India needs Indian banks: Why domestic lenders matter most for growth

RBI's bank ownership policy has shifted towards regulated institutional investors, but over-reliance on foreign capital risks limiting India's credit growth and domestic banking depth

The arc of the Reserve Bank of India’s (RBI’s) policy on bank ownership has changed over time. Just over two decades ago, the regulator attached primacy to skin in the game. The thinking thereafter evolved, and the central bank saw merit in diversified ownership with the “promoter shareholders” having limited or no ability to influence the board. The recent approvals to Tokyo-headquartered SMBC to acquire a 24 per cent stake in Yes Bank and to Dubai-based NDB to acquire around 60 per cent in RBL Bank suggest that the RBI now favours ownership by regulated institutions as its preferred mode. 

 

The early evolution of this policy is seen through Kotak Mahindra Bank Limited (KMBL).  KMBL received its banking licence in 2001, through the conversion of a non-banking financial company (NBFC), where promoters held 61 per cent of the equity. The licence required that the promoter holding be reduced to 49 per cent of the paid-up capital. Tellingly, the licence did not prescribe reducing share ownership, just the minimum threshold.

 

The policy shifted meaningfully in 2013 when the RBI revised its ownership guidelines. These required banks to be set up only through a wholly-owned non-operative financial holding company (“NOFHC”). The RBI still saw some merit in the argument that a “promoter” with a higher stake will run the banks better but began balancing this with the argument in favour of disbursed ownership — an idea it began socialising from 2005.  The guidelines mandated that promoter’s initial 40 per cent stake be locked in for a period of five years. And that shareholding in the NOFHC be brought down to 15 per cent of the capital within 12 years from the date of commencement of business.

 

Following this, the RBI asked Kotak Bank to bring down its promoter shareholding to 40 per cent by September 2014 and to 30 per cent by December 2016. The promoter holding was brought down to 34 per cent through the merger of Kotak Bank with ING Bank. Thereafter, the bank sold shares to qualified institutional investors and other investors in the open market to reduce the promoter stake to 29.79 per cent to be fully compliant with the regulations. 

 

The RBI by now seemed committed to diverse ownership. This was reinforced in its Master Direction on Ownership in Private Sector Banks of May 12, 2016. The proposed shareholding — even in existing banks should be at 15 per cent, consistent with the 2013 guidelines on licensing of universal banks. Following this, in 2017, Kotak Bank was asked to bring down its promoter stake to 20 per cent by December 2018 and to 15 per cent by March 2020.

 

The bank’s promoters were upset at further reduction — given the timelines and sums involved. Their solution: Issue non-convertible perpetual non-cumulative preference shares worth ₹500 crore. As preference shares generally do not carry any voting rights but are a part of paid-up capital, the Bank argued that Uday Kotak’s ownership had been brought down to 19.7 per cent. The RBI had a different read of the regulations; it interpreted paid-up capital as voting equity capital, and the promoters continued to hold 30.03 per cent of the shareholder vote, giving them “control” in the bank’s affairs.

 

The matter ended in court and thereafter the two sides arrived at a negotiated settlement. Uday Kotak was allowed to hold up to 26 per cent of the bank's share capital, with his voting rights in the Bank capped at 15 per cent. The voting cap has subsequently been raised to 26 per cent following a two-step revision in the RBI’s guidelines. 

 

Even after the Central bank changed its stance from skin in the game to more wide-spread shareholding, it has permitted concentrated ownership in special situations —  in seemingly weak banks. Fairfax Financials’ ownership in CSB Bank, and DBS Bank’s ownership in Lakshmi Vilas Bank can both be seen against this backdrop. We must see how the RBI reacts to Prem Watsa’s announcement that his son will succeed him, something he can ensure given his unequal voting rights in Fairfax. 

 

This brings us to the present. The RBI has recently signed off on SMBC taking a 24.99 per cent stake in Yes Bank and NDB owning 60 per cent of RBL Bank. A common thread is that both investors are large, regulated financial institutions with strong capital reserves. Bruised by the sharp practices of a few to whom the RBI had given bank licences, Kotak Bank notwithstanding, the regulatory tilt appears to favour well-capitalised, tightly regulated institutions.

 

While this could well be the RBI’s preferred path forward as it provides the banking system with a degree of stability and access to deep pools of capital, we have far too few banks for an economy of our scale and aspirations to depend on foreign capital. We have a scarcity of entrepreneurs with patient, long-term capital and although a few professional teams backed by private equity may step forward, they cannot bridge the scale gap. At this juncture, the RBI should reconsider its frameworks on bank ownership, voting rights, and the restrictions on industrial houses entering banking. The regulator should encourage large NBFCs with demonstrable records to convert themselves into banks. These companies already use technology, digital onboarding, data-driven credit assessment and monitoring, and a robust risk framework — characteristics of prudent banks.

 

India cannot jettison domestic money for foreign capital, which cannot meet our credit needs. Just as with equity markets, it’s domestic banks that will help our economy grow.

The author  is with Institutional Investors Advisory Services India Ltd.  Kotak Mahindra Bank owns an equity stake in the company. X:@AmitTandon_in.

 

The views are personal.

 

(Disclosure: Entities controlled by the Kotak family have a significant holding in Business Standard Pvt Ltd)