Introduction

Post liberalization, the Indian banking sector was opened up when the first round of licensing of private banks was done in 1993. Thereafter, there have been a few more rounds of licensing of banks by the Reserve Bank of India (“RBI”). The guidelines for the various rounds of licensing have not been uniform and as a result India has a number of banks working under differing regulatory regimes when it comes to organisation of business. There have also been concerns in the running of some private sector banks.

Against the above backdrop, RBI had constituted an Internal Working Group on July 12, 2020 to review the existing licensing and regulatory guidelines relating to ownership and corporate structure for Indian private sector banks with regard to international practices and domestic requirements. The report of the group was released on November 20, 2020 (“Report”).

The Report makes several recommendations which, if adopted, would impact the banking sector.

This note provides a snapshot of the key recommendations in the Report.

Shareholding of Private Banks

No change in initial lock-in requirement of promoter’s initial shareholding

Currently, 40% (forty percent) of paid up (voting) equity capital held by the promoters have to be locked-in during the first 5 (five) years of operations of a new bank.

The Report recommends that no change is required in the extant instructions related to initial lock-in requirements.

Maximum permitted holding in the long run proposed to be increased to 26% from the current 15%

Under the current guidelines for ‘on tap’ Licensing of Universal Banks in the Private Sector issued in 2016 (“Universal Bank Guidelines, 2016”), the shareholding by promoter/s and promoter group / non-operative financial holding company in the bank is required to be brought down to 30% (thirty percent) of the paid-up voting equity capital of the bank within a period of 10 (ten) years, and to 15% (fifteen percent) of the paid-up voting equity capital of the bank within a period of 15 (fifteen) years from the date of commencement of business of the bank.

The Report recommends that the cap on promoters’ stake in the long run (i.e. 15 years) may be raised from the current levels of 15% (fifteen percent) to 26% (twenty six percent) of the paid-up voting equity share capital of the bank. As per the Report this will balance the need for diversified ownership on the one hand and bring more skin in the game for the promoter, on the other. The 26% (twenty six percent) stake is proposed to be the maximum holding by a promoter in long run. This stipulation would mean that promoters, who have already diluted their holdings to below 26% (twenty six per cent), will be permitted to raise it to 26% (twenty six per cent), subject to meeting ‘fit and proper’ status. The promoter, if he/she so desires, can choose to bring down holding to even below 26% (twenty six percent), any time after the lock-in period of 5 (five) years.

Further, currently, for private sector banks, a shareholding limit of 40% (forty percent) is stipulated for ‘regulated, well diversified, and listed/ supranational institution/ public sector undertaking / Government financial institutions’ in the long run. As per the Report such generic qualifiers as ‘regulated, well diversified’ may dilute the rigour of the process and therefore recommends that to keep regulations simple but meaningful, a uniform shareholding limit at 26% (twenty six percent) of the paid-up voting equity share capital of the bank for all promoter categories may be stipulated.

Sub-targets for dilution at 10 years proposed to be dispensed with

Under the extant guidelines, between 5 (five) to 15 (fifteen) years, an intermediate threshold of 10 (ten) years is provided, by when the shareholding has to be brought down to 30% (thirty per cent) (and 20% (twenty per cent) for banks licensed under Guidelines for Licensing of New banks in the Private Sector, February 22, 2013 (“Licensing Guidelines, 2013”)).

The Report recommends that the intermediate sub-targets may be dispensed with. Instead, at the time of issue of licences, the promoters may submit a dilution schedule which may be examined and approved by RBI.

Shareholding by non-promoters proposed to be capped at 15% in the long run

As regards non-promoters, the extant guidelines provide for a three-tier long run shareholding limits for investors in a bank:

The Report recommends that the current long run shareholding guidelines for non-promoters may be replaced by a simple cap of 15 (fifteen) per cent of the paid-up voting equity share capital of the bank, for all types of non-promoter shareholders in the long run. However, it is recommended that RBI should reserve the right to prescribe any lower ceiling on holding or curb voting rights of the promoters/non-promoters, if at any point of time they are found to be not meeting ‘fit and proper’ criteria.

Further, the provisions to permit any higher holding by a promoter/investor in special circumstances (such as relinquishment by existing promoters, rehabilitation / restructuring of problem / weak banks / entrenchment of existing promoters or in the interest of the bank or in the interest of consolidation in the banking sector, etc.) are proposed to be continued.

Change in shareholding of major shareholders to be monitored

The Report states that it is desirable that RBI has some monitoring mechanism over the major shareholders of such entities to ensure that their control does not fall in the hands of persons which are not fit and proper. Such monitoring mechanism would have to be devised through licensing conditions, such as stipulating reporting requirements as and when any shareholder becomes a ‘significant beneficial owner’.

Pledge of shares by promoters not to be permitted to the extent of the prescribed minimum shareholding

The Report recommends that during the lock-in period, promoters should not be permitted to pledge their shares to the extent of the prescribed minimum shareholding (as mentioned above).

