Money & Banking
New Banking licenses: Confusions galore in RBI’s clarifications

From what appears from the media, the most significant interest in the new banking licenses has come from existing leading NBFCs. How would these companies convert themselves into banks?

With all humility being harnessed, one cannot call it ‘clarifications’. In fact, the whole scenario surrounding the new banking licenses has become a lot more confused, with the 165-page document euphemistically called ‘clarifications’.

For the starter, one does not have be to be impressed by the massive amount of writing that the Reserve Bank of India (RBI) might have had to do to produce the 165-pager, since the document contains questions too—questions that users may have posed to the RBI. And there are 422 questions!  And in addition, there are several answers which are repetitive.

Existing NBFCs converting into banks:

One of the most vexed questions is what would be the mode of conversion of existing NBFCs into banks. From what appears from the media, the most significant interest in the new banking licenses has come from existing leading NBFCs.  How would these companies convert themselves into banks?

It is notable that the ownership structure of banks in India would envisage substantial holding in the banking company being with another entity, a holding company, called Non-Operating Financial Holding Company (NOFHoC). The NOFHoC, in turn, must also have at least 51% of its shares held by companies, in which the ‘public’ (read non-promoter) holding is not less than 51%.

Most of the NBFCs proposing to convert themselves into banks are listed companies. If these companies were to convert themselves into banks, the issue is—what do the shareholders of these companies get? It is evident that the banking company itself cannot be held by the public, since a banking company has to be mandatorily held by the NOFHoC. Therefore, the most plausible solution seemed to be to transfer the business of the NBFC to a banking company, and hold the shares of the banking company into the erstwhile NBFC.

However, the RBI’s suggested structure, coming from Q 71 of the Clarifications, seems to be that the listed NBFC will hold shares of the NOFHoC, which, in turn, will hold the bank. This multi-tier structure creates a huge tax drain, thereby causing a loss of shareholder value. Let us not forget that India has double tax on corporate dividends, in form of distribution tax. Therefore, as we are proliferating entities, we keep increasing the tax drain.

The structure envisaged by the RBI comes in the diagram.

One must realize that this leads to two layers of dividend distribution tax, besides one layer of corporate tax. One would argue that it is possible to eliminate one layer of dividend distribution tax taking advantage of the provisions of Section 115-O (1A); however, one needs to then structure NOFHoC as the subsidiary of the NBFC.

Ideally, it would be better for the NBFC to opt for a court-approved scheme of restructuring and offer the shares of NOFHoC to the shareholders of the NBFC by way of a swap. However, the insistence of the RBI that the shares of NOFHoC should be owned by the promoter group creates a problem. In answer to Q 78, etc, the RBI seems to be permitting a listed company being a shareholder of NOFHoC.  The RBI also is clearly opposed to the idea of the listed company itself being the NOFHoC (see Q 79-b).  Further, Q 96 clearly rejects the swap of shares model. Thereby, there has necessarily to be a layer of shareholding between the NOFHoC and the shareholders of the NBFC, which will create the tax drain referred to above.

Loss of regulatory arbitrage:

One possible limitation that anyone nurturing a banking dream needs to consider is that the banking group (meaning all financial entities under the NOFHoC group) will not be eligible to carry any unregulated activities. Currently, NBFCs have absolute liberty to carry financial activities as well as non-financial activities. For example, an NBFC may even carry trading in properties, or trading in commodities, or any other activity for that matter. The only thing that NBFCs need to ensure is that their income from such non-financial activities stays limited to 50%, thereby ensuring that the principal business is financial activity.

However, once the financial group (that is, the banking company and other financial activities which necessarily have to come under the NOFHoC umbrella) has a banking company in terms of the RBI guidelines, surely enough, the banking company can only carry such activities which are regarded as para-banking activities by the RBI. The examples of these are given in Q 86. For other regulated financial activities, the group has the liberty of carrying them under other entities within the NOFHoC umbrella. But then, can any of the entities under the NOFHoC umbrella carry non-financial activities? For example, trading, or consulting? Surely, there is a restriction against a bank carrying non-banking activity under the Banking Regulation Act, but surely, there is should not be any such restriction in case of other financial entities under the NOFHoC umbrella.

However, the mood of the RBI seems to be that entities under the NOFHoC umbrella cannot engage in any non-financial activities. Answer to Q 47 seems to be putting a complete bar on “unregulated financial activities” being carried by any entity under the NOFHoC. There is, therefore, an obvious bar on any unregulated activity, clearly ruling out any non-financial activity.

Operating leasing is regarded as a non-financial activity. Hence, the RBI’s clarification may rule out operating lease business being carried out by any entity under the NOFHoC umbrella.

Not only unregulated financial activities and non-financial activities, there will also be restriction on carrying activities such as housing finance, as a separate entity. The guidelines require that all lending activities must come under the banking company. Several NBFCs currently also have housing finance companies. There is, arguably, a regulatory arbitrage that exists in keeping housing finance under a housing finance company umbrella, rather than under the bank. In Q 102, the RBI has clearly ruled out any housing finance company under the NOFHoC umbrella. This is repeated in questions 109-113 as well. So, once a financial group decides to set up a bank, it has to merge the housing finance company with the bank.

There are considerable restrictions on lending by banks—for examples, banks are generally not allowed to lend against promoter shareholdings. Most NBFCs do so. Once a banking group comes into existence, all lending transactions necessarily come under the bank, and hence, the restriction applies.

In essence, several avenues for regulatory arbitrage that exist currently will go away once a group decides to set up a bank.

