Proposals by ICICI Bank and State Bank of India (SBI) to set up holding companies to house their insurance and asset management businesses have led to the Reserve Bank of India (RBI) issuing a discussion paper on the subject. Contrary to popular impression, the central bank is not opposed to the creation of holding companies. Rather, the discussion paper points to “considerable advantages”.
It explains, “... banks would be much better protected from the possible adverse effects from the activities of their non-banking financial subsidiaries. ...(I)t may also be possible to consider allowing non-banking subsidiaries under the FHC/BHC (financial/bank holding company) structure to undertake riskier activities hitherto not allowed to bank subsidiaries such as commodity broking... However, a proper legal framework needs to be created before such structures are floated and it is ensured that no unregulated entities are present within the structure.”
So, all that the central bank is saying is that the necessary laws must be put in place to go ahead with the proposed changes in the holding company structure. That’s precisely what happened in the US, where financial holding companies were created under the Gramm-Leach-Bliley Act.
At present, banks in India conduct some of their other businesses through subsidiaries. The problem is that the law does not allow a bank to invest more than one-fifth of its paid-up capital and reserves in its financial services companies, including subsidiaries. This makes it difficult for banks to invest in a cash-guzzling business such as life insurance. That’s why banks want to transfer their insurance business to a holding company and allow it to raise capital either through listing or through other means such as private equity or a private placement. This would also free up their capital for using in the main banking business.
The RBI paper talks of two distinct holding company structures—one, where the holding company controls one or more banks, also called the bank holding company model and, another, where a financial holding company controls the bank and other financial non-banking businesses. It is the latter that’s relevant to India, though there could be an extra layer—an intermediate holding company. For instance, the ICICI Bank/SBI proposal says the bank would be the parent of a holding company, which in turn would have several subsidiaries.
The paper also says that financial conglomerates are supposed to reduce risk, lower costs, improve product innovation and allow banks to capture economies of scale and scope. But it clearly opposes intermediate holding companies and ends with the uncompromising statement: “It will be useful to contain the complexity in the BHC/FHC Model as also in the Bank Subsidiary Model of conglomeration to the bare minimum... it will be desirable to avoid intermediate holding company structures.”
RBI believes intermediate holding companies could become vehicles for increasing leverage for regulatory arbitrage, and multiple regulators could pose a problem. For instance, a holding company could be an unregulated entity, with subsidiaries in insurance, housing and the capital markets. Each of these will be under a different regulator (Irda, NHB, Sebi), while the bank as a whole will continue to be regulated by RBI.
The point is simple. RBI agrees that the holding company structure has many benefits. And it is a fact that insurance companies need cash and are hobbled by the existing rules. What is important is to change the restrictive rules and allow innovative financial structures. If, in the process, there’s regulatory overlap, the regulators can set up mechanisms such as special oversight panels, or even consider a financial super regulator, on the lines of the UK’s Financial Services Authority or Singapore’s Monetary Authority.
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