I-Sec sees $16.3 bn FDI inflows into private banks

Private sector banks have the potential to attract $16.3 billion of foreign direct investment (FDI) if foreign banks are allowed to buy up to 74 per cent of equity in these banks.

Another $2.3 billion of foreign portfolio investment is possible if the government raises foreign institutional investors (FII) ceiling to 30 per cent in public sector banks, a study by ICICI Securities (I-Sec) on bank ownership reforms said.

The existing guidelines announced in January 2004 permit FDI to the extent of 74 per cent in private sector banks. But the Reserve Bank of India's (RBI) draft guidelines issued in July 2004 have put the brakes on FDI flow in private sector banks.

The government is scheduled to announce fresh guidelines on banking sector ownership reforms this week. The FDI potential in private sector banks is based on the assumption that foreign banks acquire stake through new issue of shares.

The January 2004 guidelines had also raised FII holdings in banks to 49 per cent subject to the concerned bank board and subsequently the shareholders passing a resolution raising FII limit.

The I-Sec study says the revised norms would be geared more towards encouraging investments by foreign banks rather than non-banking entities.

While the central bank is apparently not in favour of relaxing its draft norms, the rigorous due diligence exercise conducted ahead of acquiring a stake might serve to allay apprehensions. Relaxation of norms for non-institutional stakes is spooked by recent events of alleged misuse of powers by some private bank promoters.

It expects the new private sector bank ownership guidelines to reiterate the permission for 74 per cent foreign holding in private banks, lift the 10 per cent voting rights cap after one year and allow foreign banks to take control of a private bank over a three to four year period.

I-Sec feels the FII limit in public sector banks would be increased immediately. Although the increase in FII ownership ceiling from 20 per cent to 30 per cent could be the only immediate reform, the increased capital needs of banks could force the government to expedite other reforms such as scaling down government stake to 33 per cent from 51 per cent.

Similarly, a merger of State Bank of India (SBI) subsidiaries could also be possible.

Investor interest in the first phase of reforms is likely to centre on frontline public sector banks. SBI and Bank of Baroda (BoB), with FII investment already touching 20 per cent, will be the immediate beneficiaries.

ICICI Securities expects more broadbased benefits for private banks. The overall thrust is likely to be positive and conducive for consolidation to begin in earnest; politics remains the key risk to implementation.

Ownership reforms in banking will go a long way in increasing overall investor interest in the sector. Even a phased and protracted process, than estimated in the study, could keep investor interest alive due to clarity on policy direction, thereby facilitating potential entrants to formulate their strategy.