New bank licences: CIC structures of large groups on RBI's watch list

Large conglomerates’ compliance with the Reserve Bank’s guidelines on core investment companies (CICs) may receive closer scrutiny ahead of the grant of banking licences.

The banking regulator’s August 13, 2020, circular had said the number of layers of CICs within a group (including the parent CIC) is to be restricted to two — irrespective of direct or indirect holding — and has to be adhered to by end of March 2023.

“The equity holding structure in banks is straight forward. In the case of non-banking financial companies (NBFCs), it’s not so. You can’t have a situation wherein banks start mirroring NBFCs on this front,” said a source, adding, “The need to disentangle the ownership labyrinth to understand both leverage and cross-ownership is important.”

It was also mentioned that the grant of licences will hinge on what the RBI’s onsite inspection of CICs throws up. 

In effect, the non-operative financial holding company that is to sit atop the bank will have to be ring-fenced from all manner of unrelated encumbrances for a licence.

It was pointed out that CICs within conglomerates set up over decades have linkages with their own entities and joint ventures, and it may be sometime before these are unwound. The said August circular did away with the definition of systemically important CICs (CIC-ND-SI) and with “exempted CIC”, which, RBI observed, provided unintended credibility to such firms.

The Gordian knot

• Non-operative financial holding company that is to sit atop the bank will have to be ring-fenced from unrelated encumbrances for a licence
• While compliance with CIC circular is to be applicable from date of circular, RBI allowed existing entities to reorganise structures by end of March 2023
• Investment by one CIC in another CIC in excess of 10% of owned funds has to adjusted from latter’s adjusted net worth
• There were 63 RBI-registered CICs with Rs 2,63,864 crore in assets and Rs 87,048 crore in borrowings as of August 2019
• There were 63 RBI-registered CICs with Rs 2,63,864 crore in assets and Rs 87,048 crore in borrowings as of August 2019
• Three FSRs of RBI highlighted the issue of leverage through the pledge of shares – Dec 2013, Dec 2014, Jun 2019

The circular says “any amount (direct or indirect capital contribution) made by one CIC in another CIC, to the extent that such amount exceeds 10 per cent of owned funds of the investing CIC, would have to be deducted”. Prior to this change, regulations did not provide for any deductions from the adjusted net worth of a CIC with respect to investments in another CIC in a group. While the regulation is to be applicable from the date of the circular, the RBI allowed “existing entities to reorganise their business structure and adhere to this guideline latest by March 31, 2023”.

The RBI has been seized of the extent of leverage within large groups even though some of the entities within them may not be non-performing assets on the books of banks. A related aspect is “the source of capital” that is to come into private banks — it has to be incremental, and cannot have been sourced as debt from banks in the first instance. “Otherwise, stress from the promoting entity or investors will come to affect the banking sector as well,” explained another source.

The RBI’s stance on CIC structures is to be read along with its discomfort with leverage through the pledge of shares. The RBI flagged its concerns in its Financial Stability Reports of December 2013 and December 2014, and again in June 2019. “It is highly unusual of the RBI to bring to attention an issue thrice over pointing at the high levels of leverage, albeit via a pledge of shares,” the source said. 

Incidentally, the report of the RBI’s internal working group on the ownership in private banks made clear that pledge of shares by promoters during the lock-in period, which amounts to bringing the unencumbered promoters’ shares below the prescribed minimum threshold, is to be disallowed.