RBIs Draft Guidelines for Private Banks Conversation with Bikash Jhawar

Last year, the Finance Minister made an announcement of issuing new bank licenses in his Union Budget speech in February 2010. Following this announcement, RBI had put out a discussion paper “Entry of New Banks in the Private Sector” on the website on August 11, 2010. Based on the responses received, RBI has now come out with the draft guidelines for licensing of new banks in the private sector..Last year, the Finance Minister made an announcement of issuing new bank licenses in his Union Budget speech in February 2010. Following this announcement, RBI had put out a discussion paper “Entry of New Banks in the Private Sector” on the website on August 11, 2010. Based on the responses received, RBI has now come out with the draft guidelines for licensing of new banks in the private sector..RBI is likely to issue the final guidelines for granting bank licences to corporates only after Parliament approves the Banking Laws (Amendment) Bill, 2011, which seeks to give more power to the regulatory powers of the RBI..The main features of the draft Guidelines are:.Eligible Promoters: Promoters should be resident Indians with diversified ownership, sound credentials and integrity and successful track record of at least 10 years. Promoter groups which have 10 percent or more income from real estate, construction or broking will not be eligible for the new bank license..Corporate Structure: Promoters have to set up a wholly-owned non-operative holding company (NOHC) to be registered with the Reserve Bank as a non-banking finance company (NBFC)..Capital Requirement: The minimum initial capital shall be Rs. 500 crore. NOHC shall hold minimum 40 percent of the paid-up capital of the bank for a period of five years; Shareholding by NOHC in excess of 40 percent shall be brought down to 20 percent within 10 years and to 15 percent within 12 years..NBFCs: Existing Non-Banking Finance Companies can convert themselves into banks or apply for a new banking license..Foreign holding: Total foreign holding from FDI, FIIs and NRIs should not exceed 49 percent of the total stake for the first five years..Corporate governance: At least 50 percent of the directors of the NOHC should be independent directors. The corporate structure should be such that it does not impede effective supervision of the bank and the NOHC on a consolidated basis by the Reserve Bank..The draft Guidelines have set out some other conditions:.The exposure of bank to any entity in the promoter group shall not exceed 10 percent and the aggregate exposure to all the entities in the group shall not exceed 20 percent of the paid-up capital and reserves of the bank.The bank shall get its shares listed on the stock exchanges within two years of licensing.The bank shall open at least 25 percent of its branches in unbanked rural centres.In respect of promoter groups having 40 percent or more assets/income from non-financial business, certain additional requirements have been stipulated. .In the Guidelines RBI has set out the procedure for its decision to issue licences. Banking being a highly leveraged business, licences shall be issued on a very selective basis to those who conform to the requirements, who have an impeccable track record and who are likely to conform to the best international and domestic standards of customer service and efficiency. Therefore, it may not be possible for Reserve Bank to issue licences to all the applicants meeting the eligibility criteria as prescribed. The issuance of licence is at sole discretion of RBI..The last time when the licences were issued was in 2003-04 based on the 2001 RBI Guidelines. Before that ten banks were granted licences in the year 2001 based on 1993 RBI Guidelines. The time frame that will now be taken to issue licences is not clear. RBI still has to come out with final guidelines before it starts receiving applications. Before issuance of new bank licenses, RBI has stated that the following amendments, inter alia, are required: Removal of restriction of voting rights; Empowering RBI to supersede the Board of Directors of a bank so as to protect depositors’ interest; and Facilitating consolidated supervision. .Bar & Bench spoke to Bikash Jhawar Partner at Luthra and Luthra on the Draft Guidelines issued by RBI to issue licences to new banks in private sector..Bar & Bench: Can you share your thoughts on the draft guidelines issued by RBI for licensing of new banks in the private sector? .Bikash Jhawar: The draft Guidelines are on expected lines when you consider the discussion paper issued in 2010 and previous guidelines issued by RBI when issuing licenses in 1990s and thereafter in early 2000s; Some aspects which could be a cause for concern are: (a) the proposed restriction on foreign ownership: given the expectation of significant capital dilution by Indian promoters, an under 5% entity level threshold may not be a reasonable restriction; further, Indian promoters may need the flexibility of working with foreign banks/financial sector participants to enable expertise development; (b) the requirement of housing all financial services activities (to the extent permitted by banks to undertake the same departmentally) through the bank may also pose a challenge for entities which have joint ventures especially with foreign parties or listed group companies undertaking such activities; (c) Requirements about ensuring arms-length and independence from suppliers / customers and business associates may be difficult to monitor and could lead to uncertainty in relation to the new banks ability to function unless RBI comes up with more detail on determining these entities; (d) It is not clear whether these Guidelines are an exhaustive framework on their own or merely amend the existing guidelines on private sector participation in banks..Bar & Bench: The guidelines put a condition that promoters or promoter group with diversified ownership only are eligible to promote banks. How do you think term ‘Diversified Ownership’ would be interpreted?.Bikash Jhawar: I would read it to mean business groups with multiple listed companies with significant minority interest in such companies would be eligible. RBI may need to come up with more detail to provide clarity. It should however be noted that RBI has retained a large amount of discretion with itself when dealing with new license requests..Bar & Bench: Do you think the 2 year listing stipulation put forth by RBI is a reasonable one?.Bikash Jhawar: Previously Yes Bank has listed in about that time frame. Therefore without going into the reasonableness of the 2 year requirement, you should consider that there is a significant capital dilution requirement by NOHCs and given individual foreign ownership is restricted, I think listing may be the only option left to diversify ownership..Bar & Bench: Your views on allowing NBFCs to promote or convert into banks.Bikash Jhawar: NBFCs are not really allowed to promote banks – their promoters have been given the leeway to consider banking operations provided no operational/business arbitrage remains within the NBFC and the Bank – please see the condition regarding shifting of certain activities to banks. Conversion in my view should be encouraged to ensure better regulation of what are essentially banking activities..Bar & Bench: What do you think will be the impact of these guidelines on the banking sector? Will it lead to lot of players applying for licence? .Bikash Jhawar: I dont think there would be a mad rush. Looking at the guidelines there may only be a handful of people who would have the seriousness to develop a bank and/or the ability to devote the significant amount of attention and capital required to banking operations. The group restructuring which may be required and attendant costs of the same, issues relating to the takeover code, etc or even the loss of possible business arbitrage may be a dampener. Also promoters who want to undertake banking would have to consider the impact of increased regulation on non-banking activities, including non-financial activities, which RBI is proposing.