The Banking Laws (Amendment) Bill will gradually pave the way for more competition in the sector and will carve out a more efficient and more valuable banking system, says Nomura Equity Research in its Quick Note

What is the business impact of The Banking Laws (Amendment) Bill, 2011? For the banking sector, it is a long-term positive, says Nomura Equity Research in its Quick Note. “This will gradually pave the way for more competition in the sector and, as we have seen over the last two episodes of new licenses, will carve out a more efficient and more valuable banking system, says the broking firm. Some of the salient amendments that were demanded by the RBI (as a prerequisite to issuing new bank licenses) and have been approved are as follows:

(a) RBI to have the power to supersede bank boards for a period not exceeding 12 months. Under the existing Banking Regulations Act, 1949, the RBI has the power to remove a director or any other officers of the banking company. The amendment enhances the power of the RBI to supersede the board of directors of a banking company for a period not exceeding 12 months and appoint an administrator for managing the company during that period;

(b) Raise cap on voting right to 26% in private banks and to 10% in PSU banks from the existing 10% and 1% respectively;

(c) RBI has the option to inspect information and returns from associate enterprises of banking companies;

(d) The Competition Commission of India will approve M&A (mergers and acquisitions) in banks except in the case of banks that are under trouble. In such cases, the RBI will have the final authority, as is the situation now.

Specifically for the PSU banks, the 10-fold increase in voting cap will help drive increased investor interest and hence facilitate raising additional capital. The following is a rough estimate of the capital requirements for the major banks over the next five years assuming BIS-3—in rupees billion. The percentages in parentheses indicate the extent of dilution as a percent of FY12 net worth. SBI – Rs1,000 million (120%); PNB – Rs250 million (90%); BOB – Rs150 million (50%); Axis Bank – Rs200 million (85%); HDFCB – Rs30 million; ICICI Bank– negligible.

Under BIS-3, any shortfall in provisioning or pension liability funding will have to be adjusted against core equity capital, which makes it particularly difficult for the PSU banks. Beyond driving positive expectations long term— near term business concerns like tepid loan growth and the bad loan problems should not be overlooked.

The proposed new license guidelines are summarized below:

(a) Only India resident groups / entities will be allowed to promote a bank. Promoter groups should have a minimum track record of 10 years in successfully running their businesses, which will be verified by the RBI by coordinating with other government agencies. Groups which have a significant exposure to real estate & capital market activity (measured as 10% or more of income or assets or both from these activities in the last three years) will not be eligible for a new license. The new bank will have to be set up through a wholly-owned non-operating holding company (NOHC), which will house the bank and other financial services subsidiaries. All financial services companies belonging to the promoter group will have to be ring-fenced within the NOHC. The NOHC will be registered as a NBFC with the RBI. The NOHC will not be allowed to borrow funds for investing in the companies held by it. The source of promoter’s equity in the NOHC should be transparent and verifiable.

(b) The minimum paid-up capital will be Rs 5 billion. The NOHC should hold a minimum of 40% of the paid-up capital which will have a lock-in period of five years from the date of license. The shareholding in excess of 40% will have to be reduced within two years from the date of license. Even if additional capital is raised within the first five years from the date of licensing, the NOHC will have to maintain its stake at 40%. The NOHC’s stake should be reduced to 20% of the paid-up capital within a period of 10 years and 15% within 12 years from the date of licensing.

(c) The aggregate non-resident stake (FII, FDI and NRI) should not exceed 49% in the first five years of the license date. No non-resident shareholder can hold more than 5% of the paid-up capital. After five years, the aggregate limit for foreign holding will depend on the extant regulations (currently the foreign stake in private sector banks is capped at 74% of paid-up capital).

(d) At least 50% of the board of directors of the NOHC should be independent of the promoter group and ownership and management of the NOHC should be separate. No other financial services entity within the NOHC can engage in activities that can be done by the bank. The NOHC cannot set up a new financial services entity for at least three years from the date of licensing of the bank.

(e) Shareholding greater than 5% by individuals or groups will be possible only with the prior approval of the RBI and the stake of any single entity or group of related entities will be capped at 10%.

(f) The exposure of the bank to any single promoter group company should be capped at 10% and the aggregate exposure to all promoter group companies should not exceed 20% (of the paid-up capital and reserves). All exposures to promoter group companies should be approved by the bank’s board. The RBI will have the ultimate authority on whether a particular company belongs to the promoter group or not.

(g) The bank will have to list on a stock exchange within two years of obtaining a license. It should maintain a minimum capital adequacy of 12% for a minimum period of three years after starting operations.

(h) The bank will have to open at least 25% of its branches in unbanked rural areas.

(i)  On the issue of conversion of a NBFC (non-banking finance company) into a bank, the RBI has discussed two options: Promote a new bank if some or all of the activities of the NBFC are not permitted for a bank. In this case, the NBFC will have to transfer all other activities that are permitted for a bank. The NBFC can convert itself into a bank, if all its current activities are permitted for a bank. Under the two options, a NOHC will have to be set up anyway. The existing branches of the NBFC can be converted into bank branches only in tier 3-6 centres. In Tier-1 and  Tier-2 centres, prior approval of the RBI is required for converting the existing NBFC branches into bank branches.