Business Group Ownership of Banks: Issues and Implications

Abstract

The paper for the first time provides a theoretical framework for the conduct of business group owned banks. It introduces the phenomenon of business groups in the theory of financial intermediation by banks developed by Diamond (1984) with a view to analyze their impact on the result of financial intermediation. Two kinds of business groups are distinguished depending on the relationship between the firms and the bank comprising the group. It is argued that result of financial intermediation depends on the type of business groups. Diverse historical experiences relating to India and Japan are found to be in line with the theoretical formulation. The contemporary experience in India analyzed in the paper in the form of three case studies is also found to be in agreement with the above theory. The theory developed in the paper and the evidence in its favor through case studies leads to rejection of the idea of business group owned banks in India. The paper made a pioneering attempt to econometrically examine the impact of group ownership on conduct of a bank in an emerging economy like India. The paper substantiates the findings from case studies through estimating a logit model using panel data with the help of a Generalized Estimating Equation. The results clearly show that group banks differ in their conduct from non group banks. Firstly, groups exploit the bank by getting larger funds to augment the group�s fund position. It is also evident that the group bank is subjected to higher risk and is more fragile. A hypothesis that the group cross subsidizes its activities through owning a bank is found to be true. Some of the obvious corporate governance issues like collusion with the auditor do not come out very sharply.