Gamechanger? Private equity is set to play a bigger role in Indian banks

Private equity (PE) is set to play a bigger role in banks. Of 21 recommendations accepted by the Reserve Bank of India (RBI) out of 31 made by its Internal Working Group (IWG), its stance on non-promoter holdings in private ba­n­ks is seen with excitement, though it doesn’t refer to PEs explicitly.

On non-promoter holdings in these banks, the RBI said this will be capped at 10 per cent of the paid-up voting equity share capital in the case “of natural persons and non-financial institutions and entities”; and “at 15 per cent for all categories of financial institutions, entities, supranational institutions, public sector undertaking, or the Government.” While this is a modification of the IWG’s stance for the non-promoter holding in banks at up to 15 per cent, it does open up a huge window for PEs, all the same.

This is because, while the RBI has remained silent on the eligibility of industrial houses for bank licences, fresh high-quality capital in large amounts can only come from PEs. Of course, this also foregrounds related regulatory and governance issues, such as, who is the final beneficiary of such PEs holdings? Can the RBI vet PEs in a deeper way? (They are now regulated by the Securities and Exchange Board of India.)

Will PEs be evaluated on the basis of the kind of people they bankroll in the wider business world? This ass­umes importance in the wake of l’affaire Ashneer Grover — the start-up he founded, BharatPe, had teamed up with Centrum Finance for Pu­njab and Maharashtra Co-operative Bank — now Unity Small Finance Bank.

What’s in it for governance?

In recent years, the conduct of a few private banks’ corner-room occupants and the role of their boards have come into sharper relief. Will the entry of PEs into banks lead to better governance?

Sunil Kaul, managing director and lead-financial services at Carlyle Asia, reckons that PEs can help banks bring in high-quality board members and best practices, attract quality management, and provide access to global capital markets. “Bringing in diverse and high-quality talent to boards can also act as a catalyst for the adoption of digitalisation and help them better meet their fiduciary and regulatory responsibilities,” says Kaul. “PEs often take a board seat as part of their investments, and can help strengthen governance practices.”

Gopal Jain, managing partner at Gaja Capital, argues that there is evidence that companies backed by the private sector (in general) have superior governance standards be­cau­se of the alignment between governa­nce and ownership. His poi­nt is that, on private bank boa­rds, “the voice of capital is absent which, if pre­sent, can balance the super-bo­ss culture that has affected some of them.”

That said, he notes, “It takes two to tango. For PEs to promote governance, management in private banks will also have to make a mindset shift to work with active boards that will ask more questions than before”.

It’s important to make a digression here.

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Role of the BR Act

Getting good hands on private banks’ boards has proven to be hard despite the popular belief that it’s a privilege few will pass up. Over the last few years, a clutch of them have sounded out Mint Road on their struggle to on-board top-class independent directors; many even sought extended timelines to get suitable appointees.

And in the spotlight is the Banking Regulation Act (BR: 1949). The provisions of the Act, combined with the intense scrutiny on independent directors in recent times, and the far lower levels of compensation payable to them (when compared with non-banks) has made it tough to hire good hands. This latter aspect is because the RBI does not permit part-time directors of banks to be paid any remuneration other than sitting fees, even though the Companies Act (2013) permits up to one per cent of a firm’s profits to be paid as commission to board members.

It’s even more ironic that shadow banks are not hamstrung by such regulations when they scout for independent directors — so much for the central bank’s efforts to bring them on a par with commercial banks in matters of oversight.

Section 10A of the of the BR Act says: “The Board of directors of a banking company shall consist of persons, who (a) shall have special knowledge or practical experience in respect of one or more of the following matters, namely: (i) accountancy, (ii) agriculture and rural economy, (iii) banking, (iv) co-operation, (v) economics, (vi) finance, (vii) law, (viii) small-scale industry, (ix) any other matter the special knowledge of, and practical experience in, which would, in the opinion of the RBI, be useful to the banking company.”

A few private banks had conveyed to the RBI that even when they appoint “people of repute” to their boards (from the fields mentioned in the BR Act), it is not necessary that many of them are able to bring their expertise to bear. “You may be a champion in accounting or information technology, but these skills should add value,” says the CEO of a private bank.

 

A few more questions

What is unsaid is that there is a perception that PEs are driven by the search for excessive returns.

Says Ajay Garg, founder and managing director of Equirus Capital: “Take a look at how the plot panned out at UTI Bank (now Axis Bank) and at IDBI Bank. UTI Bank brought on board CDC, and grew even as it rebranded. IDBI Bank is where it is. The point I am making is that we need more top-class banks to provide credit and grow the economy.”

He is categorical that, “I don’t agree with this view that the entry of PE capital will necessarily lead to unhealthy practices. Outlier cases will be there in every industry, but you can’t let that colour your approach to issues.”

Kaul adds: “If you look at how banks are valued, it’s rarely just about profits; and value primarily comes from consistency, high-quality risk management, reliability and transparency across business”. He makes a nuanced observation: “PE firms which are specialised in the sector and take a long-term approach can help play a role in maintaining board focus on these quality indicators.”

The truth is that you may have a Rolls Royce, a Bentley and a BMW in your garage, but feel that only a banking licence will help you to drive into El Dorado, whatever your notion of it may be. Would it be fair to view the PE interest in private banks likewise — which is to get more than a foothold into a lucrative sector?

“Indian banks have so far suffered from excessive risk-taking. The voice of capital will help balance the quest for growth with the consideration for the cost of growth,” explains Jain. He believes the “PE playbook of generating alpha is not taking inordinate risk, but improving governance and ethical processes, pursuing M&A growth opportunities and market expansion, while controlling costs to run a financially responsible organisation.”

Whichever way you look at it, a PE wave is set to enter banking.