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Thursday, April 14, 2011

Article relating to Gillanders - should business houses be allowed to open banks

This in the Economic Times . It gives some history of the tea companies

The answer is "No". A business house " is a uniquely Indian expression. It is not common in other countries. By "business house" we refer to a loose conglomerate with ownership and control usually vesting with a family. The conglomerate almost always consists of multiple private and public companies, where the shareholdings of the controlling group/family can be very low or very high. "Business houses" are lineal descendants of "managing agencies" which dominated the business scene in British India. Andrew Yule, Gillanders Arbuthnot and so on were the fabled names. When Indians emerged as entrepreneurs, they imitated managing agencies and we had the emergence of Tata Sons , Birla Brothers and so on.

The managing agency system did at first serve a positive purpose as investors were reluctant to put their capital directly into companies not "backed" by well-known names. But over time, the maze of related party transactions among the different companies managed by a single "House" was rightly seen as inimical to good corporate governance and minority shareholders. Hence the Managing Agency system was abolished. But by this time, large interlocked conglomerates had become well-established.

In the sixties, the Hazari Commission and the Dutt Committee established the fact that the principal beneficiaries of the infamous permit-licence raj were these business houses who systematically pre-empted valuable licences that were sparingly doled out by our socialistic sarkar; they effectively sabotaged the entry of competitors. In the absence of free and easy entry for new entrepreneurs our economy became sclerotic; Indian consumers were forced to buy shoddy and expensive goods all coming from the same handful of powerful and influential business houses.

The control that business houses exercised over commercial banks (through pretty low shareholdings) resulted in even more insidious outcomes. A new entrepreneur who did not have connections to these families found himself or herself pretty much excluded from bank finance. Easy bank finance (without too many uncomfortable questions being asked) was also made available to the business houses to acquire controlling interest in several companies especially the ones that British capital was pulling out of.

That is why many economists opposed to "social control" and later bank nationalisation went along with these decisions as serving a second order optimisation purpose-by eliminating the vice that resulted from the interlocking of banking with commerce. This, incidentally has been the governing principle for banking permissions in the US where there has been an abiding fear that banks are already very powerful and letting them into the world of commerce would lead to unacceptable levels of concentration of power that would be inimical to the political economy of a democratic republic. To this day, General Electric has not been granted a banking licence precisely for this reason.

The proposal to grant banking licences to Indian business houses is bad policy given the history of our country as any cursory reading of the Hazari and Dutt reports will show. It will reinforce the unhealthy trends of crony capitalism that we see so much of. It will result in the creation of gigantic Zaibatsu houses a la Japan. It will definitely dampen new entrepreneurship as cozy inter-connected clubs like to keep out upstarts. The argument that only large business houses have capital is a weak one. World-class banks like HDFC Bank , Axis Bank and ICICI Bank have emerged without such backing. At this point in time in our history, let us not give in to the phony arguments of crony capitalist ideologues.

(Jaithirth Rao has been a banker, an IT entrepreneur and now runs a company that provides low- cost housing.
A regular in the newspaper commentary space, his calling card is iconoclasm)

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