Further, it is recommended that in case the invoking of the pledge results in purchase/transfer of shares of a bank beyond 5% (five per cent) of the total shareholding of the bank, without prior approval of RBI, then the voting rights of such pledgee should be restricted till the pledgee applies to RBI for regularisation of acquisition of these shares.

ADRs and GDRs issued by banks – Proposal to require RBI’s prior approval

RBI had advised in 2005 that in case of issue of American Depository Receipts (“ADRs”) and Global Depository Receipts (“GDRs”), banks will need to obtain RBI’s acknowledgement if the shares held by depositories exceeded 5% (five percent) of the paid up capital of the bank. In 2007, RBI had advised banks to furnish to RBI a copy of the depository agreements entered into by banks with the depositories. Additionally, banks were required to provide an undertaking to RBI that they would not give cognizance to voting by the depository in contravention of its agreement with the bank and that no change could be made in terms of the depository agreement without prior approval of the RBI.

The Report states that RBI may advise the banks to seek its prior approval before entering into agreements with depositories. If promoters hold more than 15% (fifteen percent) holding, banks maybe advised to modify the depository agreement to assign no voting rights to depositories through a suitable clause in the agreement.

Further, the Report recommends that banks explicitly reckon the holdings by depository receipt holders through appropriate disclosure of these holders to the investee banks. Such a measure would enable combining of the direct and indirect shareholding in the bank for the purpose of compliance with the cap prescribed in Section 12B of the Banking Regulation Act, 1949 and for arriving at the effective voting rights of a shareholder in the bank. The banks may enter into an agreement with the depository to the effect that the depository shall disclose the list of holders of depository receipts issued by them to the bank.

Eligibility of Promoters

Individuals

Currently, the Universal Bank Guidelines, 2016 for on-tap licensing explicitly permit individuals/professionals who are defined as a resident under the foreign exchange regulations and have 10 (ten) years’ experience in banking and finance at a senior level to be eligible to promote banks, singly or jointly. Under the 2019 Guidelines for ‘on tap’ Licensing of Small Finance Banks in the Private Sector (“Small Finance Bank Guidelines, 2019”), resident individuals/professionals (Indian citizens) singly or jointly, each having atleast 10 (ten) years’ experience in banking and finance at a senior level are eligible. The Report does not recommend any change in the extant guidelines.

However, the Report recommends that the eligibility criterion is defined as ‘individuals/professionals who are residents (as defined in FEMA Regulations, as amended from time to time) and Indian Citizens (as defined in the Citizenship Act, 1955) having 10 (ten) years of experience in banking and finance at a senior level to be eligible to promote banks, singly or jointly’.

Entities / Groups

Currently, under the Universal Bank Guidelines, 2016 and the Small Finance Bank Guidelines, 2019, the eligibility criteria for promoter entity/companies/societies requires ownership and control by residents as defined in the foreign exchange regulations. The Universal Bank Guidelines, 2016 also stated that the bank should be controlled by residents, as per the foreign exchange regulations at all times. Under the Guidelines for Licensing of Payments Banks, 2014 (“Payments Banks Guidelines, 2014”), the eligibility criteria for promoters, allow companies and societies ‘owned and controlled by residents’. The Report recommends the modification of criterion to ‘entities/groups in the private sector are owned and controlled by resident Indian citizens as defined in FEMA Regulations, as amended from time to time’.

Further, the Report concludes that the stipulation of successful track record in running businesses for 5 (five) years and 10 (ten) years for promotion of small finance banks and universal banks under the extant on-tap guidelines does not require any change. However, it has recommended that if payments banks intend to convert into small finance banks, a track record of 3 (three) years’ experience as payments bank may be sufficient in case, the promoters had experience prior to setting up the payments bank.

Large Corporate/Industrial/Business Houses

In the Licensing Guidelines, 2013, RBI had prescribed structural requirements of promoting a bank under a non-operative financial holding company (“NOFHC”) which permitted industrial and business houses to set up banks with certain conditions. The 2014 Reserve Bank Guidelines for Licensing of Small Finance Banks in the Private Sector restored the explicit prohibition on large corporate and industrial houses from promoting banks which has since been consistent under subsequent guidelines.

The Report recommends that large corporate/industrial houses may be permitted to promote banks only after necessary amendments to the Banking Regulation Act, 1949 to deal with connected lending and exposures between banks and other financial and non-financial group entities.

Further, the Report recommends that RBI may strengthen the supervisory mechanism for large conglomerates including consolidated supervision and examine necessary legal provisions that may be required to deal with all concerns in this regard.

NBFCs

Currently, under the Universal Bank Guidelines, 2016, non-banking financial companies (“NBFCs”) are permitted to convert into a universal bank provided the promoters meet the fit and proper criteria including a 10 (ten) year track record of successful operations, the NBFCs are part of a group with total assets of over Rs. 5000 crore and the non-financial business does not exceed 40% (forty percent) of the group’s total assets/ total income.

