Home / Opinion / Columns /  RBI’s impossible duality: Policy clarity versus whimsy

The Reserve Bank of India (RBI), as the Indian financial sector’s custodian, initiated a two-pronged action on 17 November: a moratorium on privately-owned Lakshmi Vilas Bank (LVB) and, simultaneously, its amalgamation with DBS Bank India Ltd (DBIL), a wholly-owned subsidiary in India of the Singapore government’s DBS Bank. Three days later, an internal working group (IWG) of the central bank released a report on ownership rules and the corporate structure of Indian private banks. There are strange overlaps between the regulatory action and the subsequent report.

The LVB-DBIL scheme sends out two signals: one direct and unambiguous; the other nuanced, raising questions about RBI’s even-handedness and individual whimsy influencing policy. The IWG report, on the other hand, seeks to harmonize the confusing—and occasionally contradictory—thicket of RBI rules, but is selective in its approach and and seems to paper over other contentious issues.

Let’s examine the LVB-DBIL regulatory action first. RBI is within its rights, under Section 45 of Banking Regulation Act, to announce a moratorium on any troubled scheduled bank, as well as merge it with another bank to safeguard depositors, shareholders and the financial system’s stability. It is like bringing a running car to a standstill to enable the replacement of moving parts. RBI has adequate in-house experience on this, the last moratorium imposed as recently as 5 March on Yes Bank. The surprise element is the LVB-DBIL amalgamation scheme: While LVB depositors and employees are largely protected, shareholders have to write off investments completely.

But, by selecting DBIL to acquire the ailing LVB, RBI has signalled that wholly-owned subsidiaries (WOSs) of foreign banks, which have traditionally operated as branches of their parent institutions, rank high in its hierarchy of preferred institutions. If the merger goes through, DBIL will become India’s largest foreign bank by branches, thanks to LVB’s existing physical footprint. RBI has repeatedly said that WOSs of foreign banks in India would be provided “near equal" treatment with Indian banks. Yet, only two banks had responded positively so far: DBIL and State Bank of Mauritius.

Foreign banks have been demanding a level playing field with domestic banks in many operational areas, including in acquiring local institutions (but not for priority sector lending). On his visit to India as Citigroup board member (after retiring as US secretary of treasury in the Bill Clinton administration), Robert Rubin had lobbied with the government and RBI to allow foreign banks equal acquisition rights. ING was the only foreign bank that could successfully leverage RBI’s liberalized foreign investment rules by picking up close to 44% in the Bengaluru-based private-sector Vysya Bank in 2002, but it sold out to Kotak Mahindra Bank in 2014. However, HSBC’s attempts in 2004 to acquire UTI Bank (now known as Axis Bank) were nixed by a petulant RBI; former RBI governor Y.V. Reddy described the episode in his book Advice and Dissent: “…there was an attempt by a foreign bank, HSBC, to take over UTI Bank. It was called a ‘palace coup’, and we had to put in place policies that would prevent HSBC from circumventing the upcoming policy guidelines."

So, there you have it: foreign banks allowed to acquire local banks under RBI governor Bimal Jalan in 2002, but vetoed by his successor Reddy in 2004, and once again permitted through the WOS route by Shaktikanta Das. As governors have changed, so have policy contours. The IWG report tries to untangle and organize the skein of ownership rules for private banks, but oddly skips mention of foreign investment in Indian-owned private banks. This grey area seems earmarked for individual quirkiness.

Back to the DBIL-LVB merger design, which sends out a slightly diffused message from RBI. Under the draft scheme, LVB’s entire share capital, as well as reserves and surplus, will be written off, leaving LVB shareholders with nothing. This is justified on the grounds that LVB’s net worth has turned negative. Also, this is not the first time; private bank shareholders were sacrificed to salvage bankrupt Global Trust Bank’s shotgun merger with Oriental Commerce Bank in 2004. In both these RBI-orchestrated rescue acts, depositors have been accorded higher weightage than shareholders.

Yet, one question refuses to go away: Will RBI similarly force the government to write off its capital while resolving a state-owned bank that runs out of options, of which there are bound to be some? This is where black-and-white rules enter the grey zone. Just as the government’s shareholding cannot be compared with a private individual or enterprise, the central bank’s complete menu of actions cannot be pre-determined, leaving it with limited flexibility to adapt to changes. So, while the IWG report has afforded RBI fluidity of action in dealing with American/global depository receipts, where the ultimate beneficial ownership is hazy, there should have been some clarity on how to deal with foreign portfolio investors (FPIs) or private equity, where a similar veil shrouds the final beneficial ownership. Apocrypha suggests how some Indian investors have used FPIs or private equity vehicles in the past to indirectly influence bank board decisions, especially on chief executive choices or other strategic issues.

What is not spelt out could end up being more eloquent than what has been.

Rajrishi Singhal is a policy consultant, journalist and author. His Twitter handle is @rajrishisinghal.

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