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The curious case of Indian-made foreign banks

The curious case of Indian-made foreign banks
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First Published: Sun, Oct 18 2009. 10 11 PM IST

Updated: Sun, Oct 18 2009. 10 11 PM IST
Like Indian-made foreign liquor (IMFL), we now seem to have a set of Indian-made foreign banks (IMFBs). Commerce and industry minister Anand Sharma told Mint last month that the new foreign direct investment (FDI) policy is “so far working well”. This means that banks will not be spared the February FDI norms from which they have been seeking exemption. The guidelines will make operations difficult for quite a few home-grown banks in which foreign investors hold a stake in excess of 50%, directly and indirectly.
Under the new norms, a firm is deemed Indian-owned only if Indians own more than half its equity capital and control its management. Foreign stakes in ING Vysya Bank Ltd, ICICI Bank Ltd, HDFC Bank Ltd and IndusInd Bank Ltd are at least 51% and hence these four are foreign-owned and Indian-controlled banks. Federal Bank Ltd and Yes Bank Ltd too have high foreign holdings, at least 46% each, and if any of their existing local shareholder has more than 50% foreign stake in itself, the indirect foreign holding in these two banks can be more than half of its stake. Housing Development Finance Corp. Ltd (HDFC), India’s oldest and largest mortgage firm, holds a 14.49% stake in HDFC Bank but since the foreign stake in HDFC itself is at least 75%, three-fourths of HDFC’s stake in HDFC Bank is being considered a foreign stake and, to that extent, the indirect foreign stake in the bank goes up.
Indeed there is no regulatory challenge yet as these banks continue to be governed by the licensing norms of the Reserve Bank of India (RBI). So unlike the “foreign” banks, IMFBs don’t have any restrictions on the expansion of branches. There is no change in the mandated lending norms, too. Even though India has committed to the World Trade Organization to give 12 new branch licences to foreign banks every year, RBI has all along been allowing foreign banks to open more even though its liberalism is restricted to those foreign banks that want to go to the unbanked regions. While the branch licensing policy is not favourable to foreign banks, they do enjoy advantages over their local counterparts when it comes to mandated lending. Under current norms, Indian banks are required to channel 40% of their loans to agriculture, small industry and so on and some of them at concessional rates. For foreign banks, such lending is capped at 32% of their loans and includes loans to exporters.
While there will not be any change in regulations, IMFBs may face problems in terms of loans and investments. Also they run the risk of breaching the FDI cap if they aren’t careful enough.
How? Indian private sector banks are permitted to have a foreign shareholding of up to 74% and public sector banks up to 20%. The banks will have to keep a tab on the ownership pattern of each of their Indian shareholders since if any of them are more than 50% foreign owned, the indirect foreign holding in banks will go up. Banks normally have a large shareholder base and the stocks are highly traded. The computation and monitoring of indirect foreign shareholding through other Indian firms will pose a significant operational and administrative challenge.
The onus of ensuring compliance with the FDI limits lies with the banks. If the FDI limit in any bank is crossed, it will have to ensure that the new investor sells the stock. Since that’s not an easy task, the banks will probably have to tackle it by instituting a process to scrutinize the ownership pattern of the prospective shareholders. Again, that’s very difficult. Why do the banks need to go through this pain while RBI meticulously regulates a bank’s ownership?
The maximum holding of any shareholder in a private sector bank is limited to 5%, and in a public sector bank 1% which can go up to 10% with the approval of its board and RBI. Separately, for those banks which have issued depository receipts overseas, while the economic ownership of the shares underlying the receipts rests with foreign investors, the receipts’ holders normally do not enjoy voting rights.
Banks, by the nature of their business, directly or through their subsidiaries, provide both debt and equity financing to companies. They also often insist on borrowers to offer shares as collateral and have the right to convert debt into equity in the event of default. Also, in course of corporate debt restructuring, they convert debt into equity. But the new breed of IMFBs will face problem in doing so, particularly in those firms where the FDI limit is capped as their equity exposure may end up breaching the limit. The insurance sector has been out of the ambit of the new guidelines but the FDI limit is capped in sectors such as media, telecom, stock and commodity exchanges and banks will have problems in taking loan and equity exposures to firms in these sectors. There will be no issue at the time of taking a pledge of shares while giving loans but enforcement of the pledge and conversion of the loan into equity due to financial default or restructuring may run into trouble.
Such restrictions would have been welcome had there been no regulations on banks’ investments. But that’s not the case. Now, a bank’s investment in another firm (other than its subsidiaries) cannot exceed 30% of its paid-up capital. On a consolidated basis, a bank’s aggregate capital market exposure, including all its equity investments other than in subsidiaries, also cannot exceed 20% of its net worth. With so much of control on ownership, management and investment, do we still need IMFBs?
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as Mint’s deputy managing editor in Mumbai. Please email comments to bankerstrust@livemint.com
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First Published: Sun, Oct 18 2009. 10 11 PM IST