Ekla chalo re…

Very strangely, the RBI seems to have taken a view that more than one promoter cannot come together to form a NOFHoC. Q 116 (also Q 142-3) blanketly discards the idea of more than one promoter coming together to have control over a NOFHoC. This, by itself, seems quite self-contradicting, as there is a limit of 10% on the holding of an individual along with his relatives. There is also a minimum 51% holding required by companies which have majority ‘public’ interest. If that is so, the answer to Q 116, saying only one promoter must hold the NOFHoC, is completely non-reconciling. In answers to several questions, the RBI has stated that even a listed company can hold the NOFHoC. Is it not strange that a listed company, purportedly having wide-spread ownership interest, can own a NOFHoC, but when it comes a promoter, not more than one promoter can own a NOFHoC? In fact, the whole idea of a single promoter for a NOFHoC is completely self-contradicting and unreasonable.

In several bank-promoter groups, there will be strategic investors, joint-venturers, groups of promoters or associates joining together to put up equity in the NOFHoC. The stipulation of a single promoter will only lead to creation of one more layer at the shareholding level of the NOFHoC. That is, if two or more promoters of strategic investors want to come together to own a NOFHoC, they will together have to form a shareholding company (a CIC), which in turn will own the NOFHoC. The entire ownership structure arising as a result of the RBI guidelines will lead to proliferation of entities, thereby making the ownership structure of banking companies highly opaque.


In the 400+ list of questions, most questions came on the holding structure of the NOFHoC. The holding structure as envisaged by the RBI is either not clear, or, if it is clear, it is not practical, at least in the Indian context.

(Vinod Kothari is a chartered accountant, trainer and author. He is an expert in such specialised areas of finance as securitisation, asset-based finance, credit derivatives, accounting for derivatives and financial instruments and microfinance.)



Dayananda Kamath k

4 years ago

the govt is pushing for new banks because old banks have exhausted their resources and can not give more loans now. and may close shop shortly if the customers start to enforce their rights properly. hence they want some new banks so that they can also be abused to the hilt. and get browny points for reforms in the election year. it is high time people of this country realize the game plan. all reforms so far done are to sell the country to fiis and foreigners.

R Balakrishnan

4 years ago

Well put, Vinod. When the regulator does not like something his master commands him to do, he ensures enough obfuscation. As it is, with RBI, obfuscation does not even need an effort.
Someone is pushing and someone is holding back. What will give, let us see.

CAG seeks revenue sharing details of pvt telecom operators

Citing a Supreme Court order of August 2010, the national auditor has asked Telecom Regulatory Authority of India (TRAI) to submit revenue sharing details and documents of private telecom operators for assessment by 20th June

The Comptroller and Auditor General of India (CAG) has sought revenue sharing details of private telecom operators of last seven years beginning 2006-07 by 20th June. Citing a Supreme Court order of August 2010, the national auditor has asked Telecom Regulatory Authority of India (TRAI) to submit revenue sharing details and documents of private telecom operators for assessment.


“DoT (Department of Telecom) has commenced the assessment process of the licence fee and spectrum usage charges of the telecom service providers since 2006-07. Therefore, it has now been decided to call for the revenue sharing details and documents from the private telecom service providers,” CAG said in its communiqué to TRAI.


The auditor has asked TRAI to instruct telecom operators to submit all their revenue sharing details of last seven years (2006-07 to 2012-13) by 20th June.


Earlier, private telecom operators opposed the CAG’s demand for accessing their books and approached court through industry body, Cellular Operators Association of India (COAI).


The apex court rejected plea of COAI and said COAI members should furnish revenue sharing details or any such information required by the auditor.


US exempts India and 8 others from sanctions for Iranian oil

US Secretary of State John Kerry said that India and eight other nations have qualified for an exception to sanctions under America's Iran Sanctions Act, based on additional significant reductions in the volume of their crude oil purchases from Iran

United States on Thursday exempted India and eight other countries from sanctions for importing oil from Iran, as these countries have significantly reduced their dependence on Iranian oil in the last six months.


US Secretary of State John Kerry said that India, China, Malaysia, Republic of Korea, Singapore, South Africa, Sri Lanka, Turkey, and Taiwan have qualified for an exception to sanctions under America's Iran Sanctions Act, based on additional significant reductions in the volume of their crude oil purchases from Iran or for reducing those purchases to zero and remaining there.


United States and the international community stand shoulder to shoulder in maintaining pressure on Iran until it fully addresses concerns about its nuclear program, Kerry said in a statement.


“Today's determination is another example of the international community’s strong and steady commitment to convince Iran to meet its international obligations,” Kerry said.


“This determination takes place against the backdrop of other recent actions the administration has taken to increase pressure on Iran, including the issuance of a new Executive Order on 3rd June. The message to the Iranian regime from the international community is clear: take concrete actions to satisfy the concerns of the international community, or face increasing isolation and pressure,” Kerry said today.


Meanwhile, White House Press Secretary Jay Carney said that it appears that there is sufficient supply of non-Iranian oil to permit foreign countries to significantly reduce their purchases of Iranian oil.


“In this context, it is notable that many purchasers of Iranian crude oil have reduced or ceased altogether their purchases from Iran,” he said.


However, he noted that global oil consumption has exceeded production in recent months.


“The international response to concerns about Iran's nuclear activities has increased demand for non-Iranian crude.


“However, rising production from other countries, greater spare production capacity, economic developments, and smaller inventory draws in March and April 2013 indicate a looser international crude market,” Carney said.


The Obama administration has introduced a series of measures over the past week to step up the pressure on Iran over its nuclear program, which Washington suspects is aimed at making weapons but Iran insists is for generating electricity and medical research.


Washington hopes the pressure will force Iran to come clean on its nuclear activity so that the US and its allies can avoid any military intervention to prevent the Islamic republic from obtaining an atomic arsenal.


Despite plummeting sales overseas, Iran remains one of the world's largest oil producers. Its exports bring in tens of billions of dollars in revenue for the country.


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