SFBs reverse-merger plans at odds with RBI’s push for HoldCo model

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Summary

  • The biggest advantage of the HoldCo model is its ability to ring-fence banks, and hence depositors’ money

The sharp run-up in the shares of Ujjivan Financial Services Ltd and Equitas Holding Ltd, (both hit their upper circuit limits in early trade on Monday) is not surprising. Both are promoters of small finance banks (SFBs), Ujjivan Small Finance Bank and Equitas Small Finance Bank, respectively, and gained on news of a possible reverse merger, following the Reserve Bank of India’s (RBI) decision to allow these SFBs to apply for amalgamation with their promoter entities.

This is in line with SFB licensing guidelines and RBI’s clarification issued on 1 January 2015 in terms of which the promoter of an SFB can exit or cease to be a promoter after the mandatory initial lock-in period of five years. Provided other regulatory requirements (RBI and Sebi) are met.

If approved, the scheme of amalgamation will give an exit route to the promoters and collapse the holding company structure. Equitas and Ujjivan currently own 82% and 83%, respectively, in their respective SFBs. Both are, therefore, required to dilute their stake in their respective banks by 4 September 2021 and 31 January 2022. Their applications seeking amalgamation and RBI’s decision to allow them to do so must be seen in this light. No more no less. For now.

However, a word of caution is in order. It must be noted RBI’s approval is limited to allowing the SFBs to apply for amalgamation. There is no certainty that approval will be granted. Indeed, RBI’s approval is not without the usual ‘ifs’ and ‘buts’ that accompany most regulatory approvals, especially when it relates to unchartered territories.

The exchange filing by Equitas Holding on Saturday makes it clear, the regulator’s ‘no-objection if and when given to the Scheme of Amalgamation, would be ‘without prejudice to the powers of RBI to initiate action, if any, for violation of any licensing guidelines or any terms and conditions of the license, or any other applicable instruction.’

More to the point, RBI approval for amalgamation, if granted, will be at odds with the regulator’s oft-stated-though not-acted-upon desire to nudge banks in India towards the holding company (HoldCo) model.

This model has long been touted as vastly superior to the present model where banks in India have many subsidiaries; where impairment in one subsidiary, if large enough, could have serious implications for the safety of the parent bank and for larger financial stability. For example, note how the brouhaha over Punjab National Bank’s sale of its stake in PNB Housing to Carlyle (the deal is now in a limbo) impacted the parent bank’s shares. Or how the losses in CanStar, a scheme promoted by its mutual fund subsidiary, impacted parent Canara Bank back in the 1990s.

The biggest advantage of the HoldCo model is its ability to ring-fence banks, and hence depositors’ money. Unfortunately, after paying lip-service to the merits of the HoldCo model (its merits have been debated in more than one discussion paper), RBI has not taken any concrete steps to move existing banks to such a structure (though it did turn down ICICI Bank’s request to set up a subsidiary which would be a holding company for other financial companies some years ago.)

It is undoubtedly in the best interests of financial stability that promoters’ stake in banks is brought down (widely diversified holdings always are preferred mode, world-over). But when RBI is seemingly keen to turn all banks into companies held by HoldCos, approval for the scheme of amalgamation, as proposed by the Ujjivan and Equitas SFBs, could run the risk of suggesting that RBI is not serious about pursuing the HoldCo model. That must be avoided.

Mythili Bhusnurmath is a senior journalist and a former central banker.

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