The Report of the Internal Working Group set up to Review extant Ownership Guidelines and Corporate Structure for Indian Private Sector Banks by Reserve Bank of India dated October 26, 2020, by four members team was submitted. As the name indicates this epoch-making event unlocks the mysteries of floating a private sector bank and the ownership guidelines, eagerly awaited since the nationalization of banks in late 1975. Let us look at the report available from the RBI website as under:
An exhaustive report with 100 pages of the following contents is a complete one which will help any corporate structure from India and abroad to have a complete look at the total requirements for entering the exhaustive country called India and its most appealing economy which ranks among the best in the world.
Not all have the inclination to read or go through the whole report for whom I have given a small brief which would enthuse anyone to read, pause and decide the matter. It is not every day that a socialistic nation like India wakes up every day and issues guidelines on the licensing of banks, the most politically and economically contested issue in India.
5 chapters titled introduction, macro-economic environment and the structure of banking system, evolution of banking licensing system in India, international experience and issues and perspectives (9 of them, most important coverage) with 4 annexures containing experts’ views, the comparative position of licensing guidelines for private sector banks (PSB), the survey of licensing guidelines and international practice and regulatory guidelines in respect of bank ownership.
I have intentionally given the recommendations of the report at the end along with my views which will be sent to the email firstname.lastname@example.org for further consideration.
Uneven history of Indian banking
Prior to 1975 banking scene was dominated by private sector banks only which were run on commercial lines. Post liberalization with the first round of licensing of private banks in 1993, followed two more rounds of licensing in 2001 and 2013 culminating with the on-tap licensing regime of universal banks since 2016 dominates the scene, called uneven licensing to suit the rulers at will.
I would gladly quote the words of the report “The provisions and requirements of the various rounds of licensing have not been uniform; in fact, it reflected the regulatory preference and the generally accepted prudential principles as existed at each time. As a result, presently, India has a number of banks working under differing regulatory regimes when it comes to the organization of a business.”
Widespread disaggregated shareholding structure for banks as enshrined as Pillar III of the Basel guidelines raised the bar for Indian banks. How to organize an effective banking structure to suit the next decade in tune with the emergence of India as the next target for huge external investment by world investors forced the formation of the committee under the leadership of Dr. P.K.Mohanty, senior Director in the Group called the internal working group (IWG).
The committee gave detailed guidelines that covered the vast expanse of the formation of banks, the investment structure of banks, and other matters. Let us enlist them and discuss it later.
I have tried to use simple terms to explain their expert advice. Let us enumerate them.
- Lock-in period for promoters’ initial shareholding, limits on shareholding, in the long run, dilution requirement, and voting rights
- The initial lock-in period would continue for a minimum of 40% of the paid-up voting equity share capital of the bank for the first five years.
- The cap on promoters’ stake in the long run of 15 years may be raised to 26 percent of the paid-up voting equity share capital of the bank.
- This stipulation should be uniform for all including those who were forced to dilute below 26%. This has been a bone of contention among many of those promotors at the current levels of banking.
- Understanding their recommendations “No intermediate sub-targets between 5-15 years may be required. However, at the time of issue of licenses, the promoters may submit a dilution schedule which may be examined and approved by the Reserve Bank.” Is very important.
- As regards non-promoter shareholding, current long-run shareholding guidelines may be replaced by a simple cap of 15 percent of the paid-up voting equity share capital of the bank, for all types of shareholders. This stipulation may gladden the hearts of other investors.
- Pledge of Shares
- “Pledge of shares by promoters during the lock-in period, which amounts to bringing the unencumbered promoters’ shares below the prescribed minimum threshold, should be disallowed.” In case some do without RBI approval, the pledgee loses the voting rights.
- How to avoid ADR/GDR issued by banks route to enhance the voting share? IWG recommended RBI to issue new instructions.
- The other most contentious issue on promotors of banking has been nailed by the following recommendation:
- “Eligibility of Promoters: Large corporate/industrial houses may be allowed as promoters of banks only after necessary amendments to the Banking Regulations Act, 1949 to deal with connected lending and exposures between the banks and other financial and non-financial group entities; and strengthening of the supervisory mechanism for large conglomerates, including consolidated supervision.” Yes, RBI to study this issue afresh and issue suitable guidelines. Why is this so questionable by every economist/ politician or investor in India?
- One easily understands before the nationalization of banks that banks were owned by industrial houses in India with vast control over the depositors and borrowers but the borrowers also included the owners who were big industrial houses. RBI did not evolve so much sophistication at the early stages of the Indian economy (1947-1974) to supervise over these conglomerates who controlled the baking structures.
