RBI Eases Banking Rules, Former Officials Urge Caution on Systemic Risks

The Reserve Bank of India’s (RBI) recent push to liberalize the banking sector, including scrapping key exposure limits and allowing banks to finance corporate acquisitions, has been met with cautious optimism and stern warnings from leading financial experts.

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Former RBI Deputy Governors SS Mundra and HR Khan, along with Macquarie Capital’s Suresh Ganapathy, dissected the reforms, stressing that strong supervision is paramount to maintain stability.

The Major Concerns: Relaxed Limits and M&A Finance

The controversial reforms include:

1. Removing the ₹10,000 crore cap on a bank’s total exposure to a single corporate group.
2. Allowing banks to finance corporate mergers and acquisitions (M&A).
3. Introducing risk-based premiums for deposit insurance.

SS Mundra called the overall package “great” but labeled some aspects a “leap of faith” by the central bank. His chief worry is the reliance on board oversight and market discipline, which he fears will be ineffective for public sector banks due to their structure. He warned the RBI must keep its “supervisory antenna very, very sharp.”

On M&A financing, Mundra drew a parallel to the troubled infrastructure financing era. He cautioned that when deals sour, large banks—who can absorb losses—will likely exit quickly, leaving smaller, syndicated banks stuck with stressed assets.

HR Khan, who helped set the original exposure cap, suggested the RBI should have taken a gradual approach instead of removing the limit entirely. He also hoped the final M&A rules would mandate a minimum equity contribution from promoters to prevent inflated deals.

Analyst View: Minor Immediate Impact

Providing an analyst’s perspective, Suresh Ganapathy downplayed the immediate financial impact. He estimated that reduced deposit insurance costs would only boost bank earnings by 2-3%.

Regarding credit growth, he called the M&A financing rule a long-term supply-side reform that won’t solve current demand issues. He projected only a minor increase in credit growth, arguing that many high-risk acquisition deals already operate at rates (15-17% IRR) beyond the typical risk appetite of banks.

In essence: While experts welcome the rationalization, they see the new relaxed rules—especially on exposure and M&A—as creating a breeding ground for systemic risk if the RBI’s supervision fails to keep pace with the liberalization.