New Delhi/Mumbai: The government has cleared a proposal by HDFC Bank Ltd, India’s second largest private-sector bank by assets, to increase the foreign investment limit in the lender while taking the view that the stake held by its parent Housing Development Finance Corp. Ltd (HDFC) amounts to overseas investment.

The foreign investment promotion board (FIPB) cleared the proposal by HDFC Bank to increase the foreign investment limit in itself to 74% from 49%, according to three people familiar with the development who spoke on condition of anonymity.

As per filings with the BSE, mortgage lender HDFC’s stake in HDFC Bank was 22.5% as of September end. This means that the total foreign investment in the bank, including portfolio investments and American and global depository receipts, is now very close to 74%. “The bank does not have much headroom now to raise fresh foreign funds," a government official said after a meeting of FIPB. The official added that the Reserve bank of India (RBI) will decide on the penalty for the breach of its foreign holding limit prior to Friday’s decision.

If HDFC’s stake is considered FDI, it will also raise questions about the company’s other downstream investments and any such future investments may need FIPB clearance. The government had previously said that insurance subsidiaries would be exempt from this rule.

“The major implication would have been for HDFC’s insurance business but since that has been exempted, none of the other business vertical should see an impact," said Ananda Bhoumik, senior director at India Ratings and Research Pvt Ltd, the Indian arm of Fitch Ratings Ltd.

HDFC Bank had initially sought to increase the foreign investment limit to 67.55% from the current limit of 49%. HDFC Bank had sought to raise the limit after it hit the existing cap of 49% in December 2013.

The proposal, however, had been stalled as there was uncertainty over whether HDFC’s stake in the bank would be classified as a foreign holding.

Subsequently, the bank had filed a revised proposal to increase the foreign holding investment limit to 74%, after the finance and the industry ministry took a view that HDFC’s stake should be classified as foreign direct investment.

Foreign institutional investors hold more than 75% of HDFC. According to the extant FDI policy, if foreign entities own and control a company, its downstream investments would also be considered as foreign investment.

“Even though the larger shareholding in the company is foreign, there is no single shareholder who can influence decisions. It is actually a number of foreign shareholders with very small holding individually," said Ashvin Parekh, managing partner at Ashvin Parekh Advisory Services Llp.

The decision to classify HDFC’s stake in HDFC Bank as FDI may also have a bearing on the bank’s future capital raising plans. In May, HDFC Bank said that it proposes to raise about 10,000 crore from a share sale to fund its growth.

“The bank had mentioned that they may go for domestic fund raising and since its not a large amount, it should not be a problem," said Bhoumik of India Ratings and Research, adding that there would be no impact on the bank’s operations.

HDFC Bank’s shares rose 1.43% to 929.30 on BSE on a day the benchmark Sensex rose 0.38% to 28,046 points.

Separately, FIPB also cleared 15 out of the 26 proposals that were up for consideration before the board on Friday. These include Punj Lloyd Ltd’s entry into the defence sector.

PTI contributed to this story.

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