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New players in the banking sector are welcome. Now, ramp up the supervisory capacity
At the close of the deadline for bank licence applications, the Reserve Bank of India, in its capacity as the banking regulator, has received a number of applications for banks. This is good news. There are a large number of applicants with the capacity to run banks. The Indian banking sector, strangled for long due to lack of competition, public sector ownership and fears of foreign banks, has only been able to penetrate 50 per cent of households. That is, nearly half of India's population is unbanked.
Having taken the decision to give licences and increase the capacity of the Indian banking system, the RBI faces an enormous challenge. The first task will be to choose those among the 26 applicants who are fit to collect money from the public and who can be trusted to give it as loans to creditworthy borrowers. The second challenge will be to strengthen supervisory capacity in order to ensure that customers of these banks are protected with minimum cost to the taxpayer. This could often mean that the RBI has to prevent banks run by industrial houses from giving loans to their parent or related companies. The weaknesses in supervisory capacity, the lack of a resolution framework and weak customer protection, for many decades, contributed to the RBI's reluctance to give licences to banks. When banks owned by industrial houses lend to their companies, go bankrupt and then expect the government to bail out customers, it constitutes a diversion of funds from taxpayers to industrial houses. Even if done in good faith, where the bank managers think that the company owned by the parent is a fast-growing and healthy business, the incentive for high exposure to them would need to be restrained.