In a bid to ringfence the liabilities of non-banking finance activities in case of trouble and ensure that such problems do not pinch the more sensitive banking system too hard while also improving regulation and bringing more transparency in the financial system, the Indian central bank has mooted a financial holding company (FHC) structure for financial entities.
The Reserve Bank of India (RBI) has floated a discussion paper and has invited comments and suggestions before moving ahead with a new policy. Although certain proposals such as the RBI being the regulatory body for FHCs, even if they do not have banking operations, are controversial, the new structure will make the financial system more robust, especially after the experience from the financial/credit crisis which badly hit much of the globe just three years ago.
“The financial holding company model should be pursued as a preferred model for the financial sector in India,” a working group, headed by RBI deputy governor Shyamala Gopinath, stated in its report. It has been also recommended that the FHC model can be extended to all large financial groups, whether they have a bank or not. “Therefore, there can be banking FHCs controlling a bank and non-banking FHCs that do not contain a bank,” the panel said.
Incidentally, most large financial groups have banking as their key business and follow a bank-subsidiary model, in which the bank is the parent of all the subsidiaries. RBI, in its proposed norms for holding companies, said that the FHC can be a listed or unlisted company with all or few listed subsidiaries.
This means, for instance, that instead of the ICICI Bank being the banking holding company which has banking operations with subsidiaries engaged in other areas (such as insurance or asset management), there will be a new holding company under which the ICICI Bank will be one of the business subsidiaries. The holding company itself will not be an operating company.
Many other financial groups already operate through such a structure. For instance, Religare Enterprises is a financial services holding company with different operating subsidiaries.
According to RBI, banking groups should ensure that banking remains their core business while expanding in other non-banking areas. Currently, under the bank-subsidiary model, a bank’s total investment in its subsidiaries is capped at 20 per cent of its net worth. Under the holding company structure, the allocation of equity capital by banking holding companies to non-banking subsidiaries should also be capped, the report suggested.
“All new banks and insurance companies, as and when licensed, will mandatorily need to operate under the framework,” the report said. It also suggested slapping appropriate limits on cross-holding between different financial holding companies.
The proposed structure is similar to those existent in developed markets where holding companies like Citigroup are listed and serve as a vehicle for raising capital. The holding company, in turn, has subsidiaries in banking, asset management, insurance, investment banking and non-banking finance.
This is the second such report by RBI since 2007, when the country’s top banks SBI and ICICI Bank proposed an intermediate holding structure to meet the high capital requirements of their insurance companies. ICICI Bank, in particular, wanted to club all its insurance businesses under one umbrella and use this holding firm to raise capital for the subsidiaries. But the RBI was not in favour of such an intermediate holding company model.
In the new statement, the RBI panel reiterated its stand and said, “Intermediate holding companies within the FHC should not be permitted due to their contribution to the opacity and complexity in the organisational structure.”
The controversial bit is that RBI intends FHCs to come under its own ambit, even as a separate set of regulations under a new Act has been mooted for those. Pending the enactment of a separate Act, the FHC model may be operationalised under the provisions contained in the Reserve Bank of India Act. An FHC, accordingly, will be registered as an NBFC with the Reserve Bank, which will frame a suitable regulatory framework for FHCs, in consultation with other regulators.
“The function of FHC regulation should be undertaken by a separate unit within the Reserve Bank, with the staff drawn from both RBI, as well as other regulators,” the panel said. On paper, this appears fine, but in case of disagreement between various regulatory bodies, whose voice will prevail must be worked upon.
Although the new norms may result into a more organised financial sector, RBI has said that recasting conglomerates under the financial holding company structure can be done only after an enabling legislation is passed and the government gives a dispensation that provides a one-time tax exemption on such a recast. Also, amendments must be simultaneously made to other acts governing state-owned banks, the Companies Act and other legislations, wherever required, RBI has stated.
