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November 18 2011
The first set of guidelines on the entry of private sector banks into the banking sector was issued by the Reserve Bank of India (RBI) on January 22 1993, and 10 banks were issued with banking licences. The guidelines were subsequently revised in January 2001 and two more banking licences were issued. The 1993 guidelines referred to the fact that new banks should avoid cross-holdings with industrial groups; the 2001 guidelines went further and included a clear statement that a new bank should not be promoted by a large industrial body.
On August 29 2011 the RBI released a revised set of draft guidelines for the licensing of new banks in the private sector, which has received much attention in the banking and financial sectors.(1) The 2011 guidelines lay down a framework for the granting of banking licences by the RBI to corporate entities and non-banking financial companies, among others. This is a significant departure from the RBI's earlier policy, under which a bank promoted by a single industrial body was not eligible for a banking licence.
Although the 2011 guidelines contemplate the granting of banking licences to corporate entities, the RBI has recognised the need to ring-fence banking companies from other commercial and industrial activities within the group. In addition, it has set out policies that aim to address conflict of interest concerns in relation to:
The RBI sought views of the public on the draft guidelines by October 31 2011.
The 2011 guidelines also mention that certain amendments to the Banking Regulation Act 1949 are currently under consideration by the government. Once these amendments have been implemented, the final guidelines will be issued and the RBI will commence the process of inviting applications for issue of new banking licences.
Only entities and groups in the private sector that are owned and controlled by residents are eligible to promote banks. Promoters or promoter groups must have diversified ownership, sound credentials and integrity and a successful track record of running their businesses for at least 10 years.
The RBI has indicated that it will examine the nature of the activities in which the promoter group is predominantly engaged. Entities that hold significant (ie, 10% or more) income or assets, or both, from activities such as real estate construction and broking activities taken together in the last three years, are not eligible to promote banks. The RBI considers these activities to be inherently risky and representative of a business model and culture misaligned with a banking model. The inclusion of broking activities in the RBI's policy was unexpected, particularly given that stockbroking is an activity closely regulated by the Securities and Exchange Board and broking entities are subject to 'fit and proper' norms.
Promoters and promoter groups will be permitted to set up a new bank only through a wholly-owned non-operative holding company (NOHC), which will act as the holding company for the banking entity and all other financial services companies regulated by the RBI or other financial sector regulators. Through this structure, the RBI seeks to ensure that the financial services activities of the group are ring-fenced from other commercial, industrial and non-regulated financial activities that the group engages in. Consequently, only non-financial service entities and individuals belonging to the promoter group may hold shares in the NOHC (as financial services companies that are part of the promoter group must necessarily be held by the NOHC).
The NOHC must be registered as a non-banking financial company with the RBI and will be governed by a separate set of prudential guidelines. The NOHC will not be permitted to borrow funds in order to further invest in companies that it holds shares in, but will essentially be a vehicle to hold investments in all regulated financial sector entities that form part of the relevant promoter group.
The NOHC must hold at least 40% of the equity shareholding of the bank, locked in for a period of five years from the date on which the bank receives its licence. In addition, any shareholding by the NOHC of above 40% must be brought down to 40% within two years of the date on which the bank receives its licence.
The bank must list its shares on a recognised stock exchange within two years of receiving its licence. Other that the NOHC, no single entity or group of related entities may own shares or exercise control, directly or indirectly, in excess of 10% of the paid-up capital of the bank.
The initial minimum paid-up capital requirement for a new bank is Rs5,000 million (approximately $100 million).
The aggregate non-resident shareholding (including foreign direct investment, non-resident Indian investment and foreign institutional investment) in a new private sector bank cannot exceed 49% for the first five years. In addition, no non-resident shareholder, directly or indirectly, individually or in groups will be permitted to hold 5% or more of the paid-up capital of the bank.
Given that a private bank is required to list its shares on a recognised stock exchange within two years and that there are restrictions on foreign investment, private banks must necessarily rely largely on the domestic market for capital.
Once five years have expired from the date of issue of the banking licence, foreign shareholding will be permitted, as under the existing foreign direct investment policy. Under this policy, foreign investment in private sector banks of up to 49% is permitted under the automatic route (ie, without prior government approval) and investment of between 49% and 74% is permitted under the government route (ie, with prior government approval).
At least 50% of the directors of the NOHC must be totally independent of the promoters and promoter group entities, their business associates and their customers and suppliers. Ownership and management must be separate and distinct from that of the promoter and promoter group entities that own or control the NOHC.
No financial services entity under the NOHC will be allowed to engage in any activity that a bank is permitted to undertake departmentally. All such activities, if any, must be carried out by the bank. This rule echoes some of the RBI's concerns over regulatory arbitrage by non-banking financial companies, given that to a large extent they undertake activities similar to that of banks, but are subject to less stringent regulation.
Other conditions and exposure limits
The exposure of the bank to any entity in the promoter group cannot exceed 10% and the aggregate exposure to all entities in the group cannot exceed 20% of the paid-up capital and reserves of the bank, subject to compliance with the provisions of Section 20 of the Banking Regulation Act 1949.(2)
The promoters, their group entities, the NOHC and the proposed bank will be subject to consolidated supervision by the RBI.
The issuance of new banking licences will undoubtedly increase competition in the banking sector and is a welcome and much-awaited policy initiative by the RBI. The RBI has rightly emphasised the need for banks to penetrate unbanked and under-banked areas, and has stressed the importance of financial inclusion. In addition, the 2011 guidelines now also spell out the procedures and criteria that the RBI proposes to adopt for the granting of new licences, demonstrating a positive step towards transparency in decision making.
The 2011 guidelines refer to the fact that given that banking is a highly leveraged business, licences shall be issued on a very selective basis to those who:
Thus, for a licence to be granted, both objective and subjective criteria have been prescribed, suggesting that even if they meet the objective eligibility criteria, applicants may still be refused a banking licence.
As in the existing policy on foreign direct investment, foreign shareholding in Indian private sector banks is permitted up to 74% (49% under the automatic route and between 49% and 74% under the government route). However, the 2011 guidelines permit foreign shareholding in new banks to a maximum of 49% for the first five years. This creates an unequal playing field among old and new banks, resulting in existing banks having greater access to international sources of capital.
The RBI has indicated that the 2011 guidelines will be finalised only once the Banking Regulation Act 1949 has been amended, making it difficult to predict a timeframe within which the 2011 guidelines will be issued in final form and the process of issuing banking licences will commence. Even so, the 2011 guidelines have been viewed as a very positive step and have generated much discussion and debate among interested players.
For further information please contact Shilpa Mankar Ahluwalia at Amarchand & Mangaldas & Suresh A Shroff & Co by telephone (+91 11 4159 0700), fax (+91 11 2692 4900) or email (email@example.com).
(1) A copy of the guidelines can be accessed at http://rbidocs.rbi.org.in/rdocs/Content/PDFs/FIDGN290811.pdf.
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