RBI sets the tone for creating new age banks

In the last 3 decades since new private banks first started operations, they have not only become significantly large but also account for a chunk of the market capitalization of banking in particular and the Nifty in general.

Nov 23, 2020 01:11 IST India Infoline News Service

Reserve Bank of India
The RBI Internal Working Group (IWG) appointed in June 2020 has made significant recommendations pertaining to ownership, regulation and control of private banks. In the last 3 decades since new private banks first started operations, they have not only become significantly large but also account for a chunk of the market capitalization of banking in particular and the Nifty in general. But certain things are changing.

While the institution promoted banks have seen a lot of positive growth and traction, the private banks needed better organizational and ownership structures. Secondly, promoter ownership of private banks continues to be a contentious issue. Thirdly, RBI needed to examine its axiom of keeping large corporates out of banking. Lastly, the last few years saw the rise of a new wave of NBFCs, which are colossal and systemically significant. It is these four points that the IWG addressed in its latest set of recommendations.

Ownership and organizational structure for private banks

This had been a grey area for some time as far as banking regulation was concerned. Now the RBI has come out with more elaborate guidelines in this regard. The RBI wants to continue with the current Non-Operative Financial Holding Company (NOFHC) structure. However, in the case of private banks with group exposure to other businesses and entities, this NOFHC structure should be made mandatory.

IWG has suggested that banks with no group entities be allowed to migrate to a non-NOFHC structure in a tax-neutral manner. This will require a taxation amendment to treat the NOFHC as a pass-through tax-neutral entity. If any group entity of the bank wants to undertake lending activity, it would be subject to the same prudential norms as a bank. IWG suggested enhanced capital requirement across universal banks, SFBs and payment banks.

Regulating promoter holding in banks and dilution

In the recent cases of Kotak Bank and Bandhan Bank, dilution of ownership by the promoters became a contentious issue. Considering that a very large stake dilution is not practically possible in most cases at short notice, the IWG has suggested a more rational model to handle promoter ownership and lock-in periods.

In terms of the lock-in period, the IWG has not suggested any modifications to the upto-5 year period which stipulates a lock-in for 40% of the initial capital and voting rights. However, for the 5-year to 15-years period, IWG suggests that the cap on promoter’s stake be raised from the current 15% to 26%. This should come as a great relief to the promoters. In addition, promoters who have already diluted below 26% should also be permitted to hike their stake back to 26% if the suggestions of the IWG are approved.

In addition, the IWG has also suggested some pragmatic changes. The cap for all non-promoter shareholdings should be capped at 15%. There was some ambiguity on the subject of promoter pledge. IWG has suggested that any pledge that potentially reduces the promoter holding below the threshold be explicitly disallowed. The group has also suggested regulation of issue of ADRs/GDRs so that promoters do not exercise additional control over the bank via indirect means.

Permitting corporate business houses into banking

If accepted, this could be the most significant and far-reaching change. In what will require detailed amendments to the Banking Regulations Act, 1949, the IWG has suggested that large corporate groups and industrial houses be permitted to acquire a banking license. This is a major departure from the past;when RBI had been averse togranting banking licenses to large business groups to avoid any conflict of interest in lending decisions.

The starting point could be to allow large NBFCs owned by industrial houses to convert into banks. Currently, large business houses like Birla, Bajaj and Mahindra have very significant financial services operations under the NBFC route. This could be a starting point to convert to banks.

Regulating NBFCs more meaningfully

One contentious area of non-banking finance companies has been regulation. Senior officials of the RBI have made public statements that systemically important NBFCs should be regulated like banks. For example, finance companies like HDFC, LIC Housing Finance, Bajaj Finance and M&M Finance have significant micro-level impact on the financial system and have also acquired heft in terms of market cap. It is appropriate they be subjected to a higher level of financial regulation; just like banks.

The IWG suggests that NBFCs with assets of over Rs.50,000 crore that are well run and have a legacy of more than 10 years be converted into banks. That means; subjectingthese NBFCs to the same level of regulation with respect to capital adequacy, asset classification and other prudential norms as banks.

These are the recommendations of the IWG and it remains to be seen how many of these are finally accepted by the RBI and made actionable. But it is surely an important step towards making Indian banks more competitive and placing the financial system on a sounder footing.

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