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August 04, 2012

RBI's Checks and Balances for New Private Banks


Rukshad Davar

The issuance of the Draft Guidelines is a step forward towards the development of the banking sector. However, if the RBI considers reviewing the onerous stipulations while finalizing the guidelines, it would ensure the growth and smooth functioning of new entrants in the banking sector.

The Reserve Bank of India (the "RBI") on August 29, 2011 issued draft guidelines for licensing of new banks in the private sector ("the Draft Guidelines").

The RBI had in the past issued guidelines on licensing for banks in the private sector on two occasions, first in January 1993 which led to the issuance of ten banking licenses and subsequently in January 2001 pursuant to which only two banking licenses were issued.

Key Concepts


The key concepts specified in the Draft Guidelines are as follows:

(i) Only private sector entities/groups, owned and controlled by Indian residents are eligible to promote banks.

(ii) Promoters and promoter groups with diversified ownership, sound credentials, integrity and having a successful track record for at least ten (10) years are eligible to promote banks.

(iii) Entities or groups having 10% or more income or assets or both from real estate construction or broking activities in the last three (3) years are not be eligible to promote banks.

(iv) A bank can be set up only through a wholly-owned Non-Operative Holding Company ("NOHC") structure. The NOHC needs to be registered as a non-banking finance company ("NBFC") with the RBI. The NOHC is required to ring fence the regulated financial services/activities of the group including those of the bank from other activities of the group not regulated by financial sector regulators.

(v) The initial minimum paid-up capital for a bank is required to be INR 500 crore.

(vi) The NOHC is required to hold a minimum of 40% of the paid-up capital of the bank for initial five (5) years. The excess shareholding beyond 40% is required to be brought down to 40% in the initial two (2) years. Subsequently, the NOHC is required to bring down its shareholding in the bank to 20% of the paid-up capital within ten (10) years and thereafter to 15% within twelve (12) years.

(vii) No single entity or a group of related entities other than the NOHC shall have shareholding or control, directly or indirectly, in excess of 10% of the paid-up capital of the bank.

(viii) Applicants need to provide to the RBI a business plan while applying for bank licenses. Any subsequent deviation from the stated business plan after issuance of the banking license may result in the RBI restricting the bank's expansion, effecting a change in its management and imposing other penal measures.

(ix) The aggregate non-resident shareholding from foreign direct investment, non-resident Indians and FIIs is limited to 49% of the paid-up capital of the bank for the first five (5) years.

(x) A non-resident shareholder is not allowed to hold, directly or indirectly, individually or in groups, more than 5% of the paid-up capital of the bank.

(xi) At least 50% of the directors of the NOHC are required to be independent directors.

(xii) The exposure of the bank to a single entity in the promoter group cannot exceed 10% of the paid-up capital and reserves of the bank and the aggregate exposure to all the entities in the promoter group cannot exceed 20% of the paid-up capital and reserves of the bank.

(xiii) The bank is required to get its shares listed on stock exchanges within two (2) years of the receipt of the bank license.

(xiv) The bank is required to have at least 25% of its branches in unbanked rural areas.

Constructive and Onerous


The Draft Guidelines contain both constructive and onerous stipulations.

The constructive measures under the Draft Guidelines are as follows:

(i) The stipulation provided by the RBI in the Draft Guidelines relating to non-eligibility of entities or groups having 10% or more income or assets or both from real estate construction activities or broking activities is clearly in our view a positive step due to the recent volatility and uncertainty prevalent in the capital markets and the weak visibility in the business of real estate construction. Considering that public monies/deposits will form an inherent part of the bank, it is an appropriate move by the RBI to insulate the bank from an exposure in these sectors.

(ii) Another prudent measure promulgated by the RBI in the Draft Guidelines is that the NOHC is required to ring fence the regulated financial services/activities of the group including of the bank from other activities that are not regulated by financial sector regulators. This measure will also seek to insulate the NOHC and/or the bank from an exposure in other activities of the group and will seek to concentrate and lay emphasis in carrying on and promoting the financial services/activities.

(iii) Another positive move by the RBI in the Draft Guidelines to ensure good practices of corporate governance is to stipulate the requirement of at least 50% of the directors of the NOHC being totally independent of the promoter/promoter group or its entities.

The aforesaid positive and prudent measures stipulated by the RBI in the Draft Guidelines are over-shadowed by certain onerous stipulations as specified below which will prove to be an impediment in the growth and the smooth functioning of banks, unless the RBI rectifies the same at the time of finalizing the guidelines.

(i) While the RBI has stipulated that the promoter and the promoter group entities will be eligible to set up a bank if it has a diversified ownership, sound credentials, integrity and a successful track record, no parameters for these criteria have been specified in the Draft Guidelines. The term "diversified ownership" needs to be elaborated and clarified further by the RBI. Also, the RBI needs to provide parameters for track record being linked to profitability and the balance sheet of the promoter group.

(ii) Another deterrent in the Draft Guidelines is the requirement for the bank to list its shares on recognized stock exchanges within two (2) years from the grant of the banking license. Considering the present uncertainty and volatility in the capital markets and the inability to attract fair valuations, a mandatory listing within two (2) years seems to be a harsh measure. In our view, a listing of the bank within five (5) years from the grant of the license will be appropriate in order for the bank to build up its business, reputation and credibility for it to attract higher valuations through listing, and for the bank to list its shares at an appropriate time and not in times of uncertainty and volatility of capital markets.

(iii) The stipulation in the Draft Guidelines relating to the aggregate foreign shareholding being limited to 49% for the first five (5) years from the date of licensing of the bank is clearly a backward policy initiative, since the present Foreign Direct Investment Policy of India enables foreign investment of up to 74% in the share capital of private banks.

(iv) Other measures pronounced by the RBI in the Draft Guidelines, such as, requiring 25% of the bank’s branches to be in rural areas may prove to be onerous for new entrants seeking to establish a profitable venture. Also, the stipulation prohibiting applicants from deviating from the terms of the business plan submitted to the RBI is impractical measure. It will be prudent for the RBI to specify certain checks and balances to be in place for the applicant seeking to amend the business plan.

A Step Forward


The issuance of the Draft Guidelines is definitely a step forward towards the development of the banking sector. However, it will be prudent if the RBI considers reviewing the onerous stipulations while finalizing the guidelines to ensure the growth and smooth functioning of new entrants in the banking sector.

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