MC EXCLUSIVE High-level banking panel to review voting rights threshold for foreign bank subsidiaries

The proposal to evaluate the ceiling on voting rights at 26 percent is viewed as a step towards removing the restrictions around foreign banks .

• Govt may allow higher voting rights for foreign banks based on shareholding
• Proposal aims to attract foreign banks to invest and expand in India
• Changes need Parliament approval, apply only to foreign banks via WOS route.

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In a bid to attract foreign banks to invest and expand their footprint in India, the government is examining a proposal on voting rights, a senior government official told Moneycontrol. The proposed change, if it goes through, would allow foreign banks have a higher voting right, proportionate to their shareholding. Sources familiar with the issue say the government is open to the idea of considering requests from several foreign banks, which plan to make fresh investments, as it would result in these banks having "skin in the game".

The proposal to evaluate the ceiling on voting rights at 26 percent is viewed as a step towards removing the restrictions around foreign banks taking strategic initiatives at a shareholder and board level, said the official. Some representatives of foreign banks have made a pitch to the government asking for their voting rights to be aligned with their shareholding in Indian banks according to sources familiar with the matter.

"This is expected to be key agenda item for the high-level bank panel once constituted," said another government official, adding that while this amendment is under consideration, it would be too early to state a timeframe for its implementation. Any changes to the Banking Regulation Act (BR Act), including altering the voting right cap, would require a Parliament assent.

Email sent to the ministry of finance and the Reserve Bank of India remained unanswered till publishing the article.

That said, even if the change goes through, it would only be for a select class of investors, namely foreign banks which operate in India through the wholly owned subsidiary (WOS) route.

Experts say if a WOS in India should convert into a subsidiary of a foreign bank by way of stake acquisition (similar to the Emirates NBD - RBL Bank structure), it is only fair that the controlling interest in the Indian bank is reflective of the shareholding to truly satisfy the subsidiary status for the holding/ parent entity.

Impediment to Flow of Capital from Global Banks

Globally, an investment is considered as a subsidiary when the parent entity holds 51% or more of controlling interest in the company. Large global banks say that by capping voting rights for foreign banks wanting to acquire Indian banks, their Indian investment may not satisfy the basic condition required to be classified as a subsidiary.

This could in turn result in a consequent operational issue.

In many countries, with no distinction between voting rights and sharehoilding, subsidiaries with 51% or more of shareholding lend themselves to automatic consolidation of financials at the global parent entity level. "In India, with voting right capped at 26%, consolidation with the parent entity becomes a questionable aspect in many jurisdictions," said a banking expert not wanting to be named. "This is an impediment for flow of capital from foreign banks into Indian banks".

Such a move could also eliminate the differences in interpretation between FEMA and BR Act. While FEMA allows a foreign bank to hold stake 49 - 74% stake in an Indian bank, the BR Act currently allows foreign banks to operate in India as a WOS. A WOS enjoys 100% voting rights in an Indian bank, while FEMA is silent on voting rights, but permits a subsidiary structure, apart from a WOS, for foreign banks. Amending the clause on voting rights, could address this aspect.

Presently, State Bank of Mauritius and DBS Bank India operate in India as a WOS. As and when the RBL Bank transaction concludes Dubai's Emirates NBD would be the first test case of a foreign bank operating in India through a subsidiary route.

Indian Private Investors capped at 26%

The tricky part though, as pointed out by a former central banker is whether it would be principally okay to create a distinction in voting rights for different classes of investors. To be sure, the voting right cap at 26% is something which has been very sacrosanct for the RBI. "If the government decides to go easy on this for foreign banks, then what about a few private equity investors which have bailed out private banks in India, like Fairfax - CSB Bank, and promoters like Uday Kotak who have had to reduce their voting rights in the bank to 26% over a period of time," said a former central bank official who didn't want to be named.

During her Budget speech on February 1, Finance Minister Nirmala Sitharaman proposed setting up a "High Level Committee on Banking for Viksit Bharat", to comprehensively review the sector and align it with India’s next phase of growth, while safeguarding financial stability, inclusion, and consumer protection.

Sources say the Committee’s Terms of Reference (ToR) is expected to be finalized by mid-March.

What’s the 26 percent cap?

Section 12(2) of the BR Act restrcits the voting right of a promoter of a private bank at 26 percent. For instance, in case of CSB Bank, while Fairfax India Holdings owns 40% stake in the bank, its voting right is limited to 26%. Such a restriction has been imposed to prevent a promoter from having dominating position while seeking shareholder approvals.

In 2021 the RBI accepted a few recommendations of its Internal Working Group (IWG) report one of which was to increase voting rights of a promoter from 15% (earlier) to 26%.

The official cited said the government is open to engage with foreign banks who want to invest in India, and may tweak the clause (on voting rights) in their favour – but that can only happen after a "thorough review".

"With initiatives around deepening of capital markets, it may be a good time to re-look at the voting rights as this will drive operational efficiency and innovation significantly, which is the strategic value that foreign banks bring to the table," said Vivek Iyer, Partner and Financial Services Risk Leader, Grant Thornton Bharat.