The contentious issue of foreign ownership in local banks is set to be resolved. The Reserve Bank of India (RBI) has suggested to the finance ministry that foreign investment in local banks in the form of American depository receipts (ADRs), global depository receipts, foreign currency convertible bonds and any type of convertible warrants be excluded while calculating the foreign direct investment (FDI) limit for Indian banks.
“The RBI is of the opinion that these forms of foreign investment is quasi equity and therefore should be treated as such,” said a senior official in the finance ministry, who did not want to be identified.

The controversy was triggered when the department of industrial policy and promotion (DIPP) issued Press Notes 2,3 and 4, in February this year which suggested changes in the rules for calculating FDI. The Press Notes, which are rules for overseas investment in Indian firms, said FDI calculations should club both direct and indirect foreign investments. Going by these norms, a few Indian banks, including two leading private banks ICICI and HDFC, besides ING Vyasa, run the risk of being deemed foreign.

ICICI Bank and HDFC Bank have written to the government, seeking a  clarification. The government is likely to issue a clarification soon which would put banks outside the purview of the DIPP-suggested method of calculating foreign investment.

In ICICI Bank, in which the total foreign holding is close to the maximum permissible limit of 74%, ADRs account for 29.07%. In the case of HDFC Bank, ADR holding is 18.8%. If ADRs or GDRs are excluded for the purpose of determining whether a firm is foreign-owned, these banks would not be impacted by the rules drafted by DIPP.

The logic is that since ADR or GDR holders  do not have voting rights, it hardly makes sense to be guided by a rigid definition of foreign ownership. For these banks, clarity on this issue is important as the definition of whether they are foreign-owned or local-owned will have a bearing on their local business plans and expansion. For foreign banks, there are several fetters on local expansion.

According to government rules, a company that has more than 50% of such foreign investment would be considered foreign-owned, even if the management and control lies with Indians. Moreover, if indirect foreign investment in an Indian company exceeds 50%, its investment in subsidiaries will also be treated as foreign investment.

The downstream investments of these banks will also be counted as FDI, barring it from investing in sectors that have caps, such as banking itself. Foreign capital forms a substantial portion in the capital structure of both ICICI Bank and HDFC bank.

The controversy is not new. In 2007, former RBI deputy governor V Leeladhar had remarked of ICICI bank and HDFC bank that they “could be considered as incorporated in India but predominantly foreign-owned”.

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