Reversing reforms

The Reserve Bank of India's draft "policy framework for ownership and governance in private sector banks" marks a U-turn from the policy of opening up the country's banking sector.

The fundamental message is that the Reserve Bank does not want to encourage private banks; and where they exist, their shareholding should be widely held such that there is no promoter group.

This is a radically different approach from everything that has been said and done in recent years, and misreads the current stage of development of the Indian capital market.

Almost all Indian companies have a promoter group, and widely held entities without a promoter group can be counted on the fingers of one's hand.

Given that reality, no new private Indian banks can be born henceforth if the draft guidelines become policy. As for the existing private Indian banks, they will be forced to offload shares on to the IPO market in order to comply with the position that no one must hold more than 10 per cent in a bank (and this will certainly create a share overhang and affect valuations), or sell out to foreign banks "" who, ironically, are allowed to hold up to 74 per cent in an Indian bank (if certain conditions are met).

The logic of this quixotic set of draft rules is difficult to fathom, and marks in some ways a return to the kind of thinking that prevailed when Fera was re-enacted 30 years ago, in 1974 "" but this time moving against domestic promoters, not foreign ones. The net result will be to penalise entities that had, in good faith, made their decisions in accordance with the existing guidelines.

Readers should be aware that one of the entities to be affected is Kotak Mahindra Bank, which is the largest shareholder in this newspaper. However, the issue is one of general policy.

The draft guidelines, if they get firmed up, will affect HSBC's recent acquisition of a 14 per cent stake in UTI Bank (already the subject of a recent RBI ruling), and ICICI Bank's holding in Federal Bank. It will affect smaller entities like Bank of Punjab and Bank of Rajasthan, and perhaps the Singapore investment in ICICI (which is above the proposed 10 per cent limit).

It will probably affect Centurion Bank and also the Yes Bank that is about to be launched, since both have promoters with significant holdings at this stage of their history.

In short, virtually all the private Indian banks that one can think of will now have to start offloading stock and promoter holdings. Many of them will consider selling out to foreign banks who will be willing to pay a premium for control "" so the net result will be that Indian promoters sell out to foreign ones.

Almost every expert group, from the Narasimham committee onwards, has said that the banking industry needs consolidation. The new guidelines, if pushed through, will come in the way of such consolidation.

Another surprise is the decision to increase the minimum capital requirement for new banks, from Rs 200 crore to Rs 300 crore "" which may well affect the plans of some new banks that have been intending to get started.

The pattern makes the objective clear: raise new entry barriers. This will result in less investment in the sector, less competition, less efficiency and less choice for the consumer.