The report of the working group on the introduction of financial holding company (FHC) structure in India is another step forward in the somewhat multi-dimensional upgrade of our financial sector regulatory architecture. In the last one year, there has been an array of discussion papers, draft guidelines and proposed legislative changes dealing with financial sector regulations. The central bank?s approach of discussions, consultations, feedback and final regulation is now established as a credible process. This is positive for the sector. This is also positive for the regulators, as it further reinforces the perception of RBI as a mature regulator in the global community of investors and regulators alike.
The report is a high level ?point of view? on the subject, rather than a recommended framework with its attendant complexity. The report also helpfully documents the evolution of consolidated supervision, provides the wider context of the global financial crisis and goes into relevant details of similar regulations in other jurisdictions, particularly the US. Further, it lays the scope for much work for regulators, tax authorities and the government, the latter being in a somewhat unenviable predicament as both the final point of approval for the framework and the owner of public sector banks (PSBs).
The dominant thought process around the need for bank holding companies (BHC) and FHC comes as no surprise. It is not a day too early. Banks have expanded into financial businesses including securities and insurance. Financial groups with exposure to multiple asset classes are showcasing themselves as prime contenders for new banking licenses. To make it more interesting, corporates have shown interest in the banking business, which brings alive the debate around commingling of banking and commerce. These developments make it imperative that the regulatory architecture clearly prevents depositors against contagion from leveraged businesses?by exercising better monitoring of intra-group transactions, effective supervisory control over consolidated capital and adequate oversight over governance.
The surprise element in this report is the intent to extend a supposedly similar regulatory regime to FHCs that do not have any banks. While the underlying principle behind the consolidated regulation and supervision of financial conglomerates (FCs) with banking business remains the protection of depositors? interest, the principle behind the regulation of FHCs with no depository institution is the generic notion of ensuring ?financial stability?. The report contains indications of concerns around systemic risks from such FCs, but provides somewhat open-ended resolution to the issue. There are indications of consolidated supervision being exercised by respective regulators, a happy picture of regulators working together to pick and choose and regulate such entities and also a one-stop shop within RBI for implementing the FHC framework for all identified FCs.
Admittedly, there is a lot of ground to be covered before clear answers emerge. Also, there are new legislations to be enacted, multiple existing Acts to be amended and many regulations to be effected. Yet, it is worth examining what this indicative framework augurs for the different stakeholders.
The difficulty relating to PSBs has been recognised in the report itself. If the government decides to list the holding companies of the PSBs, it is saddled with supporting the capital requirements of non-bank subsidiaries. If, on the other hand, the step-down bank subsidiary is also listed, it poses administrative and implementation challenges.
Private sector banking groups are likely to be given a more straight-jacketed alternative?existing banks get a timeframe to migrate to a simple structure, wherein the resultant structure has one FHC that holds all entities directly under it. The report concludes that the one step structure is adequate for the existing size and requirement of Indian FCs and does not favour intermediary holding companies. While that may be true, it is more likely to be a self-fulfilling prophecy. Given that the entire process of creation of the regulatory framework around FHCs and the attendant legislation will take considerable time, there is a case for thinking ahead and creating a framework that will serve the need of the economy beyond what it currently is. Ability to raise capital with ease will be one of the key drivers of growth in the financial sector. The creation of a listed holding company on top of the financial services companies may have implications for investors, given the valuation discounts normally applied to holding companies and the varying valuations of stocks across asset classes such as insurance, banking and broking, not to mention the different FDI thresholds for different sectors. The option to list individual entities has its own operational challenges.
The fallout for new licensees is considered to be less than that for the existing banking and financial groups. It does, however, raise the existential question of how these developments are likely to affect the timeline. Achieving a simple one step holding structure and bringing all existing businesses under it may be easier said than done given that most promoter groups hold their interest through holding companies. Also, if banking groups are to remain ?predominantly? banks, what happens to the existing businesses of these groups? Do they get regulatory indulgence or is it goodbye to banking dreams?
The author is director, Tax & Regulatory Services, PwC India