RBI, in June of this year, had constituted an internal working group (IWG) to review the ownership guidelines and corporate structure for Indian private sector banks. The group submitted it’s report on November 20 with the following key recommendations –
1. Raise promoter’s stake limit from 15% to 26% by the end of 15 years – hence requirement of lower dilution by the promoters
This has been a major point of contention between the regulators and the promoters of some existing banks. Whereas, promoters have always wanted bigger stake (and hence control + more growth participation), the regulator has always been in favor of controlling their stake (and hence influence) due to the nature of the industry (banks are of systemic importance as they deal with public money and have extensive economic linkages).
2. A uniform cap of 15 per cent for non-promoter shareholders
This should help in attracting increased long term passive capital.
3. Large corporate/industrial houses can be allowed as promoters of banks after necessary amendments to the Banking Regulation Act, 1949 (to prevent connected lending and exposures between the banks and other financial and non-financial group entities)
This is the most argued issue and many experts and economists have already highlighted how this can potentially result in long term structural deterioration of the Indian banking industry.
The main reason – conflict of interest and how the operations of the bank might be run by corporates to suit their own varied business interests.
I don’t deny the concerns. However, it might be premature as the detailed contours of the proposal are still unknown. What I believe –
- Regulator will not be benevolent in issuing bank licenses to anyone and everyone. On the contrary, I believe it will be extremely choosy.
- I don’t expect Corporates to line-up to open banks. Banking is an extremely difficult and regulated business. Any corporate trying to open a bank would be aware about the associated risks of extra scrutiny over it’s other businesses as well.
It would be interesting to see how this shapes up as we move forward.
4. Well run large Non-banking Financial Companies (NBFCs), with an asset size of ₹50,000 crore and above, including those owned by a corporate house, may be considered for conversion into banks subject to completion of 10 years of operations
Given the extra scrutiny + liquidity reserves that banks are subjected to vis-a-vis NBFCs, I personally don’t expect many to convert… at least not voluntarily.
However, given the DHFL experience, I would not be surprised if there is a more tighter leash over some too big to fail NBFCs.
5. Mandatory holding Company structure (i.e., NOFHC) for banks with group entities. Besides, significant regulations for existing banks with group entities till the holding company structure is not implemented
Banks undertaking related and non-related activities through subsidiaries, associates, JVs etc has again been a long contentious issue. We all are aware about every major bank in India being involved directly/ indirectly into varied activities including home finance, insurance, NBFC, asset management, private equity, credit cards, brokerage, investment banking etc etc etc.
Regulator is now trying to bring in some sanity into these web of activities by proposing a clear holding and corporate governance structure. Key proposals include –
- Mandatory Non-operative Financial Holding Company (NOFHC) for new banks by the promoters with other business interests
- Conversion of existing banks with other activities (through subsidiaries/ JVs/ associates) into NOFHC structure within a period of 5 years once govt ensures a tax neutral conversion of existing structure into NOFHC structure. Till then, RBI needs to frame fresh regulations incorporating the points below and existing banks need to comply within a period of 2 years.
- there can not be any overlap between the bank and it’s other group entities, whereby both carry similar activities;
- if a group entity carries any lending activity, the prudential norms applicable to it would be same as that of a bank; and
- bank cannot invest more than 20% into any new entity or fresh capital into an existing entity carrying a financial activity
There are some other recommendations related to promoter’s pledge of shares, minimum capital requirements, listing, conversion of Payments banks into Small Finance Banks etc. However, I didn’t find them critical to discuss in this post. Interested readers can download the Press Release and IWG_Report for details.Why is it done what is done, why now, and how am I factoring it in my investing strategy?
Banking is dynamic and ever evolving
Neither is this the first time and nor will be the last. Banks are so critical and closely linked with the economy that there cannot be status quo… ever !
Regulators learn from experiences, try to gauge the economic requirements and adjust to improvise. In the process, some things work and some don’t. What doesn’t, sow the seeds for the next set of reforms/ regulations/ guidelines.
It’s proven and accepted that Private Banks are way ahead of Government banks – on every parameter
No amount of data is required to prove this. Asset quality, cost ratios, growth, return on capital, share price performance – everything leads to only one conclusion.
Experts, economists, investors, regulators and government itself has accepted it wide and clear.
So if that is the case, every effort should be made to promote them. Isn’t it?… and that’s what the intention of the current set of recommendations is !
So how does one draw more capital towards private banks?
By making the proposition promoter friendly and opening the sector for large pool of private capital lying with good Corporates.
By opening the sector for Corporates, reducing dilution requirements, increasing holding limits… that’s what the intention seems to be.
But why is Capital even needed?
In my mind it’s for repair as well as growth –
- Repair – position of many existing banks is not that strong as it optically seems. Remember, we are still in a sort of semi-moratorium, deferral mode. One still doesn’t know the exact asset quality situation of many banks. The result – many banks especially smaller size might be vulnerable and hence might need heavy doses of new capital.
- Growth – regulators and government are excited with the economic revival over the last few months and expect the momentum to strengthen further as Covid19 fades away. Under the scenario, bank credit is expected to pick up speed and hence need for the new capital.
What about new banks… do we even need them?
This is tricky and my regular readers would relate that I have raised this issue in many of my previous posts. On one hand we are finding it difficult to control the existing players and have witnessed failures over the last 2-3 years, but then we are trying to promote new players. Why !
Why can’t existing large, good players be promoted and incentivized to expand further?
I guess now I am reaching to the conclusion that existing players themselves don’t want to come out of their comfort zone. They have a set way of working and happy expanding only within their comfort zone.
Under the scenario, if one needs to provide banking facilities to a country as large and diverse as India, guess we don’t have a choice. We have to promote new banks, especially when public sector banks are struggling to deliver.
Result – new banks and that too supported by private hungry promoters are bound to create tricky credits and practices but that’s the price one pays to try enlarging the coverage !
My strategy as an investor
Nothing changes and I continue to be comfortable only with the banks that I am ready to entrust my money with !
Banking is a faith business and irrespective of the new or old regulations, the only thing that matters is trust. Trust gives access to low cost deposits and save a run on the bank in difficult times. Low cost allows bank to be competitive but also choosy about it’s credits, that in turn translates into margins and stock prices.
As I always say and believe, banking is a boring business and if anyone is trying to make it exciting, I am happy watching it from the sidelines and clapping 🙂
Disclaimer: View expressed are my own and not any recommendation. Please do your own research before taking any investment related decision.