Is composite foreign cap such a game changer for private banks?

Private sector bank stocks shot up on Thursday on hopes that the government’s decision to club different heads of foreign investment into a composite limit will benefit the likes of Axis Bank Ltd and Yes Bank Ltd.

These banks have foreign stakes of close to 45%, much lower than the overall foreign holding cap of 74%. Prior to this decision, they were hamstrung by the fact that the majority of this holding was foreign institutional investor stake, which had a separate cap of 49%. Now, this decision suggests that these banks have much more room for foreign shareholders irrespective of the colour of their money.

Drawing more foreign investment has its appeal. From the point of view of minority shareholders, it is a positive event—there are more people who can buy their shares now. Moreover, it will give the likes of Yes Bank a chance to get back into MSCI indices, which will be a magnet for more foreign investors. It would perhaps be easier for banks to raise funds at home; they would no longer have to resort to the depository receipts route.

But is this event such a game changer?

There is still some confusion about whether this announcement means that banks would no longer need to seek government approval to have foreign holdings up to 74%. That would be a key change.

As it is, banks do get permission now and then to increase their foreign holdings limit. Earlier this month, Kotak Mahindra, for instance, got a nod from the Foreign Investment Promotion Board to increase its foreign holdings to 55%.

In any case, investor reaction would seem to be dictated by sentiment since the government announcement was no more than a ratification of a proposal first mooted in the Union budget earlier this year.

The top private banks are already investor favourites. They are among the best in terms of asset quality and credit growth. Axis Bank trades at 2.8 times its estimated book value for this fiscal year, Yes Bank at 2.5 times and Kotak Mahindra at 5.8 times. It is doubtful whether there will be a sharp rise in these multiples in the absence of improvement in factors such as growth or better asset quality.

Investors would also do well to remember the flip side. Higher foreign participation from FIIs also means they are at risk of sharper falls when there are outflows.

The writer does not own shares in the above-mentioned companies.