Seeks control over FHCs, irrespective of bank’s presence.
The Reserve Bank of India (RBI) on Monday paved the way for a holding company structure for financial entities. But it was done with an important caveat — the apex bank has sought to be the sole regulator of financial holding companies (FHCs), irrespective of a bank’s presence in the holding company. In addition, it has called for a separate regulatory framework and a new Act for regulation of FHCs.
A working group headed by RBI Deputy Governor Shyamala Gopinath has recommended that the FHC model can be extended to all large financial groups, irrespective of whether they have a bank or not. “Therefore, there can be banking FHCs controlling a bank and non-banking FHCs that do not contain a bank,” the panel said.
| THE BLUEPRINT Highlights of the proposed Financial Holding Company (FHC) structure |
| OBJECTIVE |
| FHCs will be non-operating entity, to carry out activities through subsidiaries |
| TYPES |
| FHCs will be of two types — banking and non-banking. For a banking FHC, restrictions will be imposed on expansion of non-banking businesses |
| REGULATOR |
| RBI will be the regulator of all FHCs. A separate unit within the central bank, formed by drawing staff from both RBI and other regulators, will regulate FHCs |
| REGULATION |
| FHCs will be regulated by a separate new Act, which will supersede all other Acts governing banks and companies in case of any conflict. Intermediate holding companies within FHCs will not be permitted. There will be limits on cross-holding between different FHCs |
| TAX TREATMENT |
| Transition to FHC model to be tax and stamp duty neutral. Dividend Distribution Tax to be exempted |
| LISTING |
| Both FHC and all or some of its subsidiaries can be listed, depending on objectives and strategy of the financial group and prevailing regulations on investment limits |
When the holding company structure was first mooted by ICICI Bank and State Bank of India in 2007, the regulator’s main concern was how to bring such structures under its purview, because a holding company may not come automatically in its ambit.
Now, the panel has made a strong case for RBI to be the regulator of FHCs. It feels that the implicit mandate of the central banks to ensure financial stability and monitor systemic risks makes it imperative to vest the responsibility of regulating FHCs with RBI. A holding company structure would ring-fence a bank or any other financial entity from the downside risks of its subsidiaries.
“RBI would be best suited to design a separate framework for regulating FHCs, with discernibly different focus from the regulation of banks,” the report said.
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It has been suggested that the function of FHC regulation should be undertaken by a separate unit within RBI, with staff drawn from both RBI as well as other regulators.
Till the time a new law is enacted and existing regulations are amended, the panel wants the FHCs to be registered with RBI as non-banking financial companies, while financial conglomerates having a bank within the group will need to convert to the FHC model in a time bound manner.
In cases the business conglomerates do not want to convert to FHCs, the panel wants such entities to confine to only banking activities. “This would mean that such conglomerates should eventually divest their holding in their subsidiaries,” it said.
For all other banking groups, conversion to the FHC model may be optional till the enactment of the FHC Act.
However, all new banks and insurance companies, as and when licensed, will mandatorily need to operate under the FHC framework.
“I would say the drafting of the report was done considering the global financial crisis and lessons learnt from it. The objective is primarily to prevent contagious risk flow from one group company to another. It is an important reform. I think banks would be keen to have a holding company structure. It reduces the reputational and operational risks,” said Ashvin Parekh, national leader, global financial services, Ernst & Young.
The FHC model, which should be the preferred one for all financial groups, will be a non-operating entity and permitted only limited leverage. The FHCs will be allowed to carry out all financial activities though subsidiaries only.
Importantly, in order to ensure growth of banking activity is not compromised by a bank-FHC, RBI will also consider limiting non-banking business expansion after the existing financial groups dominated by banks migrate to a holding company structure.
“Under the FHC structure, the allocation of equity capital by banking FHCs to non-banking subsidiaries should be capped at a limit deemed appropriate by RBI to ensure that banking continues to be a dominant activity of the group,” the report said. At present, a bank’s total investment in subsidiaries is capped at 20 per cent of its net worth.
In case the holding company wishes to function as an anchor for capital support for all its subsidiaries, the panel proposes either to have the holding company listed with the subsidiaries unlisted or some of subsidiaries listed along with the holding company.
In case of public sector banks, in which minimum government holding is stipulated at 51 per cent, the panel has suggested alternative approaches.
One, government holding in its banks get transferred to a holding company, which also holds shares in demerged bank subsidiaries. In such a scenario, government will be able to continue its support to banks and subsidiaries’ capital requirement. The alternative is that the government continue to hold directly in the bank while holding of all private shareholders gets transferred to the holding company. In this case, government can only support the capital need of the bank.
In the latter approach, which will create two large shareholders, the government and the holding company, the challenge will be governance of the bank with two blocks of director who could have differing interests.
Since the transition to the FHC model would involve demerger of various bank subsidiaries and transfer of ownership from bank to the holding company, the panel has suggested suitable amendments to various taxation provisions to make the transition tax and stamp duty neutral. In addition, the working group proposes exemption of dividend distribution tax for dividends paid by subsidiaries to the FHC if the dividends are used by the FHC for investment in other subsidiaries.