Legal Briefing

The banking sector 
in India: capitalising 
on reforms?

The In-House Lawyer Logo

Corporate & Commercial | 01 October 2012

The Indian central bank – the Reserve Bank of India (RBI) – is committed to implementing the Basel III norms in a phased manner in India, commencing from 1 January 2013, with Indian banks being required to comply fully with the new capital adequacy norms by 31 March 2018. Like elsewhere across the globe, banks in India will face several challenges in complying with these new norms, with the principal one being the raising of additional capital. In its annual report published on 23 August 2012, the RBI disclosed its estimate of the additional capital that is likely to be required.

The numbers are staggering – the public sector banks alone would require equity capital of about 1.4-1.5 trillion rupees on top of internal accruals, in addition to 2.65-2.75 trillion rupees in the form of non-equity capital. For major private sector banks the estimated requirement is new equity capital to the tune of 200-250bn rupees on top of internal accruals, in addition to 500-600bn rupees of non-equity capital. 


In light of the pressing need for Indian banks to raise substantial amounts of additional capital, the RBI has been actively pushing for some much-needed reforms of the banking sector in India. One of the key obstacles that banks in India face for raising capital is the extremely onerous restrictions imposed on them in relation to the quantum and nature of share capital they may 
hold and the voting rights associated therewith. In order to amend the existing law to address these issues, the Banking Laws (Amendment) Bill 2011 (the Bill) 
was introduced in the Indian parliament in March 2011.

The Bill was referred to the Standing Committee on Finance for its consideration, which, after consulting with various stakeholders, submitted its report in December 2011. The government had listed the Bill for tabling before parliament during the recently concluded monsoon session and it was widely expected to be passed into law but, unfortunately, the Bill could not be taken up as the opposition prevented the parliament from functioning on account of the controversy surrounding allocation of coal blocks by the government. The Bill seeks to amend the principal statutes governing banks in India, including the 
six-decade-old Banking Regulation Act 1949 (the 1949 Act), and, in light of the reforms recently announced by the government, it is hoped that these amendments will be implemented in the very near future.

The majority of the amendments proposed by the Bill fall into two broad categories – those intended to facilitate the raising of capital by banks and those that provide for enhanced supervision of banks by the RBI and the strengthening of its regulatory powers.

Facilitating capital raising

The key amendments proposed to facilitate the raising of capital are set out below.

  1. Increasing the cap on voting rights: the 1949 Act currently limits the voting rights of any shareholder to 10% of the total voting rights of all shareholders, regardless of the fact that such holder may own a higher percentage of the total share capital of the bank. It is now proposed that such cap on voting rights be increased to 26%, but only for private sector banks1.
  2. Issuance of preference shares: banking companies in India will be allowed to issue preference shares in accordance with RBI guidelines. At present, the 1949 Act provides that the share capital of a banking company can only comprise of equity shares and preference shares, but only if issued prior to July 1944.
  3. Rights issue and bonus shares: nationalised banks will be allowed to raise capital through bonus issue and rights issue of shares.
  4. Removal of cap on authorised capital: nationalised banks will be allowed to increase their authorised capital with the approval of the government and the RBI; with no limit set for the maximum authorised capital. At present, the authorised capital of such banks can only be increased to 30bn rupees.
Enhanced powers of the RBI

The key changes as regards RBI’s increased regulatory role and powers are set out below.

  1. RBI approval for acquisition of 5% or more of shares or voting rights: no person will be allowed, without prior RBI approval, to acquire or agree to acquire shares/voting rights in a banking company which entitles such person to hold 5% or more of the total paid-up share capital, or exercise 5% or more of the total voting rights, of a banking company. An approval may be granted by the RBI for acquisition of such shares or voting rights if it is satisfied that the applicant is a fit and proper person. RBI will also have the power to impose such conditions as it deems fit while granting approval including specifying a minimum percentage of shares to be acquired by the applicant.
  2. RBI’s power over associates of banking companies: RBI will have the power to direct a banking company to furnish financials and other information in respect of any ‘associate enterprise’. RBI may also inspect the books of accounts of the associate enterprise. The definition of ‘associate enterprise’ is very broad and includes enterprises which, in the opinion of RBI, ‘exercise significant influence on the banking company in taking financial or policy decisions’2 and ‘enterprises which 
are able to obtain economic benefits from the activities of the banking company’3. The definition also includes a holding company, subsidiary, joint venture, subsidiary or joint venture 
of the holding company of the banking company.
  3. RBI’s power of supersession of board of directors: perhaps the most controversial of all the amendments in the proposal is that RBI have the power to supersede the entire board of directors of a banking company for a total period not exceeding 12 months and to appoint an administrator to perform the functions of the board. At present, RBI’s powers are limited only to seeking the removal of the chairperson of the board, any director or any other officer of a banking company.
  4. Enhancement of fines for contravention: fines for contravention of the provisions of the Act will be increased manifold 
to give the penal sections more teeth. As an illustration, fines for contravention of certain provisions are proposed to be increased from 2,000 rupees to 2m rupees.

As would be evident from the scope and nature of the proposed amendments set out above, the government and RBI appear to be proceeding very cautiously and though the clear emphasis is on enabling banks to raise more capital by providing newer sources and making investment in banks more attractive, the proposed amendments are likely to fall short of the expectations of potential investors and the private sector banks. There is, at the same time, a simultaneous tightening of RBI’s regulatory leash over the banks, where some of the new powers of the RBI are likely to raise significant concern for the banks and shareholders. However, the Bill reflects the RBI’s long-held views on maintaining strict controls over Indian banks and the credit crunch and on-going sovereign crisis have only strengthened their resolve to keep a very close regulatory watch on the Indian banking sector in these clearly turbulent times for the global economy.

Notes

  1. The Bill in its original form proposed that such restriction on voting rights in the case of private sector banks be removed entirely and provided for proportionate voting rights to shareholders. However, the Standing Committee on Finance recommended that instead of removing the voting rights restriction altogether, the ceiling should be increased to 26%.
  2. Clause 10 (inserting new s29A in the Banking Regulation Act 1949), Banking Laws (Amendment) Bill 2011.
  3. Ibid.