New FDI norms may be revised for banking sector

To avoid problems for Indian banks with majority foreign equity.

The new foreign direct investment (FDI) guidelines may be revised with respect to the banking sector to avoid an adverse fallout for Indian banks with majority foreign equity.

Under the new regime, as defined by Press Notes 2, 3 and 4, any downstream investment by a firm with more than 50 per cent foreign equity will be considered as FDI. Thus, banks like ICICI Bank, which have more than 50 per cent foreign equity, will be treated as foreign-owned but Indian-controlled entities and any downstream investment by them will be subject to FDI restrictions.

The Reserve Bank of India had recently pointed out to the finance ministry that the press notes, released by the Department of Industrial Policy and Promotion (DIPP) in February 2009, could impact seven Indian private sector banks.

According to the provisions of the these press notes, ICICI Bank, ING Vysya, YES Bank, HDFC Bank, Development Credit Bank, IndusInd Bank and Federal Bank are foreign-owned Indian-controlled banks, the central bank observed. As a result, their downstream investments will have to conform to restrictions applicable to the FDI route.

DIPP feels that since banking is a regulated sector, it may need some additional provisions on FDI. “The issue will be examined, followed by inter-ministerial consultations between DIPP, Department of Financial Services, Department of Economic Affairs and even the RBI. If there is a consensus in these discussions that specific relaxations need to be provided to the banking sector, they would be carried out,” said a government official.

The new regulations will be applicable only after they are notified under the Foreign Exchange Management Act (FEMA). However, this process will take time due to inter-ministerial consultations.

ICICI Bank has written to DIPP, stating its current shareholding pattern, and asking for a clarification on its status. “DIPP has not received any other communication from other banks,” the official added.

The industry department maintains that the new foreign investment guidelines are one of the most comprehensive and ensure foreigners do not get control of Indian firms in sensitive sectors, which have FDI limits. “Concepts like ownership and control, which were incorporated in the FDI policy for the first time, ensure this. These definitions were finalised after consulting legislation like the Companies Act, lawyers and industry experts,” the official said.

RBI, in its observations on the FDI policy, had also stated that the new FDI norms could lead to “de-facto” capital account convertibility, which is restricted at the moment. Moreover, the DEA also expressed similar views on the new press notes and maintained that they would lead to breach of sectoral caps.

DIPP maintains that the new FDI guidelines were finalised after inter-ministerial consultations and approved by the Union Cabinet, after the nod of a Group of Ministers headed by Finance Minister Pranab Mukherjee.

Press Note 2 broadly implies that downstream investments by companies having more than 50 per cent shareholding by Indians, and majority Indian directors, need not follow FDI related restrictions like sectoral caps.

Press Note 3 mandates that government approval is necessary for transfer of ownership or control of Indian companies to overseas firms and individuals.

Press Note 4 divides companies into four categories based on their type of operations —investing or operating or both.