To hold, or not to hold?

ICICI Bank's proposal to set up a holding company, which in turn will own its life insurance firm, raised questions about a possible breach of the 26 per cent cap on foreign investment in the sector. In theory, the foreign investor can own up to 26 per cent directly in the life insurance provider, while also owning a significant stake in the holding company. Going by the Insurance Regulatory and Development Authority's (IRDA's) norms, this does not explicitly violate any rule, but it does appear to be a de facto increase in the cap. Given that the bank itself is regulated by the Reserve Bank of India, the central bank's views on the matter are, obviously, material. These have now been placed in the public domain through a discussion paper titled "Holding Companies in Banking Groups". The paper articulates a broad framework within which it assesses the pros and cons of various types of financial conglomerates. The concept of a "bank holding company", in which every bank is owned by a holding company which can also own other banks, is central to the model. Recognising the increasingly blurred lines between banking and other financial services, the paper also examines the concept of a "financial holding company" which, apart from owning a bank, can also own other financial service providers. This is seen as a clear step ahead from the current structure in India, where the bank itself owns shares in other financial service providers. While a holding company structure will allow for the exploitation of synergies, it will also insulate the bank itself from the risks intrinsic to the other businesses and therefore make for more efficient risk management within the banking system.

The paper, however, cautions that the benefits from this transition are not unambiguous. In order to contain risks, the holding company cannot own businesses outside the financial realm; nor should it be allowed to own businesses which are unregulated. It also goes into some detail about the dangers of multi-tiered holding structures in which the parent holding company owns other holding companies, which eventually own the actual businesses. This, the paper argues, can lead to great difficulties in measuring and monitoring the overall risk levels within the portfolio of businesses. Broadly, it favours movement towards the holding company model, but within certain boundaries dictated by transparency and the imperatives of managing system risks.

So, what is the RBI's view on the ICICI proposal? The paper addresses the issue of foreign ownership in one paragraph. It indicates that, while in the current structure the back-door increase in the cap is permissible, it would not be so in a holding company framework. In a rather ambiguously worded statement, it says that the exemption would not be allowed, or at least the regulator's approval of such a proposal would be open to legal challenge. Given the paper's overall advocacy of the holding company structure and the view that the proposal would not fly were that structure in place, it would be reasonable to infer that the RBI is not in favour of it. If so, the paper is a somewhat round-about way of saying this. It would be good to have some clarity and consensus on what exactly constitutes the foreign investment cap in the insurance and, perhaps, several other businesses as well.