Conversion into a universal bank may not be the best future course of action for leading financial institution Industrial Development Bank of India, according to Raghuram G Rajan, professor of finance at the Indian School of Business, who has recently been awarded the Fischer Black Prize.

Rajan said, "There should be a compelling reason for IDBI to convert itself into a universal bank in terms of a strong value proposition for its customers."

The Fischer Black Prize is awarded by the American Finance Association for outstanding contribution in the field of finance by a person under 40 years of age.

According to Rajan, who is also the Joseph L Gidwitz professor of finance at the Graduate School of Business in the University of Chicago, not many banks across the globe have managed the transition to universal banking well.

"When institutions enter into multiple activities, there is a threat of a blowing up of risks and the institutions being run down," he said.

Rajan, however, said with the growth in the bond and equity markets, there was no need for an institution like IDBI to continue with development financing.

"Long-term funding by development financial institutions is no longer required since this activity is now being taken over by the bond and equity markets. In India, state-owned banks too have started such lending with their access to low cost retail deposits," he said.

The government should actually consider breaking up IDBI and let its assets be acquired by other banks. Before the government thinks about merging IDBI with another bank, for example, IDBI Bank, it should look at the institution's record in recovering the huge non-performing loans.

"The worry about IDBI and IFCI Ltd are their huge NPLs," he said, adding, "throwing good money after bad may not be a good idea."

The bailout of banks and financial institutions by the government is dangerous not because poor performers were being left unpenalised but because it resulted in a gradual spread of the rot in the entire financial system.

"In bailing out sick banks and FIs, the government actually forces other institutions to bear the cost of poor performance and simultaneously drives healthier banks to compete with the laggards on the pricing front. This can lead to a sequence of possible failures," Rajan said.

The professor also said that it was time for to separate the banks from the apron strings of the government. He, however, said there should be careful thinking before banks are privatised. The government should ensure adequate governance in the banks' management before deciding to privatise them. "Privatisation is not the easy and quick answer," Rajan said.