Banking on Reforms

The Indian Parliament has finally passed the Banking Laws (Amendment) Act, 2012 (the "Act") in its recently concluded winter session and the President provided his assent soon thereafter. The Act amends the principal statutes governing banks in India, including the six-decade-old Banking Regulation Act, 1949 (the "1949 Act"). The Act has generated a lot of debate ever since it was first tabled and has undergone a fair number of changes through its seven-and-half-year-long journey through the Indian Parliament.

Certain amendments under the Acthave been keenly awaited and are much needed at a time when Indian banks commence the process of complying with the Basel III norms – which are to be implemented in India in a phased manner from April 1, 2013 with full compliance required by March 31, 2018. Like elsewhere across the globe, banks in India will face several challenges in complying with these new norms, with the principal one being the raising of additional capital. In its annual report published on August 23, 2012, the Reserve Bank of India (the "RBI") disclosed its estimate of the additional capital that is likely to be required. The numbers are staggering - the public sector banks alone would require fresh equity capital of about '1.4 – 1.5 trillion on top of their internal accruals, in addition to '2.65 – 2.75 trillion in the form of non-equity capital. For major private sector banks, the estimated new equity capital that will need to be raised is about '200 - 250 billion on top of their internal accruals and in addition to about '500 - 600 billion of non-equity capital.

In the light of the pressing need for Indian banks to raise substantial amounts of additional capital at a time when the Indian economy is facing challenging times and most of the public sector banks are reporting a spike in non-performing assets, the RBI has been actively pushing for some much-needed reforms. Further, as has been widely reported in the media, the RBI has been unwilling to issue new banking licences before it is given greater supervisory powers.

As such, the majority of the amendments under the Act fall into two broad categories – those which facilitate the raising of capital by banks and those which provide for enhanced supervision of banks by the RBI and the strengthening of its regulatory powers.

Facilitating raising of capital

The key amendments which facilitate the raising of capital are set out below:

1. Increasing the cap on voting rights – the cap on voting rights of shareholders will be significantly increased from 1% to 10% for nationalised banks. As regards private sector banks, the Act provides that the cap may be increased by the RBI from the current 10% to 26% but only in a phased manner. In its original form, the bill proposed the removal of the restriction on voting rights in the case of private sector banks to allow proportionate voting rights to all shareholders. However, the Standing Committee on Finance, to which the bill was referred, recommended that instead of removing the voting rights restriction, the ceiling should be increased to 26%.
2. Issuance of preference shares – private sector banks will be allowed to issue preference shares in accordance with RBI guidelines. At present, the 1949 Act provides that the share capital of a banking company can only comprise equity shares and preference shares, but only if the preference shares were issued prior to July 1944. Nationalised banks are however permitted to issue preference shares.
3. Rights issue and bonus shares – nationalised banks will be allowed to raise capital by way of a bonus issue or rights issue of shares in addition to a public issue which is the only means allowed at present.
4. Alteration of authorised capital – the authorised capital of nationalised banks may be altered by the Central Government in consultation with the RBI with no limit set for the maximum authorised capital. At present, the authorised capital of such banks can only be increased to '30 billion.

In addition to the above, in order to facilitate the conversion of branches of foreign banks operating in India into wholly owned subsidiaries in India, the Act will make certain amendments to the Indian Stamp Act, 1899 providing stamp duty exemptions for such conversions and transfer of assets in relation to such conversions in terms of a scheme or guidelines to be notified by the RBI.

Enhanced powers of the RBI

Perhaps the most significant of all amendments provided for in the Act is the RBI’s power under the 1949 Act to supersede the board of directors of a banking company after consultation with the Central Government and appoint an administrator instead for a total period not exceeding 12 months. At present, the RBI has the power to remove the chairman, any director or any other officer of a banking company but not the entire board of directors. In the insurance sector in India, broadly similar provisions are present in respect of appointment of an administrator for management of the business of an insurer. However, the power to make such an appointment rests with the Central Government (upon consideration of a report submitted by the sectoral regulator - IRDA). It is worth noting though that the grounds on which the existing management of an insurance company may be superseded under the Insurance Act, 1938 are much more limited compared to those under the Act.

