A V Rajwade: Holding companies holding back banks

WORLD MONEY

It would be a pity if the growth of banks like SBI and ICICI is held up by the RBI's rigid views.

In an earlier article ("Bank credit and capital," May 11, 2007), I had argued that the scheduled banking system in India would need Rs 250,000 crore of additional capital in the current and next two years, given the likely credit growth in India. Operational risk capital of the order of Rs 50,000 crore under Basel-II, besides additional capital for expansion of off-balance sheet transactions and overseas operations would be extra. Core banking business apart, several banks have gone in (or are going in) for investment in insurance companies, securities business, AMCs, and so on. In short, with the approval of the regulators and owners, many banks are well on the way to becoming financial conglomerates. Of these allied businesses, insurance is a hugely capital-hungry activity. Clearly, the needs of the banking system for capital in its core and other financial services businesses are large; the two largest banks in India, SBI and ICICI, have already announced capital raising plans for the immediate future.

It is in this context that the current debate about the structure of commercial banks' holdings in insurance companies, securities business, asset management, and so on, assumes importance. The issue is of particular urgency for the two largest Indian banks who are active in all these areas, and has become a matter of some controversy after the RBI published on August 27 a discussion paper on "Holding Companies in Banking Groups". The two models under debate may be summarised as follows:

Model 1: A bank or financial holding company as the parent, with the commercial bank, insurance companies, and so on, as its direct or indirect (thatis, through an intermediate holding company) subsidiaries.

Model 2: The commercial bank as the parent, with investments in insurance and other financial services companies directly or through an intermediate holding company, which would be a subsidiary of the parent. ICICI Bank seems to have gone significantly ahead for augmenting its capital structure, using this model, which SBI has also announced that it is adopting.

The discussion paper suggests that the central bank prefers the Model-1 approach with the "caveat that suitable statutory framework is created a priori and un-regulated entities within the structure are avoided." The central bank's worry is that the intermediate holding company under Model-2 may not fall within its regulatory ambit; may leverage itself in a risky fashion, forcing the parent commercial bank to come to its rescue in the event of any problem.In turn, this could jeopardise the capital ratio of the parent bank, and hence the interest of its depositors. The central bank's apprehension is that the operations of the intermediate holding company could be so structured that "it would not require registration under Section 45-I A of the RBI Act and would therefore not come under the regulatory purview of the Department of non-Banking Supervision of the Reserve Bank of India." In the debate, the Indian Bank's Association has supported Model-2, at least as an interim measure, arguing that the IHC would come under RBI supervision as an NBFC.

From a practical perspective, the following points occur to me:

If the RBI were to insist on Model-1, this would obviously delay ICICI Bank's capital raising endeavours, particularly as legislative enactment would be needed and could be time-consuming. Clearly, this would be against the interests of the fast-growing Indian bank, which is catching up quickly on SBI as the largest bank in India.

This apart, a more general point is whether the central bank needs to have a legal enabling provision for its supervisory function: for a long time, the Bank of England managed to be a very effective banking supervisor, without legal powers of any kind. The RBI's apprehensions that the IHC would be unregulated, therefore engage into imprudent borrowings, threatening the capital adequacy of the parent, with RBI as the helpless spectator, seem somewhat far-fetched. Legal powers apart, would any commercial bank dare defy or flout any serious "advice" given by the central bank which, in any case, has licensed its functioning? Or ignore any conditions put by it on the intermediate holding company (that is, the bank's subsidiary)? (There are, of course, other areas of its supervisory functions as well where the RBI may find giving such informal "advice" useful: but it is also a matter of its organisational culture "" perhaps a bureaucratic, "note-based" culture can function only with its powers derived from Section ... of ...) It would be a pity if the growth of ICICI (or SBI) is affected because of a rigid stance on the part of the RBI, particularly when foreign investment in its IHC has already been cleared by New Delhi.

avrajwade@gmail.com