Winds of change

Written by The Financial Express | Updated: Mar 30 2011, 08:15am hrs
The global crisis that rocked the financial world in September 2008 has forced regulators and governments to reset policy frameworks to incorporate the lessons learnt. The Reserve Bank of India, which has won accolades for its conservative approach thereby ensuring that the Indian banking system got away virtually unscathed in the aftermath of the financial meltdown, continues to remain prudent. Indeed, the central bank now wants to make sure that foreign banks operate as subsidiaries so that risks are ring-fenced. Moreover, the RBI would also like to see that financial groups that operate across businesses, are structured such that the non-banking business segments do not pose a risk to the core banking business. The RBI has meanwhile issued a discussion paper on permitting the entry of new banks in the private sector, largely to push the financial inclusion agenda. However, it is making sure that tougher norms are in place before industrial groups are allowed entry.

The central bank has constituted an internal working group, headed by deputy governor Shyamala Gopinath, to review the road map for the introduction of a bank holding company structure. The group is expected to make the financial holding company or FHC structure mandatory for new entrants to the banking space. An FHC will typically have a bank, an insurance company and an asset management company operating under it.

The RBI also believes foreign banks in India should convert themselves into wholly-owned subsidiaries to enable it to have better regulatory control over these entities and ring fence risks. In return, the central bank may offer the foreign banks more branch licences though it is expected to ask them to list on the Indian bourses at some point. Foreign banks have welcomed the RBI step cautiously, seeking clarity from the RBI on national treatment, tax implications and whether dilution would be compulsory.

Sanjiv Bhasin, GM and CEO, DBS India, says his bank is keen to operate as a subsidiary in the country. Subsidiarisation would help the country as banks would bring in newer products and improve the penetration of financial products in the market, he observes.

Adds Neeraj Swaroop, CEO, Standard Chartered Bank India, Subsidiarisation will increase competition, which would be beneficial to customers. Additionally, foreign banks have the ability to access global capital, which is also good for the economy.

Bobby Parikh, partner, BMR & Associates, believes the structural changes that RBI is considering would deepen the Indian banking space. Subsidiarising foreign banks would enable them expand their network and improve banking penetration, he says.

Even as foreign banks ready themselves to function through a new structure, the banking industry could soon see some new players. More than the central bank, however, its the government that has been keen on opening up the banking space to new entrants. Following an announcement made by the finance minister in 2010, the central bank initiated a discussion paper in August 2010 which also put out the pros and cons of allowing non-banking finance companies (NBFCs) into banks. However, in December 2010, RBI governor D Subbarao had said that there was no clear clear-cut public opinion on the proposed norms for issuance of new banking licences as divergent feedback was received on the discussion paper that was open to the public. The RBIs discussion paper on the subject suggested it was not keen on allowing large industrial groups into the space.

Says BMRs Parikh, In the first phase the RBI would probably restrict the number of licences to between four and five. These would perhaps be granted to existing financial services companies that are not affiliated to industrial houses. Parikh feels players like IDFC, Sundaram Finance and Shriram could be the likely candidates to secure a banking licence.

In the early 1990s, the RBI allowed the first set of private banks to start business, following which, in 2000, it permitted two more players to set up shop. Currently, India has 27 public sector banks, seven new private sector banks, 15 old private sector banks and 31 foreign banks.

Finance minister Pranab Mukherjee indicated, in his budget speech for 2011-12, that the central bank would release the final guidelines for new banks by the end of this financial year. The economic survey, released a day before the budget, had mooted the a dual-licensing policy, one a basic banking licence exclusively to meet financial inclusion obligation and the other for private sector aspirants that will offer all commercial banking services. The government also called for graded capital requirements, given the diverse nature of risks that players would be operating with.

Observes Hiresh Wadhwani, partner, Ernst &Young, The government has suggested that there should be a dual licensing policy but it would not be viable to run a bank with only limited focus, which is basic banking. We would have to wait and see if the RBI incentivises applicants to pursue the basic banking licence by way of prescribing lower statutory liquidity ratio or cash reserve ratio for these players.

BMRs Parikh is also of the view that the new entrants should be given a full bank licence as the financial inclusion agenda alone may not be a viable proposition. But the Chennai-based Shriram Group, an aspirant for the new banking licence sees huge potential in inclusive banking. Observes GS Sundararajan, MD, Shriram Capital, There is a higher perception of risk in financial inclusion by existing players. Banking services to the financially excluded does not just mean opening a savings account, they need many other services like insurance, cash and trade products. Sudararajan believes the Shriram team has the expertise and the capability to handle financial inclusion profitably.

The government has made a strong pitch for other reforms in the banking space including amendment to the Banking Regulation Act, 1949. Section 12 of the BR Act contains provisions relating to the regulation of paid-up, subscribed authorised capital and voting rights of shareholders. The amendment will give the RBI more regulatory powers when it comes to superceding a bank board. Currently, under section 45 of the BR Act, it can force amalgamation or merger of a bank with another, and force reconstruction of the board to protect the interests of depositors, shareholders and employees.

The amendments to the regulations are critical as the RBI is in the process of drafting guidelines for setting up of new banks. Additionally, these amendments would also pave the way for the formation of financial holding company or FHC structure, which the RBI plans to make mandatory for all new entrants in the banking space. Also, this would give the RBI clear powers to regulate the holding company. The Gopinath group has recommended a fully-capitalised model for the holding company, instead of an intermediate holding structure, since that would make the relations between the operating companies and the holding company complex. The need for a holding company structure in India has arisen as banks have diversified into several lines of business and need more capital from markets to expand further. A holding company model would, among other things, give them the advantage of being able to raise capital riding on the brand value of the group, which is not possible now.

On supervision, the group has apparently recommended consolidated supervision to ensure the safety of depositors, investors and creditors.

The Shriram Group, like some of the other corporate houses already has a structure similar to the one proposed by the RBI. Sundararajan of Shriram says, Shriram Capital acts as a holding company for all our financial services subsidiaries, be it insurance or mutual funds. It can also house the bank if we get the licence. Adds the CEO of another financial conglomerate, For existing players, adopting the FHC model would be optional but it would not be easy for them to switch to the new model. For instance, if ICICI Bank decides to adopt the FHC model, it would have to demerge the bank and become a 100% subsidiary of the holding company and then list the holding company. However, the problem here is that the bank is also listed, making the change somewhat complicated. Besides, there are tax issues.

The central bank, however, is likely to insist that banks adopt the new structure. In an increasingly risky and dynamic world, it would understandably not like to take any chances.