The Report recommends that well run large NBFCs, with an asset size of Rs. 50,000 crore and above, including those which are owned by a corporate house, may be permitted to convert to banks provided that they have completed 10 (ten) years of operations and meet the due diligence criterion and satisfy the conditions under the extant Licensing Guidelines, 2013. The Report also suggests that RBI may consider putting in place a tighter, bank-like regulatory framework for scale-based regulation of NBFCs.

Corporate Structure – NOFHC

The Licensing Guidelines, 2013 required new banks to be held by promoters only through a NOFHC. The Universal Bank Guidelines, 2016 modified the requirement and NOFHCs were made mandatory only in cases where there is at least another entity, not necessarily a financial entity, in the group apart from the bank. In all cases with NOFHCs, all regulated financial services entities, including the bank, belonging to a corporate group had to be held through the NOFHC whereas the other business had to be necessarily held outside the NOFHC. The Universal Bank Guidelines, 2016 refined the above to NOFHC holding only those financial services entities in which the individual promoter(s) / group have significant influence or control.

The Report recommends the following:

• New banks:

NOFHCs should continue to be the preferred structure for all new licenses to be issued for universal banks. However, the NOFHC structure may be mandatory only in cases where the individual promoters / promoting entities / converting entities have other group entities.

• Existing banks:
  • Banks currently under NOFHC structure may be allowed to exit from such a structure if they do not have other group entities in their fold.
  • Once the NOFHC structure attains a tax-neutral status, all banks licensed before 2013 should move to the NOFHC structure within 5 (five) years from announcement of tax-neutrality.

• The concerns with regard to banks undertaking different activities through subsidiaries/JVs/associates should be addressed through suitable regulations till the NOFHC structure is made feasible and operational. RBI may frame suitable regulations in this regard, inter alia, incorporating the following and the banks must be required to fully comply with these regulations within a period of 2 (two) years:
  • The bank and its existing subsidiaries/JVs/associates should not be allowed to engage in similar activity that a bank is permitted to undertake departmentally. The term ‘similar activity’ may be defined clearly.
  • If a group entity desires to continue undertaking any lending activity, the same shall not be undertaken by the bank departmentally and the group entity shall be subject to the prudential norms as applicable to banks for the respective business activity.
  • Banks should not be permitted to form/acquire/associate with any new entity (subsidiary, JV or associate or make fresh investments in existing subsidiary/JV/associate for any financial activity. Investments in asset reconstruction companies may be as per extant norms. However, banks may be permitted to make total investments in financial or non-financial services company which is not a subsidiary/JV/associate upto 20% (twenty per cent) of the bank’s paid up share capital and reserves, subject to all other conditions of the guidelines on para-banking.
  • Banks should put in place group-wide capital management policy with respect to risks faced by its subsidiaries/JVs/associates, subject to supervisory review.

Minimum Initial Capital Requirement

The Report recommends that the minimum initial capital requirement for licensing new banks be enhanced as follows:

1. For universal banks: The initial paid-up voting equity share capital/net worth required to set up a new universal bank, has been proposed to be increased to Rs. 1000 crore.
2. For small finance banks: The initial paid up voting equity share capital/net worth required to set up a new small finance bank, has been proposed to be increased to Rs. 300 crore

3. For urban co-operative banks transiting to small finance banks: The initial paid-up voting equity share capital/net worth has been proposed to be increased to Rs. 150 crore which must be increased to Rs. 300 crore in 5 (five) years

Further, the Report recommends that RBI put in place a system to review the initial paid up voting equity share capital/ net worth requirement for each category of banks, once in 5 (five) years.

Listing requirements

Currently, under the Universal Bank Guidelines, 2016 banks are required to be listed within 6 (six) years of commencement of business. The Payments Bank Guidelines, 2014 for payments banks mandates listing within 3 (three) years from date of reaching a net worth of Rs. 500 crore. The Small Finance Bank Guidelines, 2019 prescribes 3 (three) years for listing after reaching a net worth of Rs. 500 crore for the first time.

The Report states that small finance banks to be set up in future must be listed with 6 (six) years from the date of reaching the net worth equivalent to the prevalent entry capital requirement prescribed for universal banks or 10 (ten) years from the date of commencement of operations, whichever is earlier.

Further, the Report recommends that existing small finance banks and payments banks are listed within 6 (six) years from the date of reaching net worth of Rs. 500 crore  or 10 (ten) years from the date of commencement of operations, whichever is earlier. Universal banks must continue to be listed within 6 (six) years of commencement of operations.

Harmonisation of various licensing guidelines

The Report recommends that whenever a new licensing guideline is issued, benefit should be immediately given to existing banks if the new rules are more relaxed. In case, the new rules are tougher, legacy banks should confirm to new tighter regulations. However, the transition path may be finalised in consultation with affected banks to ensure compliance with new norms in a non-disruptive manner.  If changes in norms as recommended in the Report are accepted by RBI, these should be applicable to existing banks in the same manner.

This note has been prepared by Adity Chaudhury (Partner) and Rongeet Poddar (Associate).