Financial conglomerates under scanner

Large groups to set aside more capital if exposure to group entities is above 20% of their paid-up capital.

In an effort to bring down the risk profile of financial conglomerates with diversified business interests, the Reserve Bank of India (RBI) has asked them to set aside more capital if their exposure to associated entities exceeds 20 per cent of the paid-up equity of these entities. The earlier threshold for such capital provisioning was 30 per cent.

Several financial conglomerates such as SBI, ICICI Bank and HDFC have exposure across the spectrum, including insurance, brokerages, securities, investment banking and mutual funds, with varying risk profiles.

The central bank’s move comes just ahead of the setting up of the Financial Stability and Development Council, which will oversee diversified financial conglomerates. The move also comes against the backdrop of global efforts to ensure financial stability and the ongoing debate over vulnerability of large financial entities. It is in accordance with Basel-II norms, which stipulate capital adequacy norms for financial conglomerates.

In its second quarter review of monetary policy, RBI has proposed that wherever the investment exceeds 20 per cent, “the paid-up equity of such entities shall be deducted at 50 per cent from Tier-I and 50 per cent from Tier-II capital, when these are not consolidated for capital purposes with the bank.”

“In addition, all investments in other instruments eligible for regulatory capital status in these entities shall be deducted at 50 per cent from Tier-I and 50 per cent from Tier-II capital; and the deductions indicated above will also be applicable while computing the capital adequacy ratio of the bank on an individual basis.”

Simply put, RBI wants financial conglomerates, which are not incorporating their exposure to associated entities in consolidated accounts, to make additional provisions to mitigate any risk from such exposures.

“While reporting to RBI, if banks don’t consolidate investments in their subsidiaries, the financials of such investments are not reflected in their balance sheets. In turn, it leaves the banks’ capital adequacy requirement opaque. This move is to ensure that banks are well capitalised to meet their consolidated capital needs and conglomerate exigencies, if any,” said Abizer Diwanji, executive director, head – financial services, KPMG.

RBI also wants to put limits on inter-group transactions and exposures in conglomerates. But it stayed away from issuing detailed guidelines on the matter, for the time being.

Analysts said the moves were on expected lines, keeping in mind the global effort to increase the cost of speculative activities and regulate financial conglomerates. RBI, too, has set up a panel to supervise financial conglomerates.

“The regulator is also trying to bring minority shareholders to provide more capital for their subsidiary investments by lowering investment limits. The central bank wants holding institutions to be well capitalised for contingency and risk associated with subsidiaries,” said Ashvin Parekh, partner – national industry leader for global financial services at Ernst & Young.

Raising capital in India will not be a challenge for banks at this juncture, as the requirement will not be very high, but analysts feel fund-raising can also impact the return on equity, impacting investor sentiments.

These norms will be revised when the Basel-III norms kick in. “The best part about Basel III is that it will be implemented in two phases — one in 2014 and the other in 2019. Banks have enough time to comply and provide the extra capital required,” Parekh said.

Holding co structure in the works
The Reserve Bank of India reiterated it was working on a discussion paper on the introduction of a bank holding company structure in India. However, it did not mention any time-frame. A working group under Deputy Governor Shyamala Gopinath has been constituted to look into its introduction. RBI said it was work in progress. Among other things, the group will look at legislative framework required by the likes of ICICI Bank and State Bank of India to rework their structure.

The holding company model is expected to reduce the burden on banks to infuse funds into capital-intensive businesses like life insurance. RBI has insisted that banks with various subsidiaries maintain a higher capital base to ensure the core banking business does not suffer for want of adequate capital.