The reason that globally rules on who can set up a bank and what regulatory hoops they need to constantly jump through are much tougher than for a biscuit or a car company or even a telecom service provider has to do with the nature of banking itself. If a non-bank fails, the problem is only for the employees, the shareholders, the raw material and parts sellers and for those who liked the biscuit or car and now can’t have it. But when a bank fails, it takes down the savings and deposits of average households who trusted the bank. Worse, a too-big-to-fail entity can take down the whole system.
The report released by the Reserve Bank of India’s (RBI) Internal Working Group last week has generated a flood of opinions on why manufacturing firms should not be given a bank licence. But the issue is deeper than just that. There is a premise that expanding the number of banks and a supply of credit will fix India’s problem of being credit starved. But banks have turned risk-averse and even the existing flow of liquidity from RBI is deposited right back through the reverse repo window rather than being lent out to the non-triple-A-plus rated entities. Just expanding the supply of banks is not going to improve the flow of credit to the corporates, including the small and medium scale firms.