While the powers granted by the amendment may appear very extensive, the RBI has been advocating for a strengthening of its regulatory control as it prepares to grant new banking licenses. As the new provisions are drafted in very broad terms and do not provide any clarity as to the circumstances in which such powers may be exercised by the RBI, it is hoped that this does not prove to be a disincentive to prospective applicants of new banking licences. It may be relevant to note that the new UK prudential regulator, Prudential Regulatory Authority (the “PRA”), also appears to have the power to require a change of management and/or composition of the board of the entities regulated by it.

However, there seems to be greater clarity on the exercise of these powers by the PRA as it is required to establish a Proactive Intervention Framework with clearly demarcated stages based on the risk assessment and viability of the entity and the remedial actions prescribed are commensurate with the viability of the regulated entity.2 It may help allay fears of unwarranted or unpredictable use of these powers if the RBI issues an approach paper outlining the broad principles and guidelines governing its use of such powers of supersession.

The other key changes as regards the RBI’s increased regulatory role and powers are set out below:

1. RBI approval for acquisition of 5% or more of shares or voting rights – no person will be allowed, without prior RBI approval, to acquire or agree to acquire shares/voting rights in a banking company which entitles such person to hold 5% or more of the total paid-up share capital, or exercise 5% or more of the total voting rights, of a banking company. An approval may be granted by the RBI for acquisition of such shares or voting rights if it is satisfied that the applicant is a fit and proper person. The RBI will also have the power under the 1949 Act to impose such conditions as it deems fit while granting approval including specifying a minimum percentage of shares to be acquired by the applicant.
2. RBI’s power over associates of banking companies – The RBI will have the power under the 1949 Act to direct a banking company to furnish financials and other information in respect of any “associate enterprise”. The RBI may also inspect the books of accounts of the associate enterprise jointly along with the board of authority regulating such associate enterprise. The definition of “associate enterprise” is very broad and includes enterprises which in the opinion of the RBI, “exercise significant influence on the banking company in taking financial or policy decisions”3 and “enterprises which are able to obtain economic benefits from the activities of the banking company”4. This amendment was one of the key requirements by the RBI prior to issuance of banking licences to corporate houses.
3. Enhancement of fines for contravention – fines for contravention of the provisions of the 1949 Act will be increased manifold to give the penal sections more teeth. As an illustration, fines for contravention of certain provisions will be increased from the present '2,000 to '2 million.

As would be evident from the scope and nature of the amendments set out above, the Government and the RBI appear to be proceeding with banking sector reforms very gingerly and though the clear emphasis is on enabling banks to raise more capital by providing newer sources and making investment in banks more attractive, there is, at the same time, a simultaneous tightening of the RBI’s regulatory leash over the banks. Separately, as far as understanding the precise scope and extent of the change to the regulatory landscape in the banking sector is concerned, the passing of the Act is only the first stage as most provisions in order to be implemented require further action from the RBI – whether by way of issuance of relevant guidelines or otherwise. As such, all eyes will now be on the RBI as the market keenly awaits the implementation of the reforms and the issuance of the new banking licenses.

Footnote:
1 Pursuant to Section 52A of the Insurance Act, 1938, if the IRDA has reason to believe that an insurer carrying on life insurance business is acting in a manner prejudicial to the interests of holders of life insurance policies, the IRDA may make a report to the Central Government. The Central Government may if it thinks fit appoint an administrator to manage the affairs of the insurer. From the date of appointment of the administrator, the management of the business of the insurer will vest in such administrator and any person vested of such management immediately prior to that date shall be divested of that management. 2 See The Bank of England, Prudential Regulation Authority, Our approach to banking supervision at http://www.fsa.gov.uk/pubs/speeches/boe_pra.pdf. 3 Clause 9 (inserting new Section 29A in the Banking Regulation Act, 1949), Banking Laws (Amendment) Bill, 2012, 4 Ibid.

Disclaimer – The views expressed in this article are the personal views of the author and are purely informative in nature.