The Reserve Bank of India (RBI) working paper which recommends that manufacturing groups and business houses be allowed bank licences , while mapping global norms against this and disclosing that all but one of the experts consulted were against this, has generated plenty of heat. Like almost everything else right now in India, views on the issue largely depend on which side of the political spectrum you swing on policy matters. Considering the content, disclosures and manner of this idea’s presentation, it looks to me as if this is a kite flown to see what reactions emerge. The Narendra Modi government is unlikely to spend political capital on such a big change if there are enough signals that it would be a vote loser. But since the kite is in the sky, we should use the opportunity to think through the issue of letting manufacturers own banks while trying to keep politics out of it. I will outline three areas to look at this question from different windows.
But first, why do we need manufacturing groups in banking? Because India is capital starved and needs money to grow. Public sector banks (PSBs) have eroded their capital through a mix of poor lending decisions and politically-nudged free money to business cronies for the past many decades. The playbook of funding cronies with the public money of PSBs, then recapitalizing these banks using taxpayers’ money (and by borrowing), and then inflating away the debt, has destroyed the balance sheets and morale of PSBs. Private banks find retail lending more profitable and less risky than corporate lending. The flow of capital that India needs for its next stage of growth is missing. Therefore, the need for letting firms with the deep pockets required into the banking sector at this juncture. But this is a contentious issue, globally. So, how should we look at it?