Large corporate defaults, supervisory challenges amongst top concerns for the plan.

India’s plan to allow corporate ownership of banks poses high risks for the sector at large given the country’s weak corporate governance, according to S&P Global Ratings.

Recently, the Reserve Bank of India’s (RBI) working group recommended awarding new licenses to well-managed Indian non-bank financial companies (NBFCs), a move that could improve financial stability and help restore a level playing field for all players, S&P analysts said.

However, one of the working group’s recommendations—to allow corporates to control banks – has been met with less enthusiasm from S&P’s analysts.

Corporate ownership of banks raises the risk of intergroup lending, diversion of funds, and reputational exposure, noted analysts Geeta Chugh and Deepali V Seth Chhabria in a media note.

“In our view, the working group's concerns regarding conflict of interest, concentration of economic power, and financial stability in allowing corporates to own banks are potential risks,” they noted, later adding that the risk of contagion from corporate defaults to the financial sector increases significantly.

The performance of India's corporate sector over the past few years has been notedly weak with large corporate defaults. Nonperforming loans (NPLs) for the corporate sector stood at around 13% of total corporate loans as of March 2020, highlighting the more pronounced risk in India compared with other countries, said S&P.

Performances of new banks set up in India over the past three decades has also been mixed. Of the 14 new universal bank licenses issued by the RBI since 1993, Global Trust Bank and Yes Bank had to be bailed out by government-owned banks.  Three of the newer banks were eventually acquired by HDFC Bank, whilst ICICI Bank and IDBI Bank merged with their parents.

In addition, RBI will face challenges in supervising non-financial sector entities and supervisory resources could be further strained at a time when the health of India's financial sector is weak, said Chugh and Chhabria.

On the upside, the regulator was noted to have adopted “a very calibrated approach” in awarding new licenses, and a change in the regulation by itself would not lead to RBI liberally allowing corporates to start a bank.

Most importantly, it remains to be seen how many of these recommendations become law, Chugh and Chhabria added.

Other recommendations could see the banking sector ensure better capitalization and stronger supervision. For example, RBI's proposal to raise the minimum net worth for all universal banks to $134.8m (INR10b) will ensure better capitalization and that only promoters with deep pockets can enter the banking sector, according to S&P.

RBI proposes that only well-managed NBFCs with over 10 years of experience and $6.7m (INR500b) of assets will be allowed to convert to a bank. This recommendation will help limit the size of shadow banking in India and ensure stronger supervision of the sector in general.