Somasekhar Sundaresan: Banking FDI lost in regulatory maze

A sunshine story always makes one feel good"" be it the in-the-face India Shining campaign or a subtler media campaign about the burgeoning foreign direct investment (FDI) into India.

Recent news reports rejoice at how FDI into India is comparable with that in China but for the sleight of hand adopted by the Chinese in computing their numbers.

But do we truly come out smelling of roses? If the banking industry were any barometer, we miss the mark by a long stretch. And this is not because of the Left parties that are supposed to be opposed to FDI"" their counterparts rule China"" but because of lack of clarity in local institutional thinking.

Consider the maze of regulations that regulate investment in banks and mostly work at cross purposes.

In March 2004, the NDA government announced that foreign ownership in Indian banks may extend to 74 per cent, with no individual sub-limit on either FDI or foreign institutional investors' (FII) holding.

Nearly a year later, but for whispers from the corridors of power, there is no sign of any operational amendments to exchange controls that are necessary to give effect to the stated policy of the government.

By itself, this should not have posed an issue. Numerous instances abound where the Reserve Bank of India (RBI), which administers exchange controls, has amended regulations under the Foreign Exchange Management Act, 1999 (Fema), months after the government's policy was published.

For instance, the restrictions on FII subscription to shares issued by print media companies came in when the government's views were known to the world for years.

Although the protectionist Press Note 18 of the government has been replaced by less restrictive Press Note 1, the regulations under Fema are yet to be amended.

Fema regulations governing remittance of funds abroad for subscription to foreign ESOP (employee stock option plan) have not been formally amended years after the RBI has substantially liberalised this activity through circulars.

However, what stoked potential investors' trepidation is the publication by the RBI of "draft guidelines" in May 2004, which, if implemented, would render nonsensical the government's stated policy on foreign investment in banking. If the RBI had its way, no person, Indian or foreign, may hold more than 10 per cent beneficial ownership in any Indian bank.

Worse, those holding above 10 per cent stake would have to scale down their holding in a phased manner. Since the draft communicates the thinking of the RBI to the world, no person in a right frame of mind would think of making an investment of above 10 per cent in any Indian bank ""leave alone 74 per cent (See Without Contempt, July 27, 2004).

The RBI is said to have concerns about foreign banks having a presence not only through an Indian branch but also through a controlled affiliate or subsidiary.

This may be a genuine concern (although the Banking Regulation Act caps voting power for any group of shareholders at 10 per cent), but should not come in the way amending Fema regulations to give effect to the government policy on foreign ownership. For, within the fungible limits of FDI and FII holdings, an Indian bank could have multiple shareholders and still stay away from being a controlled affiliate or subsidiary of another bank.

There is an even more confusing law in the form of guidelines issued by the RBI in February 2004 for issuing an "acknowledgement" (read "approval") for any acquisition of 5 per cent or more in an Indian bank.

To compute this 5 per cent holding, these guidelines include the holdings of all "associated enterprises" as defined in the Income-tax Act, 1961. The tax definition was meant to cover transfer-pricing practices, and includes all enterprises that are owned, managed or controlled, or are under common ownership, management or control.

But the adoption in the banking laws makes this very difficult for any institution to purchase banking shares.

For instance, all holdings of bank shares in various schemes of a mutual fund would get aggregated into the holdings of the sponsor of the mutual fund, and the promoter of the asset management company. On any given day, there could be a plethora of inadvertent violations of these guidelines, and which the RBI may not care much about.

But for those who would not wish to even technically cut corners, monitoring compliance with these guidelines can be a nightmare.

(The author is a partner of JSA, Advocates & Solicitors. The views expressed are his own.)