Diversified firms should not run banks: Rajan

services as their sole business. He also favoured allowing smaller entities to run banks,indicating the need for the central bank to revisit its current thresholds that act as entry barriers. Rajan’s comment comes at a time when RBI is contemplating a further increase these limits.

Industrial houses such as the Tatas,the Aditya Birla Group and the Anil Dhirubhai Ambani group are keen to enter the banking space while many NBFCs want to be converted into banks. RBI governor Duvvuri Subbarao recently said a discussion paper on new bank licences would be released in August.

Rajan,who was among the first to point out problems in the US financial sector that finally resulted in a full-blown global crisis,said : “I would be wary,given our stage of development,of encouraging business houses to get banking licences. I think the history of combining banking and commerce,that is having a financial licence and having industrial activity,implies there is a lot of self-dealing. I am not sure we have enough experience to manage the impact of this.”

Even the US still does not have the confidence to allow corporates to run banks,he said,adding that the history of other countries that have adopted such models is of serious banking disasters. These countries experienced a lot of (potentially harmful) intra-lending. Instead of giving licences to a few large entities,the authorities can experiment with the entry of “small banks”,he stressed.

Rajan,the Eric J Gleacher Distinguished Service Professor of Finance at the University of Chicago’s Booth School of Business,was in the Capital for launch of his latest book Fault Lines.

“In many ways,I would be more favourable towards allowing a few smaller entities to get licences because it is easy to monitor them,investigate their growth and even shut them down if necessary,” he said. A 2008 committee on financial sector reforms headed by Rajan too had recommended this.

“The fixation with size as the necessary criteria,that you have to be above a certain size,typically again limits the possibilities to a few,and also implies that the central bank is taking more risk because this can be a disaster,” Rajan said,referring to the minimum net worth of Rs 300 crore that is must to apply for a banking licence as per RBI guidelines.

In the early 1990s,when it issued licences to over half-a-dozen new private banks,they were required to have a minimum net worth of Rs 100 crore. This was raised to Rs 300 crore in 2005 when two more private banks were permitted. The central bank is expected to significantly raise the minimum net worth norm when it issues fresh licences this time. The ownership and governance norms issued by the RBI in 2005 do not allow an individual or a group of related entities to own more than 10% stake in a bank.

While restricting the ownership by a single entity is important,what is even more crucial is control,Rajan said,adding that a portfolio interest is not worrisome. It is the control the corporate can exercise which matters. Also,if a corporate is running a largely financial company,then there is no real cause for concern. The greater worry is about corporates that are not financial conglomerates. Such firms would need funding and might source it from the bank that they own,even when it is not in the bank’s interest to lend to the firm,he pointed out.