Times have never been this good for foreign banks operating in India. The last few weeks have seen a spate of announcements relating to foreign banks, with the focus on allowing them greater operational flexibility. First came the Reserve Bank of India?s clarificatory circular, saying that foreign banks could borrow funds from their head offices abroad and show them as capital in their Indian books. This meant that those smaller foreign banks which were starved of capital could now breathe easy and go about without fear of having to wind down the show in India. Then came the second RBI circular which laid down once again the consolidated guidelines for foreign direct investment in the banking sector. Together, these two announcements ensured that foreign banks, long confused about where they stood in terms of both capitalisation issues and the question of FDI, were now able to understand the Indian banking sector scenario better. The second RBI circular, for instance, made it clear that foreign banks, including those operating in India, could hold up to 49 per cent in private sector Indian banks under the ?automatic route?, and classified which categories of shares would qualify for this.
But perhaps the most important dimension has been added by finance minister Yashwant Sinha?s announcement in the union budget that foreign banks can now set up subsidiaries in India. Thus far, all foreign banks had to operate in India as branches of their parents, with specific permission from RBI. But this major relaxation has given a completely new spin to the issue. However, the finance minister has made it clear that foreign banks can choose only one of the two options.
It?s interesting to consider what this means. There?s no denying that this is a major step forward for foreign banks, long used to working under somewhat strait-jacketed conditions and whining about them all the time. Now, there?s a multiplicity of options. Already, investment bankers have started drooling over the prospects of the finance minister?s announcement for business. A frontline investment banker I spoke to recently says at least four to five deals of considerable size can happen in the banking sector, once the rules of the game are more clearly laid down, and the fine print of Mr Sinha?s announcement is on the table. With some Indian private banks desperate for respectability and stability (read capital), it would not be surprising to see some of these deals taking place quickly. More so, because in the recent past, some of the strong new generation private banks have become stronger, at least one financial institution ? ICICI ? is turning into a bank, and the era of consolidation in Indian banking is well and truly here. Against such a background, it?s only natural that foreign banks with growth aspirations and Indian private sector banks which require partners come together. Now consider the options.
If a foreign bank comes in with FDI, it can go up to 49 per cent, but with restrictions on its voting rights. The laws categorise voting rights into four, and the one relating to those in private sector banks limits voting rights to 10 per cent of the total voting rights of all shareholders. Foreign banks with aspirations of control or substantial holdings in Indian banks may want to venture into the FDI route, but even here, the voting rights issue will be critically examined by them.
Those banks which are not hung up on controlling other banks, but are keen on operating and growing in India over the long term, are bound to prefer the subsidiary route. For a variety of reasons. One, it allows you to operate virtually as an Indian entity if you follow the existing laws for banks incorporated in India. And two, it allows you flexibility in terms of raising funds. A subsidiary of a foreign bank will, however, have to fall in line with the existing laws limiting the holding of equity stakes in another company (30 per cent) as per section 19 of the Banking Regulation Act and the other exposure guidelines. Not to forget the priority sector norms. But all that may be acceptable to the larger foreign banks who see huge business opportunities. And the lucrative business of housing and export finance come under priority sector lending anyway.
The critical issue will still be the voting rights to be enjoyed. While the finance minister has said the 10 per cent limit to voting rights will be ?relaxed for such subsidiaries?, the key question is how the relaxation will happen. A review of the entire issue of voting rights for banks seems to be on, and one suggestion is that of having proportional voting rights to prevent hostile takeovers of private sector banks. For instance, if an entity has 25 per cent stake, then proportional rights would mean limiting it at one-fourth.
Even for voting rights in subsidiaries, wholly owned subsidiaries would need to be treated differently from subsidiaries of foreign banks where the stake is between 51 per cent and 100 per cent. All these issues would have to be addressed by the finance ministry and RBI before the final regulations on voting rights are in place. Foreign banks will be hoping the fine print doesn?t spoil the party which has only just begun.