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Shyamal Banerjee/Mint
Shyamal Banerjee/Mint

Far reaching changes in powers of the banking regulator

Among the changes, the Bill has increased voting power of shareholders in private and public banks.

The Banking Laws (Amendment) Bill, 2011 passed by Parliament on 18 December will make far reaching changes in the power accorded to the regulator. While on one hand it paves the way for issuance of new banking licences and greater play for foreign banks in the wholly owned subsidiary form, on the other hand it provides power to the Reserve Bank of India (RBI) to supersede the boards of banks and inspect the books of accounts of associates including holding company, subsidiary company, joint venture, an enterprise that controls the composition of the board of directors or other bodies governing the banking company and any other entity able to obtain economic benefits from the activities of the banking company.

Among other changes, the Bill also raised the voting power of the shareholders from 10% to 26% for private banks and from 1% to 10% for public sector banks. In addition, the Bill also allows private banks to issue preference and bonus shares. This Bill also keeps banking mergers and acquisitions within the purview of the Competition Commission of India. Furthermore, the Bill also increases the authorized capital of the banks to 3,000 crore from the existing 1,500 crore and it can be increased or decreased with the prior approval of the regulator.

Overall, the Bill provides an enabling environment for the banking sector to increase capitalization and grow into larger organizations. It also clears the way for enabling environment for RBI to issue the guidelines for new banking licences in the private sector by giving it the powers to inspect the books of accounts of associates and supersede the board. We will now see more banks in the private sector which will increase competition in the banking space as well as deepen financial inclusion, which has been the focus area for regulators and policymakers. Retail depositors will benefit from the increased coverage and penetration of banking services as well as have more options. However, since the new banks will have to be focused on financial inclusion, they will need to have strong business models to be successful as there is a very strong element of cross-subsidization that will need to be built in the model.

The biggest impact of the Bill is expected to be the powers granted to the regulator. Since the new banking licences were announced almost two years back, the regulator has maintained that intra-group exposures present a huge regulatory challenge especially in case applicants which are part of large conglomerates and unless the regulator has access to records of all such associates within the group, the risks to the bank would be difficult to be segregated from the other businesses of the group. Now the regulator has powers to check all books of accounts of connected entities as well as supersede the board of the bank in case of any irregularity.

The removal of stamp duty for a foreign bank converting to wholly owned subsidiary is a substantial incentive for foreign banks who are seeking a larger play in the banking sector. The wholly owned subsidiary will be treated at par with the domestic banks with freedom to expand their branches and operations. Under the current laws, foreign banks are required to pay 20-30% tax as capital gains and stamp duty when transferring branches to a new legal entity. The development will promote growth of operations of foreign banks in India. Furthermore the increase in voting rights will be favourable for investors and may lead to further investments into the banking sector as they will have a larger say in the functioning and running of the bank.

The Bill will provide a stable regulatory environment with adequate powers and oversight to the regulator for further development and growth of the banking sector into the grassroots of the economy as well as create large-sized banks which would be comparable to banks globally in terms of assets and balance sheets. While we are unlikely to see a significant spurt in the merger and acquisition activity, there might be some consolidation among the smaller private banks. The increase in number of banks would lead to more competition and better pricing for the retail customer both for deposit as well as credit products as the newer banks innovate to garner market share. Overall the Bill provides an enabling environment for the regulator and the development and growth of the banking sector.

Ashvin Parekh is national leader–global financial services, Ernst and Young.

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