The holding company model for PSBs is an idea whose time has come

The non-operative financial holding company (NOFHC) is back in the headlines, thanks to the report of the Reserve Bank of India’s internal working group (IWG) on ownership guidelines in private banks. While attention has been drawn to it in the context of the banking ambitions of large corporate groups and fine-tuning of structures within existing bank-led financial conglomerates, the elephant in the room is the applicability of the holding company model to state-run banks through the Bank Investment Company (BIC).

That’s because in the immediate future, a decision on the level of capital infusion needed for state-run banks is up for review — and substantially more may be needed, post-pandemic. The RBI’s Report on Trend and Progress of Banking in India 2018-19 had noted: “Their capacity to sustain credit growth in consonance with the financing requirements of the economy will, however, warrant that capital is maintained well above the regulatory minimum, providing these banks confidence to assume risk and to lend.”

The idea of a financial holding company first found favour in the Shyamala Gopinath-led working group’s 2011 report and was later fleshed out by the PJ Nayak Committee (2015). “There is a need to design a radically new governance structure for these (state-run) banks, which would better ensure their ability to compete successfully, so that repeated claims for capital support from the Government, unconnected with market returns, are avoided,” the Nayak Committee had said. It favoured a BIC being set up under the Companies Act (2013) and repeal of the Bank Nationalisation Acts of 1970 and 1980, the SBI Act (1955) and the SBI Subsidiaries Act (1959).

Good starting point

“From an economic and efficiency perspective, it makes eminent sense,” says Subhash Chandra Garg, former finance secretary. “It’s a good starting point”, adds D Subbarao, former governor of the RBI, even though it does not amount to divestment. Of course, there is also the granular aspect to deal with, as Abizer Diwanji, partner and national leader-financial services at EY, thinks — it pertains to the fact that the subsidiaries of these banks could command higher valuations vis-à-vis the parent bank on removal of the Centre’s control. “If they were to come under the BIC, that wouldn’t help,” he says.

So, how has the BIC been imagined?

The Centre transfers its shareholding to the BIC, and every subsequent stake sale leads to fiduciary gains. “The government essentially gets leverage at two levels,” says NS Vishwanathan, former deputy governor of the RBI. The onus of finding a buyer is on the BIC under this construct, he says; hence, negotiations for stake sales (or divestment) take a market-oriented approach. The dividends accruing to the BIC from profit-making banks could be used to recapitalise those in need of funds. “The BIC is essentially a rubber between the government and the banks,” he adds.

It’s akin to the DBS Bank model. The bank’s holding company — Temasek — is essentially a sovereign wealth fund. “The structure will institutionalise an arm’s length relationship by severing the direct link the government has with state-run banks,” says Subbarao. That said, it does not mean that good governance will automatically follow from it.

“Regulations are meant to be ownership-neutral, but that may not really be the case,” points out Rajnish Kumar, former chairman, State Bank of India. State-run entities of all hues are prone to interference. Concurs Vishwanathan: “The Banking Regulation Act (1949) does not give the same powers to the RBI over state-run banks (compared to private banks).” This aspect was raised by former governor Urijit Patel as well.

The BIC can usher in changes on the human resource front, too — hiring at the top management level would be market-oriented. This would also add depth to board composition. “The quality of credit appraisal has been poor because they prefer to play it safe and lend to government entities,” notes Garg.
 

In a nutshell

• The Bank Investment Company (BIC) is to be set up under the Companies Act. It will be a core investment company under the Reserve Bankof India. Its other features:
• The Centre will be required to transfer its stakes in state-run banks to the BIC
• BIC’s business will be like that of a passive sovereign wealth fund
• The Centre and BIC are to sign a shareholder agreement that assures the latter autonomy and sets terms for financial returns
• BIC’s CEO is to be a professional banker or a private equity professional to be appointed through a search process
• BIC’s non-executive chairman and CEO are to be nominated by the Centre; all other directors are to be independent
• If needed, the Centre should hold less than 50 per cent in BIC

Source: PJ Nayak Committee Report (2015)

And if the Centre’s stake in state-run banks (even if indirectly held) is to eventually fall to 50 per cent, constraints emanating from the Central Vigilance Commission and Central Bureau of Investigation can be eased. The Nayak report had been blunt: “It is a fundamental irony that presently the government disadvantages the very banks it has invested in.”

As for the Centre’s willingness to cede control, “that’s the tricky part. If that desire isn’t there, then whatever is done isn’t going to yield results,” says Kumar. It would also entail massive statutory costs — stamp duty and income tax. The IWG observed that achieving tax-neutrality will be critical for banks (albeit private banks) to adopt the NOFHC structure. This would come into play for the BIC too. It would call for amendments on taxation of dividends, and a one-time relaxation of capital gains tax. And states should be willing to let go of stamp duty revenue on transfer of shares.

As to whether the BIC can absolve the Centre of its capital infusion responsibility for all time is doubtful, Diwanji says “the funding obligation would vest with the government,” if the BIC is going to be a 100 per cent subsidiary of the government. And therefore, a public-private partnership is critical for the model’s success.

In short, it’s a question of whether the government is willing to foot a heavy one-time bill for a long-term solution. Time is of the essence from here on.