- What about huge non-banking finance companies to enter banking? Leaving the scare which engulfed Indian minds earlier, well run large Non-banking Finance Companies (NBFCs), with an asset size of ₹50,000 crore and above, including those which are owned by a corporate house, may be considered for conversion into banks provided they have completed 10 years of operations and meet the due diligence criteria and satisfy the additional conditions specified in this regard.
- How about payments banks well run since inception?
- For Payments Banks intending to convert to a Small Finance Bank, a track record of 3 years of experience as Payments Bank may be sufficient, as per IWG. This is a reality check on the Indian economic scene which witnesses the fastest growth of payments banks in the world. Let us admit the Indian public and private sector banks failed to enliven the payment sector with myriad and timely products. Their services desired vast improvements. But I may not require them anymore with the best payment bank on my cellular phone.
- Small finance banks with the best business practices and strong economic structure would offer the best services to any depositor, investor, or borrower the best service with the most memorable experiences.
- Yes, what about initial capital, the most important consideration for starting a bank?
- Please permit me the exact words of IWG for clear understanding.
- “Initial Capital
- (i) The minimum initial capital requirement for licensing new banks should be enhanced as below:
- For Universal banks: The initial paid-up voting equity share capital/net worth required to set up a new universal bank, may be increased to ₹1000 crore.
- For Small Finance Banks: The initial paid-up voting equity share capital/net worth required to set up a new SFB, may be increased to ₹300 crores.
- For UCBs transiting to SFBs: The initial paid-up voting equity share capital/net worth should be ₹150 crore which has to be increased to ₹300 crores in five years.
- (ii) As the licensing guidelines are now on a continuing basis (on-tap), the Reserve Bank may put a system to review the initial paid-up voting equity share capital/net-worth requirement for each category of banks, once in five years.”
- One sincerely hopes the stipulation that RBI ventures in to review the share capital scene even earlier if the necessity arises. Just presuming the term five years as the ultimate premise may not hold good in these days of every minute technological up-gradation of banking products.
- Some of the major recommendations on the corporate structure of banks, directly drawn from the report are intentional and it will ensure a clear structure imposed by the IWG for our learning and application, if necessary.
- “Corporate Structure – Non-operative Financial Holding Company (NOFHC) (i) NOFHCs should continue to be the preferred structure for all new licenses to be issued for Universal Banks.
- However, NOFHC may be mandatory only in cases where the individual promoters / promoting entities / converting entities have other group entities.
- (ii) Banks currently under the NOFHC structure may be allowed to exit from such a structure if they do not have other group entities in their fold.
- (iii) While banks licensed before 2013 may move to a NOFHC structure at their discretion, once the NOFHC structure attains a tax-neutral status, all banks licensed before 2013 shall move to the NOFHC structure within 5 years from the announcement of tax-neutrality.”
- As an international tax consultant, I fully agree with the recommendation of IWG to the Reserve Bank to ensure that the tax provisions treat the NOFHC as a pass-through structure after suitable discussions with the Government of India.
- The issues related to banks undertaking various activities through subsidiaries/joint ventures/associates need suitable regulations from RBI within the next two years. Clear instructions on activities forbidden for group entities or its subsidiaries in relation to the activities of the bank need the immediate attention of RBI. The same is applicable to the banks in relation to its group companies.
- RBI also to ensure that banks would not be permitted to form/acquire/associate with any new entity [subsidiary, JV or Associate (>20% stake – signifying significant influence or control)] or make fresh investments in existing subsidiary/JV/associate for any financial activity. It is taken for granted that supervising standards of RBI will be upgraded to the world standard that new banks grow organically without any miscarriage of their commitments and new scams emerge to rerail Indian growth in the banking scene.
- The listing arrangements have been of prime importance by the committee so that benefits of the new banking scene help the common investor with minimum capital. Unfortunately, the nationalization of banks needs a lot of improvements to extend the benefits to an average investor.
- Let me explain the listing arrangements as under.
- “1) SFBs to be set up in future: Such banks should be listed within ‘six years from the date of reaching net worth equivalent to prevalent entry capital requirement prescribed for universal banks’ or ‘ten years from the date of commencement of operations’, whichever is earlier.
- (2) For existing small finance banks and payments banks: Such banks should be listed ‘within six years from the date of reaching a net worth of ₹500 crore’ or ‘ten years from the date of commencement of operations’, whichever is earlier.
- (3) Universal banks: Such banks shall continue to be listed within six years of commencement of operations.”
- As expected, IWG recommends RBI to make available all revised instructions to old banks under function and in the future full instructions must be available in one shape rather than dispersed over decades of issue.
