) that have much greater powers than traditional bank holding companies to engage in a wide range of financial services. Securities trading and underwriting, insurance and traditional commercial banking activities can now be combined in a single holding company.
So Indian intellectuals must debate whether the classical separation is desirable in a world with ‘Fintech’ and ‘Platform’ revolutions.
Depositors’ interest supreme
Depositors in India must be encouraged to put their money in banks and not invest it in gold or land, which often leads to growth of the underground economy and rent seeking. But depositors are worried about the health of their banks and NBFCs.
Micro foundations cannot be ignored by macro logic – a fundamental principle of economics.
In 2013, the then RBI Governor did propose a regulation, through the central bank, to facilitate entry of the corporate sector in banking. But the IWG now is asking for a much stronger ‘legal’ framework, enacted by Parliament with no discretion to the RBI in certain matters – cutting across banks, NBFCs, UCBs, SFBs, and other entities.
Many of IWG’s recommendations are based on fundamental principles and two months have been given for comments. But India must first develop a stringent law to penalise connected lending and then think of allowing corporates. The depositors’ interest and confidence in the system is of paramount importance, an issue being ignored in the current debate
The writer teaches Economics and Finance at University of Hyderabad. Views expressed are personal.