[By Shashwat Shukla & Kumar Aryan]
The authors are students of National Law University Delhi.
Introduction
India is emerging as one of the world’s fastest growing economies incentivizing global markets to claim a piece of this pie. Foreign banks are keen on deals in India especially as it angles for regional trade agreements. Such pacts could open up new opportunities in India for global lenders elsewhere in Asia and the Middle East. Moreover, the Indian banking regulator has shown willingness towards the entry of these foreign banks in the Indian banking sector in order to introduce a fresh stream of long-term capital into the market.
The RBI last month relaxed its rules to let a Japanese bank, Sumitomo Mitsui Financial Group Inc., acquire 20% stake in YES BANK amidst reports of two foreign institutions vying for a stake in IDBI Bank. In light of these developments, certain impediments can act as deterrents for such stake sales. We can trace the policy architecture when it comes to letting foreign banks enter the Indian market back to 1991 when Committee on the Financial System (CFS) was established to examine the existing financial system and make recommendations for reforms in India. One of the objectives of the CFS was to introduce competition into the banking system by encouraging the entry of new foreign banks and the expansion of existing foreign banks. This objective becomes all the more crucial to adopt and formulate a regulatory approach in alignment with the current economic ambitions of the state.
While there are norms established by the RBI which puts a cap of 26% on voting rights of a promoter of a registered banking company, which serves as protection from excessive control by a single entity over a sector which is of national economic relevance. The same, as will be argued in this article, is not in consonance with the overall regulatory framework and the objective which the regulator seeks to achieve. Hence, an objective reconsideration of the quantum of these caps is required.
This article is structured into four key sections, the next section examines the regulatory framework with a focus on RBI and FDI norms. Following this, the section critically analyses the rationale and drawbacks of the voting rights cap, drawing on the global best practises. The article concludes by offering a forward-looking perspective on recalibrating regulatory policy to align with India’s growth ambitions.
Regulatory Framework Governing Foreign Ownership in Indian Banks
When identifying structural regulatory flaws, it becomes crucial to look at the entirety of the regulatory framework governing any concerned transaction. In the case of foreign banks or entities seeking to acquire a stake in Indian private sector banks, FDI rules are the primary regulations that govern all foreign long term capital investments in Indian entities. While FDI rules do permit acquisition of up to 74% of any Indian private bank by a foreign entity with government approval (up to 49% through automatic route), the rules of RBI on holding and acquiring of Indian banks puts a cap of 26% of voting rights for promoters and a cap of 15% on investments by financial institutions.
Furthermore, the SEBI Takeover Code mandates that if any company acquires a 25% stake in another company, then they will be required to further make an open offer to acquire 26% of that entity, effectively giving the acquiring company a majority stake of the acquired company. This is done to give other shareholders an opportunity to leave their stake in the company where the leadership is changing. However, in the context of the present transaction, the dilemma for foreign companies arises when they try to acquire an Indian bank, as soon as they hit the 25% mark, they will be mandatorily required to make an offer for majority stake meanwhile the RBI rules will not let them have voting rights proportional to the stake they will be required to acquire due to the 26% cap.
Therefore, any increase in the 26% cap on voting rights, or the 15% investment threshold could encourage foreign bank investors. There could be opportunities for investments in India’s mid-sized banks by foreign banks looking to expand their presence in India, although it can be inferred that the RBI’s preference is for foreign banks with a strong performance and governance record to acquire stakes larger than 26% through wholly owned Indian subsidiaries regulated in India. Therefore, the current regulatory framework severely discourages any foreign entity to acquire a stake of more than 25% because of the takeover code, effectively defeating the objective RBI is seeking to achieve.
Reforming the Cap: A Case for Phased Liberalisation
The regulations were brought to ensure diversification and prevent the shareholders from dominating bank policy or ownership. This was in line with protecting financial stability and public interest. The regulator is trying to ensure bank governance remains dispersed by capping it acts as a shield against the takeovers and instability that may be created by the exit of a single investor. Though the RBI’s framework stresses on having a cautious approach to foreign control by the diversification route, the 26% voting cap is a unique feature, as major countries allow shareholders voting rights in sync with their equity. The capping, as a result, leads to a situation where even highly capable foreign banks cannot control the board decision and have to comply with strict voting limit requirements, and this deters them from entering the Indian ecosystem. The ownership restrains are codified in the Banking Regulation Act and the RBI Guidelines, which fit into a broader Indian framework, emphasising fit and proper test and RBI approvals for any significant bank investor.
These legal safeguards have created major impediments for the burgeoning economy, which currently finds itself in a capital shortfall. As per one of the RBI reports, the credit to GDP ratio in India, i.e., 90% lags much behind the global average of approximately 113% highlighting the loan deficit market. Strategic investments by way of long-term infusion of capital are needed to bridge the gap. The foreign banks account for only 4% of India’s outstanding bank credit, partly because of the strict limits imposed by the regulators. The voting limit has made any large acquisition unattractive, the recent Fitch Ratings noted that voting rights caps have been a key deterrent to larger foreign stake sales.
Focusing on the trend across major economies, the USA permits proportional voting rights, allowing banks to own majority stakes subject to the approval of regulators. Even traditionally restrictive markets like China have eased their regulations, leaving India as the outlier. The Indian economy, where the credit and growth needs are immense, with RBI itself stating that it prefers foreign banks to invest with strong governance models to acquire Indian banks through wholly-owned Indian subsidiaries. Foreign investors should not be viewed merely as sources of capital, but injection of global best practices in the Indian economy. Foreign participation will also reduce the risks associated with the management of Indian banks and the governance for stability.
In sum, the voting cap, which were intended to protect banking stability, but are constraining capital access, needs to be reconsidered. The RBI has also acknowledged the need to revisit eligibility conditions. Reforms such as raising the voting cap in a phased manner to 40% or beyond could act as a catalyst in balancing stability and capital needs. The relaxation of the 15% limit would hugely benefit the Indian markets in unlocking fresh capital. The strategic investors’ concerns about their voting rights commensurate with their equity are a step long overdue. The continuing trend of approving on a case-by-case basis should also be done by providing clearer guidelines so that the scope of ambiguity is ruled out in larger acquisitions. The applications made by the foreign investors with sound credentials should not face the hurdles of the regulator. While the RBI’s caution stems from past governance failures, evolving supervisory tools like fit and proper tests can be seen to mitigate the risks from higher voting stakes.
Conclusion
India is entering a new financial era and urgently requires an infusion of capital. Foreign banks and investors could help meet this need it regulatory framework align with the country’s economic priorities. The current 26% cap on foreign voting rights which was originally intended to ensure stability and diversified ownership now conflicts with efforts to attract long-term investment and improve governance in the banking sector.
India’s policy currently gives mixed signals; it invites foreign capital but restricts foreign influence. As other countries ease restrictions to attract strategic investors, India risks appearing overly cautious or indecisive. A phased relaxation of the cap, with strict eligibility criteria and fit and proper tests, could balance caution with progress. Attracting appropriate foreign investor while safeguarding the banking sector’s integrity would allow India to unlock new capital, adopt global best practices and drive its next phase of economic growth.