Somasekhar Sundaresani: Policy yo-yo in banking laws is retrograde

WITHOUT CONTEMPT

The common minimum programme was dismissed by the market as being retrograde and confused. However, it was but a political agenda written for consumption by the electorate that voted the new government into power.

But what followed from the Reserve Bank of India (RBI) weeks later had no such excuses to hide behind.

By far India's most informed and professional financial market regulator, the RBI, recently published a draft document called "A Comprehensive Policy Framework for Ownership and Governance in Private Sector Banks". The document fails several tests of what a good law ought to entail.

At the outset, the draft policy envisages that the currently applicable 10 per cent cap on voting rights shall continue. This in itself is a policy rollback. Successive Budget speeches have held out that the law will be amended to remove this cap on voting rights.

But what follows is worse. The RBI now seeks to expand the scope of restricting private interest in Indian banks. The draft policy would have the RBI restricting direct and indirect economic and beneficial ownership in Indian banks, to 10 per cent.

Curiously, if a shareholder in a bank is a corporate person, then no other person ought to hold more than 10 per cent control or beneficial ownership in that corporate shareholder.

Considering that the maximum shareholding in a bank is sought to be capped at 10 per cent, the policy will actually mean no person can hold more than one per cent in a bank, if such holding is through a corporate entity.

A good legal system is known by its predictability and consistency. It is also a settled legal position that new laws can only be prospective and not retrospective. But the RBI has sought to make this a retrospective policy""it requires even existing banks to bring their shareholding pattern in line with the proposed policy in a "time-bound plan".

Several private investors have reposed faith in the Indian banking system by wholeheartedly stepping in to bail out ailing Indian banks, despite there being a cap on voting rights""with approval and knowledge of the RBI.

A case in point is Centurion Bank, which under the RBI guidance was bailed out not with taxpayers' funds but with private equity investment from various investors.

Bank Muscat SAOG, which folded its single-branch Indian operation into Centurion Bank for a 26 percentage stake in the Indian bank. If the draft policy becomes law, foreign direct investment by any single entity or group of related entities should also not exceed 10 per cent.

This intent of the RBI was never stated when foreign investors invested in Indian banks to bail them out.

Another example is that of ING Bank, which folded its Indian operations into ING Vysya Bank. The Development Credit Bank recently attracted private investment to bolster its capital adequacy. UTI Bank has consistently attracted private equity notwithstanding the legal limit on voting rights.

Limiting beneficial ownership and the economic returns that can be earned by an investor is an entirely new dimension that threatens to take the Indian banking system back to the dark ages it belonged to prior to the opening up of private investment a decade ago.

Gyrations in the legal and policy framework are not something the RBI was too notorious for. But with the draft policy, the RBI has joined the ranks of other Indian financial regulators that indulge in a frequent policy yo-yo. But that is a subject matter of a separate column altogether.

(The author is a partner with JSA, Advocates & Solicitors)