FHC recast to allow banking groups to undertake riskier businesses

RBI DOCUMENT

Extracts from the Reserve Bank of India's discussion paper on holding companies in banking groups:

Financial holding companies (FHCs) control about 80 per cent of the banking system in the US. Since the passage of the Gramm-Leach-Bliley Financial Services Modernisation Act of 1999 (GLB act), leading financial services companies are now doing business across financial sectors.

At present there are more than 600 FHCs in the US, most of them were banking holding companies (BHCs) and had opted to convert into FHCs.

In the US, BHCs can own or control one or more banks and can make only limited investments in the non-banking companies. FHCs are companies that own or control one or more banks or non-bank financial companies. The GLB Act permits banks, securities firms and insurance companies to affiliate with each other through the FHC structure.

Issues in introducing BHCs/FHCs in India:

Need for separate law: If we have to have only BHCs, the purpose could be achieved perhaps even by amending the Banking Regulation Act, 1949. However, in case it is decided to go for FHCs by expanding the scope of permissible financial activities by including all possible financial services, a separate law on the lines of GLB in the US may be required.

Permissible activities: Internationally, there are restrictions on the activities of BHCs or FHCs. While BHCs are not allowed to invest in non-banking related activities, subject to certain exceptions, restrictions in the case of FHCs mostly relate to investments in non-financial commercial enterprises. Further, BHCs and FHCs are required to be non-operating in nature. Appropriate restrictions on these lines will have to be prescribed by us (RBI).

Regulatory issues relating to BHCs/FHCs:

Capital adequacy framework would be governed as per Basel-II norms. The capital adequacy norms would be applicable to the BHC at the consolidated level wherever the entire group would qualify as the banking group. (If more than 50% of the group's assets are banking assets and more than 50% of income is derived from the banking activities). In other cases, the capital adequacy would be applied at the banking subsidiary level.

In the US, BHCs/FHCs are necessarily regulated. In some jurisdictions, these could be unregulated. Such conglomerates pose significant challenges to financial sector regulators. Therefore, BHCs/FHCs in India should be made regulated entities by law. Further, the primary supervisor of the BHC should be the RBI as in the case of the US.

Suitable cross-holding restrictions for the intra-group (within BHC) as well as inter-group (inter-BHCs) transactions will have to be prescribed. The BHC/FHC structures could be useful in Indian context subject to creation of a suitable statutory framework and ensuring that unregulated entities within the structure are avoided.

Advantages: There are considerable advantages in having FHC/BHC structure in as much as the bank would be much better protected from the possible adverse effects from the activities of their non-banking financial subsidiaries.

In fact, it may also be possible to consider allowing non-banking subsidiaries under FHC/BHC structure to undertake riskier activities hitherto not allowed to bank subsidiaries such as commodity broking.

It will be useful to explore the possibility of adopting a BHC/FHC model. However, a proper legal framework needs to be created before such structures are floated.