Consolidation time

The Union Budget and the Reserve Bank of India's "Roadmap for Presence of Foreign Banks in India and Guidelines and Ownership and Governance in Private Banks" will have a significant impact on the financial sector.

Several reform initiatives have been announced. These include the removal of the upper and lower limits on the statutory liquidity ratio (SLR) and cash reserve ratio (CRR).

The intention is to equip the RBI with the flexibility to determine these ratios. After all, when the FRBM Act stipulates a gradual reduction in the fiscal deficit, the lower limit for the SLR too should logically be reduced.

If government borrowing is to come down in the next few years, it is all the more important to ensure that the economy has a vibrant corporate debt market.

The Budget's proposal to appoint a committee on corporate bonds and securitisation, to look into issues related to the development of the corporate bond market, needs to be seen in that context.

Amending the Securities Contracts (Regulation) Act to provide a legal framework for trading in securitised debt will also provide banks the wherewithal for ensuring greater flexibility with regard to their assets.

The Budget has also clarified that acquirers will get the benefit of carry forward losses after mergers or acquisitions, removing one uncertainty with regard to M&As.

Removing uncertainty is also supposed to be the objective of the RBI's road map for foreign banks. The road map is divided into two phases. In the first phase, up to March 2009, foreign banks will be allowed to acquire shares in only those private sector banks identified by the RBI for restructuring.

They will be allowed to convert their branches into a wholly-owned subsidiary or set up a wholly-owned subsidiary. But the wholly-owned subsidiaries are attractive only if they are treated on a par with local banks, whereas the RBI says that their branch expansion will be on a par with existing branches of foreign banks.

After April 2009, full national treatment may be given to the foreign banks. In short, if foreign banks had hopes of being allowed to acquire local banks or of operating on a par with them, that hope will now be realised after a time gap.

Nevertheless, the decision to remove the cap on voting rights is a positive move, as is the decision not to disturb existing licensing agreements whereby private bank promoters have a higher than 10 per cent stake. That limit will also not apply to restructuring weak banks, where private sector acquirers could be allowed a higher stake.

In short, the RBI is trying to ensure that the ownership of private sector banks is diversified, that they are adequately capitalised and operated by "fit and proper" persons.

At the same time, it wants to protect Indian banks from unrestricted foreign competition for at least four more years. It might seem that these guidelines slow down consolidation in the banking sector.

But that is not likely to be the RBI's intention. What the road map ensures is that the RBI remains able to determine the need for mergers and acquisitions on a case-by-case basis. The government and the regulator, rather than the market, will drive bank consolidation.