View: Conglomerate Vatapis and Bank Agastyas

Banks represent the agglomerated retail savings of small depositors, intermediated through them for prudent and profitable lending to industrial and commercial activity.

Banks, by virtue of the “deposit multiplier effect” – which (simply put) enables them to make loans in multiples of the actual deposits they hold – also have a disproportionately large impact on the fate and future of the nation’s economy.

Their success or failure, therefore, has enormous implications beyond that of any ordinary industrial or commercial enterprise. For this reason, strict regulations on the conduct of banks have evolved and banking is a licensed business.

Among one of the critical conditions for becoming a bank, the world over is the criteria of “fit and proper”. To paraphrase, it is a licence to permit entry to a chicken coop full of retail depositors and profit from lending their hard-earned monies. To this purpose it is incumbent on the government, through the central bank regulator, to ensure that this market of limited-financial-knowledge and poor-ability-to-assess-and-understand and risk-averse retail depositors, is protected from wolves entering the banking space.

The history of banking in India and its regulatory legacy, owing to a colonial past, has largely been of British or Anglo-Saxon origin of import, than any development of indigenous mechanisms or institutions of banking or finance.

Prolonged periods of abuse of banks acting as “piggy banks” for industrial conglomerates and the regulator having to repeatedly step in to prevent failure – among other political reasons - led to a wave of bank nationalisation in the 1970s/80s.

While public sector banks have acted as creditable instruments of state policy in expanding the reach and financial inclusion of a large part of the population, they have also unfortunately served as “piggy banks” for political purposes and often handmaidens of crony industrial lending. In most, banking as an independent enterprise and profession in India has been effectively destroyed in the 50 years of nationalisation. This has led to the current mess of commercially uncompetitive public sector mammoths without banking management leadership, and dependent on perpetual government bailouts.

Post-liberalisation in the 1990s, an effort was made to develop the banking industry through giving licences to “non-affiliated professional” bankers. It set off a wave of new-age banks. Bank of Punjab, Times Bank, Centurion Bank, Global Trust Bank, Kotak Mahindra Bank, HDFC Bank, UTI (Axis) Bank, IndusInd Bank, Yes Bank et al. The mortality rate and failures among these banks are too well known to recount.

With the exception of Global Trust Bank, and now Yes Bank, none of the bank promoters whose banks failed/faltered for poor loan book quality and were consequently “merged”, faced investigation or prosecution. All walked away from banking disasters of their creation with significant monies – some with high returns - of their equity even while the public exchequer and the nation picked up the tab for their excesses.

The most recent example being of a co-promoter in Yes Bank being declassified as part of the promoter group, selling family equity shareholding for a handsome sum even as the regulator and the government bailed out Yes Bank with taxpayer monies and its AT1 bondholders – including retired pensioners who were mis-sold the product by the bank – saw their monies wiped out.

That this implicit and unstated knowledge of being “Too Big To Fail” more often encourages immoderate and excess risk-taking behaviour in the least, and crony lending at the worst, by bank promoter managements is also well known. Global Trust Bank and Yes Bank are prime examples.

Even among well-run banks, the enormous market capitalisation premium that is commanded by them is primarily the arbitrage they enjoy over their sick and inefficient public sector competitors in the restricted and licenced banking space.

That a single “New Age” bank is more valuable in its market capitalisation than the combined ICU ward of public sector banks speaks of the unlevel playing field in this exclusive and limited entry club, and the “Super Premium” they enjoy for being banks. Yet the truth is that, like most industrial houses, but particularly for banks in India, every private bank too is essentially a reflection of its individual promoter capabilities than any demonstrated institutional resilience.

If Yes Bank was Rana Kapoor and Global Trust Bank was Ramesh Gelli, Kotak Mahindra Bank is Uday Kotak and HDFC Bank was Aditya Puri. Similarly, if IL&FS was Ravi Parthasarathy, Reliance Industries is Mukesh Ambani. If Reliance ADAG was Anil Ambani, Adani Group is Gautam Adani.

While both Kotak Mahindra Bank and HDFC Bank are poster boys of well-run banks, that both are in their first generation of entrepreneurial leaders and not demonstrably seasoned over other successor professional leadership are reasons for caution and makes it perhaps too early to deliver conclusive verdicts regarding their development into banking institutions spanning multiple generations.

