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REVISITING PROMOTER OWNERSHIP IN INDIA’S PRIVATE BANKING SECTOR

Soon after the Reserve Bank of India (RBI) released a discussion paper on private bank governance dated June 11, 2020, proposing term limits for CEOs and Whole Time Directors of banks, the regulator also constituted an Internal Working Group to review regulatory guidelines relating to promoters’ holding, the requirement of dilution, and voting rights in private banks. These measures point to a rethink of extant norms on promoter shareholding in India’s private banks, with the objective of transitioning all private banks to uniform regulations.
The 2016 licensing guidelines of the RBI state that the individual promoter (or Non-Operative Financial Holding Company) must hold minimum 40% of the paid-up voting equity capital of the bank, which shall be locked in for a period of five years from the date of commencement of the business of the bank. It is pertinent to highlight here, that this ownership is not synonymous with complete control over the bank.
A larger shareholding does not necessarily lead to greater control, as the voting rights of each shareholder are subject to prudential limits. Section 12 (2) of the Banking Regulation Act, 1949 allows the RBI to extend voting rights of an individual shareholder up to 26%. However, RBI in its 2016 licensing guidelines has set the current ceiling on voting rights at 15%, regardless of the extent of the promoter shareholding. Interestingly, such rules do not apply to Public Sector banks where the government is the majority shareholder.
Towards Ownership Dilution
In the recent past, the RBI has continuously revised ownership norms, in a flip-flop fashion. It increased the promoter holding limit to 49% in 2002 and then reduced it to 10% in 2005 as a reaction to the Global Trust Bank failure, which was linked to higher promoter shareholding. Subsequently, in 2013 RBI licensing guidelines specified that new private banks would be required to reduce the shareholding to 15% within 12 years of the commencement of banking business. Most recently this was revised in the 2016 ‘on tap’ licensing guidelines, which directed private banks to bring down promoter shareholding to 40% in the first three years after starting operations. Thereafter, the promoter shareholding must be reduced to 30% in 10 years and 15% in 15 years.
Promoter Shareholding Dilution Schedule (RBI On-tap Licensing Guidelines, 2016)
Time Elapsed from Commencement (in years)
Dilution Requirement
3
40%
10
30%
15
15%
The rationale behind this reduction is to bring about a diversified ownership structure for better governance which is critical for banking institutions which are ‘special’, as they not only accept and deploy large amounts of uncollateralised public funds in fiduciary but also leverage these funds through credit creation.
Although the regulator has issued the above-mentioned guidelines for ownership levels, they have not been consistently followed which has created ambiguity in relation to bank licensing.
Regulatory Conflict and Ambiguous Signaling
  • Kotak Mahindra-RBI Tussle: Kotak Mahindra Bank failed to reduce promoter shareholding to 20% from 30.3% by December 31, 2018, as mandated by RBI rules. For this reduction, the bank issued perpetual non-convertible preference shares – a method of dilution that the RBI did not find acceptable.
Kotak Mahindra Bank challenged the decision of the RBI in the Bombay High Court but eventually reached a ‘middle ground’ with the RBI. As per this, Uday Kotak was required to reduce shareholding to 26% (as opposed to the regulatory requirement of 15%) of the paid-up voting equity share capital, with voting rights being capped at 15%.
  • Bandhan Bank Restrictions: In 2018, Bandhan Bank had failed to bring down the promoter’s shareholding (which stood at 82%) to 40%, three years after the commencement of its operation. As a penalty, the RBI directed the freezing of Bandhan Bank CEO’s salary and placed a restriction on the opening of new branches without RBI-approval. Consequently, in 2019, through the acquisition of Gruh Finance, the bank was able to reduce the level to 61%, still failing to meet designated targets.
Bandhan Bank only arrived at the stipulated promoter shareholding dilution in August 2020. Yet, in February 2020 itself, the RBI removed the restrictions on new branches “considering the efforts made by the bank to comply with the said licensing condition”, and on the condition that at least a quarter of the new banking outlets to be opened in a financial year serve unbanked rural centres.
These cases highlight inconsistency in the application of RBI’s ownership norms. Not only was the permissible limit not arrived at by the banks, but different standards were applied to them, sending confusing signals to the industry on licensing norms. Most importantly, once specific guidelines have been set by the regulator, it is inappropriate to ‘settle’ with the regulated entity based purely on discretion.
Revisiting Ownership Norms
Given the situation outlined above, a relook into ownership norms by RBI has become necessary. With voting rights below 25%, the promoter does not possess even negative voting rights, and control lies completely with the management. Such an ownership structure is a major disincentive in the creation of new banks, as evinced in the limited interest shown in new private banks in the last four years since the on-tap licensing guidelines were released.
India’s experience with bank failures, both in the public and private sector, shows that mere compliance with ownership limits does not guarantee good governance, propriety and ethics. Recently, former RBI deputy governor R. Gandhi stated that the RBI needs to revisit rules that restrict large corporates from promoting banks and allow single entities to hold up to 26%.
The universal argument supporting this stand is that since the promoter’s wealth and reputation are tied to the bank, s/he would work to protect both, and be directly accountable to shareholders. Yet, there is also a more nuanced rationale to this argument as stated below:
  • If the goal is to limit the promoter’s control over the management of the bank, the 15% cap on individual voting rights already achieves this. Thus, the need to dilute equity ownership is not entirely clear.
  • Prohibiting willing promoters from holding more than 15%, opens the doors to scattered investors who may not be invested heavily enough to scrutinise the affairs of the bank.
  • Finally, foreign investor influence is an increasing concern for the strategic banking sector. A Centre for Economic Policy and Research report from 2018 states that four of India’s top private banks (ICICI Bank, HDFC Bank, Axis Bank and IndusInd Bank) are majority-owned by foreign investors. This ownership pattern takes up increasing importance amidst reports that several public sector banks are set to be privatised.
Rather than repeatedly focusing on entity-based norms, the RBI must focus on activity-based regulation, governance and scrutiny. There is a need for a focus on broader governance issues such as internal conflict of interest, strengthening the role of independent directors, refining audit processes and enhancing supervision – the major factors behind recent bank failures. The RBI’s proposal to limit the tenure of Chief Executive Officers (CEOs) and Whole Time Directors (WTDs) to 10 years (for persons from the promoter group) and 15 years (non-promoter group), will serve as a check on the promoter unduly taking up a seat on the Board while also allowing newer banks time to stabilise operations.
The RBI’s recent relook at corporate governance and ownership norms is a welcome move and it is hoped that all decisions arrived at advance the responsibility and accountability of bank board members, including the promoters.

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ABOUT THE AUTHOR

 

Priyanka Sahasrabudhe is a student of Masters in Public Policy at the National Law School of India University, Bengaluru.

 

In Content Picture Credit: The Indian Express

 

 

Kindly note that the views and opinions expressed are of the author and not of the Indian Journal of Law and Public Policy.

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