Former RBI officials urge caution as central bank eases banking rules

A recent raft of proposals from the Reserve Bank of India (RBI) aimed at liberalising the banking sector has been met with cautious optimism by leading financial experts, who, while welcoming the changes, have flagged potential systemic risks that warrant heightened supervisory vigilance.

In a discussion, former RBI Deputy Governors SS Mundra and HR Khan, along with Suresh Ganapathy, Managing Director and Head of Financial Services Research at Macquarie Capital, dissected the implications of the proposed reforms. The measures include allowing banks to finance corporate acquisitions, removing the ₹10,000 crore cap on total banking exposure to a single corporate group, and introducing risk-based premiums for deposit insurance.

Mundra described the overall package of over 22 measures as "great" and containing many long-overdue rationalisations. However, he expressed significant reservations, terming some aspects a "leap of faith" by the central bank. His primary concern is the heavy reliance on market mechanisms and board oversight for discipline.



He argued that for a "sizable section of industry"—likely alluding to public sector banks—board oversight and market discipline might not be as effective due to their inherent structure and leadership tenures. This situation, he warned, requires the RBI to keep its "supervisory antenna very, very sharp."

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On the topic of financing for mergers and acquisitions (M&A), Mundra voiced worries about the potential aftermath, drawing a parallel to the banking sector's troubled experience with infrastructure financing. He foresees a scenario where large banks lead the assessment for M&A deals, with smaller banks participating in the syndicate. However, he cautioned that these larger players often have a greater capacity to absorb losses and are adept at exiting exposures at the first sign of trouble, leaving smaller banks to hold the stressed assets.

Echoing these concerns, Khan, who was part of the committee that originally recommended the exposure cap to encourage the development of the corporate debt market, suggested a more gradual approach. "Possibly we could have increased the threshold and seen how it is working," he said, instead of removing the cap entirely. On M&A finance, he expressed hope that the final RBI guidelines would mandate a minimum level of equity from the promoter to prevent 'gold plating' of deals.

Providing an analyst's perspective, Ganapathy downplayed the immediate financial impact of the reforms. He estimated that even a significant reduction in deposit insurance costs would likely have only a 2-3% positive impact on bank earnings. He also made a crucial point that historically, the RBI has always stepped in to protect depositors of scheduled commercial banks, which should be a factor in premium pricing.

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Regarding credit growth, Ganapathy believes the new M&A financing avenue is a long-term supply-side reform and will not immediately solve the sector's demand issues. He stated that much of the acquisition credit market operates at high internal rates of return (15-17%) that are beyond the risk appetite of most banks.

He projected a potential improvement in credit growth of "a percentage point here or there," but not more, especially with alternatives like external commercial borrowings (ECBs) available to corporates.



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