This dependency on individuals is not limited only to banks but also corporate houses. The storied house of Birla is today recognised for the success of only the Aditya Birla branch under Kumarmangalam Birla, the other branches have withered away to obscurity or bankruptcy. The story is the same for most other marquee industrial houses of the 20th century. Modis, Thapars, DCM Shriram, Singhanias, Sahu-Jains, once titans of industry and even banking, but failed in subsequent generations.

It is in this environment of the inability of the Indian banking (and industrial) sector to build robust and demonstrated individual-independent institutional and sustainable management capacity and governance, that the proposal to reintroduce corporate ownership of banks is being discussed.

That this discussion is taking place in a particularly vulnerable situation, as India grapples with the post-pandemic and its public sector bank crisis, is particularly ominous.

The realpolitik temptation to use banking and banking licences to spark a cycle of equity market IPO or private equity financing of new banks and a corollary of exuberant fresh lending is seductive in a bog of anaemic loan growth in a risk-averse public sector banking monolith.

Yet it is in crisis that one needs to be the most careful.

The overleverage of the excesses of the Glided Age of the first decade of the millennium is not yet entirely adjusted or absorbed. Some corporate groups still teeter on edge, as they attempt to either raise private equity, structure mergers on the promise of future possibilities or seek to sell off businesses to reduce leverage. Others look to embark on exponentially ambitious expansion plans, fuelled largely by stratospheric and spiralling equity share prices. Either way, both strategies speak of either reducing significantly in size or exponentially scaling up in speculator bets far out into an unforeseeable future. In either context, not the most stable or reassuring scenario of industrial activity for gifting any banking licences.

The scenario analysis of outcomes of such possibilities in the current environment can be examined in just two recent examples, the failure of IL&FS and the failure of HDIL-PMC Bank. If “AAA” rated IL&FS – which was a systemically important NBFC with a large infrastructure projects portfolio that subsequently ran into trouble - had been permitted to convert to a bank what would have been the systemic outcomes?

Its undiscovered deficit funding bubble from borrowed monies, which almost doubled in the period 2014 to 2018, would have continued to grow even more as a bank, till it would have exploded much later one day with potential extinction-level impact. As it is, the small meteor as an NBFC caused the crisis that it did, what would the impact have been if it had been a banking asteroid? Arguments of more stringent RBI inspection and supervision as a bank are specious. Its track record in Yes Bank, Global Trust Bank and PMC Bank is too well known to recount.

The second is of HDIL-PMC Bank. HDIL, a real estate developer with significant exposure in redevelopment projects, allegedly got strapped for cash as its projects stalled. It leveraged an existing relationship with PMC Bank, to allegedly “hijack” it and use its depositors’ monies to fund their fund deficit bubble and increasing liabilities. Which was not discovered by the regulator till it all went bust. With dire consequences for the PMC Bank depositors as it was deemed “Not Too Big To Fail”, and who are now to be repaid in a schedule that runs to ten years.

The scenario can be extended. What would have happened if Reliance Capital as an NBFC in its heyday had been permitted to convert to a bank? Or if Vijay Mallya, as the then widely respected and creditworthy UB conglomerate in its glory days, had been permitted into the banking sector? Essel’s Chandra? GVK’s Reddys? GMR’s Raos? Sahara’s Subroto Roy? Srei’s Kanorias? Jaypee’s Gaurs? Unitech’s Chandras? The list is endless.

All were in glorious expansion and poster boys in their time in the sun in the past. And for those who believe the selection system is strong enough to withstand pressures and keep out the “undeserving” don’t know India or how it has always functioned. “Undeserving” in India is mostly discovered as post mortem and in retrospect, to much public handwringing despite evident warning signs.

The “fit and proper” criteria for a banking licence – if objectively applied by principles - is of a multigenerational ability to build and maintain trust in an institutional capacity independent of its promoters or individuals.

The requisite for this is the building of a strong, independent and professional management cadre with requisite checks and balances, strong corporate governance and vigilant regulation accompanied by market intelligence and robust supervision.

In the absence of these, “thinking-out-aloud” noises are just public attention distracting – and potentially dangerous - attempts to recycle old and failed policy wine in new corporate bottles claiming “this time it is different”.

The banking regulator’s mandate requires it to promote, regulate and supervise the orderly and long term development of the banking sector – as custodians of the wealth of the nation and its citizens – and ensure prudent lending practices in promoting economic activity in the country while assuring a greater degree of objective safety to the monies entrusted to the banking system.

The Reserve Bank of India must stand resolute with an eye to its fiduciary mandate and the long term interests of the economy and the nation.