New RBI norms on bank subsidiaries to overhaul equity holding structures

The Reserve Bank of India (RBI) is set to overhaul the equity holding structures in financial conglomerates and take the first formal steps towards the holding company (HoldCo) model when it comes out with guidelines on banks’ subsidiaries. The norms, expected to be announced soon, will bring to fruition a glide path that has engaged the regulatory authorities since 2007.

The new guidelines from Mint Road will entail a thorough review and recast by banks of their current exposure to subsidiaries, which straddle businesses ranging from investment banking and mutual funds to insurance and broking. In some cases, they have dedicated arms for credit cards and various back-end services. 

The move comes at a time when a host of state-run banks are set to jettison some of their non-banking ventures to raise capital. In effect, the stage is set for a spate of portfolio buyouts, leading to consolidation across the financial mart as outright mergers and acquisitions among banks will get a fillip. The differentiated-bank licensing policy, which has been articulated by the RBI in various discussion papers, will gather steam.

“It (new norms) will lead to cleaner holding structures within banking groups. The bank will not sit on the top of its subsidiaries, and as an investor you will have better visibility of what you are getting into,” said a source. 

The source pointed out that both the HoldCo and its one-drop subsidiaries can be listed; in the case of the latter, it will depend on the nature of business – whether it is a capital guzzler or not. A big benefit is that once the subsidiaries are separated from banks, their growth would not be constrained on account of capital, given that as on date there are also restrictions on the level of exposure to these entities. 

The RBI, it is surmised, may also come out with a variant – a main banking subsidiary under the HoldCo, which, in turn, will house all pure-play banking related arms as these anyway will have to report to Mint Road for operational purposes even as it helps cut down on regulatory and supervisory overlaps.

The Committee on Financial Sector Assessment (CFSA), in its report of March 2009, had noted the absence of the HoldCo structure in financial conglomerates, which it said exposed depositors and the parent company to risks and strains its ability to funds the core business. In the new arrangement, it will be up to the HoldCo to infuse capital in the subsidiaries. This will act as a bulwark for the bank -- from the direct impact of the losses in the subsidiaries when it is up-streamed to the consolidated balance sheet (of the bank). Bank boards, too, need not be burdened with the hassles of managing the subsidiaries. It will also enable a cleaner resolution in the cases wherein the parent bank is liquidated, without leading to the same fate for its subsidiaries.

The bigger picture is that after the financial crisis of 2008, deduction from a bank’s capital of its investments in the subsidiaries was not the uniform practice to test the capital adequacy on a standalone basis. The Basel-III framework wanted to plug this loophole, and since banks were found to be undercapitalised, it provided a long phase-in period till 2019 for banks and banking groups to recapitalise themselves. From this perspective, the HoldCo is seen as faring better.

It’s not known how the HoldCo will work in the case of state-run banks as statutes will need to be amended. The advantage though is that the capital needs of banks’ subsidiaries would be de-linked from the banks’ capital.

The P J Nayak Committee, which reviewed governance in banks in India, was for the Centre transferring its holding in banks to a Bank Investment Company (BIC), which, in effect, would be the HoldCo, and the transitioning of powers to bank boards with the intent of fully empowering them. It suggested the BIC to be set up as a core investment company under the RBI's registration and regulation. “The character of its business would make it resemble a passive sovereign wealth fund,” the panel said.

How restructuring will help 

• Move will lead to cleaner holding structures within banking groups

• Will ringfence banks from change in the fortunes of   subsidiaries

• Growth of arms will not be constrained by capital constraints of parent bank

• Bank boards will not be burdened with hassles of managing subsidiaries