The committee clearly does not own any rights over the vast expanse of real reforms in-licensing of banks but credits their ideas over detailed discussions with previous RBI experts who since retired, industrial houses who have shown interest to enter banking which has been prohibited due to our socialistic structure which favored banking in government sector with its attendant risks that have enormously drained the tax payer’s money over generations.
I would like to mention some of the major statements of the report comparing the Indian banking scene with relation to the international scene which opens our minds to the vast arena of growth required by us to match up to world standards. As one of the fastest-growing economies, no more sheltering of our banking scene would do justice to our capabilities.
- The evolution of Indian banking has been dotted with many discontinuities that reflect quite conspicuously in the structure of the sector today.
- The banking sector has grown significantly over the years but the total balance sheet of banks in India still constitutes less than 70 percent of the GDP, which is much less compared to global peers, particularly for a bank-dominated financial system. Can you believe that we stand at 16th position among 21 countries which have been compared? As an ex-banker, I wish the youngsters take note of this for vast improvements.
- Domestic Bank Credit to Private Sector (% to GDP) – 2019 was compared among 19 countries, our position was 17 out of 19 countries. Yes, sad but true.
- As of December 31, 2019, in the list of top-100 global banks by asset size, Banco de Sabadell, a Spanish bank, with total assets of $251,408.59 million (approx. ₹18 lakh crore) was at the hundredth position. State Bank of India as of 31st March 2020 stood at Rs 39,51,394 Crores as total assets. All are aware of total patronage given by the Government of India both at the central as well as the state level to reach this position. Yes, let us not gloat over this development.
- Let us get some good news to note that in terms of the number of banks, as well as the total size of the banking system, India ranks in the top decile globally among the 158 banking systems tracked as part of The Banker database. However, the average Tier 1 capital of banks in India at $ 4.92 billion (approx. ₹37,000 crores) as of March 2019 is less than most of the global peers. Among 20 countries compared, we stand at 20th
- As an active investor in Indian private sector/public sector banks over the last 4 decades, none of them took care of my investments, and even the service offered as an investor has been excellent since the Indian banks are under the impression that the Government of India would venture in to save them.
- The Indian banking sector cannot be said to be highly concentrated. The Herfindahl Hirschman Index (HHI) for India is around 0.08 for both credit and deposits which indicates an unconcentrated industry. The share of the five largest banks in India is one of the lowest as compared to other jurisdictions.
- However, in terms of cost efficiencies, Indian banks are just at the bottom of the list, primarily on account of large staff costs. The net pre-tax profit generated by the Indian banks per unit of operating costs is just around $ 0.14 million (approx. ₹1 crore) as against a global average of $ 1 million. We stand at 24th position among the efficiencies compared among 24 countries taken for study.
- What about the growth of public sector banks and private sector banks in various sectors? The contribution of private sector banks towards deposits and advances of Scheduled Commercial Banks has increased from 12.63 percent and 12.56 percent in 2000 to 30.35 percent and 36.04 percent respectively in 2020. The PSBs have been consistently losing market share to the private banks, a process which has markedly hastened over the past five years.
- A much lower gross NPA ratio and a smaller pool of written-off accounts give private sector banks a much cleaner balance sheet for more productive utilization of capital as compared to that of public sector banks with increased NPA levels.
- What about capital requirements of private sector banks vis a vis public sector banks? capital has really not been a problem for private banks. During the last five years, private banks have been able to raise an aggregate capital of ₹1,15,328 crore from the market (through follow-on public offers, qualified institutional placements, American depository receipts/global depository receipts, employee stock option scheme, etc.) as compared to ₹70,823 by PSBs, which needed a massive infusion of another ₹3,18,997 crore from the GOI. Yes, your, mine, and our neighbor’s tax payments strengthened the position of public sector banks in spite of their worsening performance during the last 5 years.
By simple statistics, performance on various parameters both among Indian public sector banks and private sector banks have shown the dire need for more private-sector talent to enter more banking scene negating the social sentiments that the public interest is affected by private sector entry in banking scene. Moreover, our comparison with foreign banks as quoted by IWG indicates the worst position for India as compared to others who have been extensively quoted. Let us wake up to face the world. India woke up one morning to reach leadership levels in IT/Pharmacy and is ready to help more than 150 countries that urgently need the vaccine to face the pandemic. Let us emulate also in banking to open up the sector for internal and external capital flows so that we reach among the top 5 positions in world efficiency levels in banking but by a private route where the keenest competition produces the best results. IWG with its realistic recommendations has done an excellent report which will show the future for a brighter tomorrow in banking.
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