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The numbers game

June 17, 2004

After almost six-and-a-half months, the HSBC-UTI Bank deal was consummated last week, that too partially.

HSBC could not pick up 20.8 per cent stake in the private bank as it had originally planned and announced in December last year. It could buy only 14.62 per cent stake in the UTI Bank. What's more, there will be no HSBC representatives on the UTI Board.

How did this happen? Well, the Reserve Bank of India has not allowed HSBC to go ahead with the 20.8 per cent stake buyout plan even though it had given the foreign bank an in-principal verbal approval in December.

Things have changed since then, with the regulator moving the finance ministry with a plan that caps the acquisition of stake in a local bank by foreign banks already having a subsidiary or a branch in India, at 10 per cent.

In other words, the banking sector regulator does not want a foreign bank, which has a presence in India, to have more than 10 per cent stake in a domestic bank. If the ministry approves this, HSBC is likely to be directed to pare its 14.62 per cent holding in UTI Bank to 10 per cent in due course.

The Indian banking system's obsession with 10 per cent can be a subject of interest for any researcher. Capping foreign banks' holding in a domestic bank at 10 per cent is only a small chapter of the 10 per cent story. Voting rights in private sector banks have historically been capped at 10 per cent.

Big corporations' foray into the banking business is also limited to a 10 per cent stake. What is so sacrosanct about this magic number? No one really knows. And 10 per cent is only one important number in the banking sector. There are others, too: 1 per cent, 20 per cent, 33 per cent, 40 per cent, 49 per cent, 51 per cent, 74 per cent... The list can go on.

These numbers are the maximum levels of the stakes of various categories of investors' in different kinds of domestic banks. They change continuously, either reacting to certain developments or creating new developments. The changes create level playing fields for various players in the banking space and destroy the existing ones.

Take, for instance, the politically-sensitive topic of the government's stake in public sector banks. In the 1990s, the Banking Regulation Act was amended to bring down the government stake in PSU banks to a minimum of 51 per cent. This allowed the banks to enter the market and raise money from the public.

Subsequently, the plan was to bring the government's stake down to 33 per cent. Faced with stiff resistance from some political fronts, this proposal has been lying with the standing committee on finance for quite some time now.

What was the logic behind bringing down the government's stake to 33 per cent? If it was to enable the government to call the shots in running the banks, the purpose could have been served even by bringing it down to 26 per cent, since under the Companies Act, a 26 per cent stakeholder can block any special resolution.

The idea was to let the government, the foreign partners and the Indian public have equal, 33 per cent stakes in these banks. The objective was to ensure that 66 per cent of the bank was owned by Indian entities (government and public), or 66 per cent was held privately (foreign partners and the public) -- whichever way you look at it. But that logic does not hold water any more because the foreign holding in a bank can be 74 per cent.

At one point, the impression was that the foreign investment in an Indian private bank can go up to 98 per cent. In May 2001, the ministry of commerce and industry had announced a 49 per cent foreign direct investment in private sector banks.

Since portfolio investment was not a part of the FDI, industry was fairly certain that the foreign stake in private banks could go up to 98 per cent. The assumption was based on simple arithmetic: the FDI quota was raised to 49 per cent, while the existing norms permitted banks to raise the foreign institutional investors' investment limit to 49 per cent.

But in January this year, the finance ministry said that the FIIs can acquire up to 49 per cent stake in private banks but that is within the 74 per cent overall foreign investment ceiling. Does that mean that the FDI quota alone can go up to 74 per cent if there is no FII stake in a bank? The RBI is yet to issue a notification on this.

Even at 74 per cent, it is advantage foreign investors vis--vis Indian promoters because the Indian promoters for private banks are required to dilute their stakes to 49 per cent with time. When the first set of new generation private-sector banks were given licence to set up shop in the mid-1990s, the RBI had stipulated that the promoters must bring down their stakes to 40 per cent after a year of operation.

Later, the time frame for dilution of stakes was extended because the market conditions were not right for floating initial public offerings.

Subsequently, the RBI raised the limit of domestic promoters' stake in private banks to 49 per cent to match the foreign stake (then capped at 49 per cent). But with the government allowing foreign stake of up to 74 per cent, it has once again become an unlevel playing field for domestic promoters.

The reverse is true when it comes to banks' investment in another bank. A foreign bank that has operations in India -- either through a branch or a subsidiary -- will not be allowed to hold more than 10 per cent stake in a private bank but an Indian bank can invest up to 30 per cent in a peer. Clearly, there are different laws for different players in the same sector.

The same is the case when it comes to FIIs' exposure to Indian commercial banks. They can pick up as much as 49 per cent stake in private banks but not more than 20 per cent stake in PSU banks. Take the case of State Bank of India. The global depository receipts holders have around 8 per cent exposure in this bank. This leaves only 12 per cent for the FIIs in SBI -- roughly one-fourth of their permissible holding in a private bank.

The 10 per cent cap for voting rights in private sector banks has been a subject of intense debate. Irrespective of an investors' holding in a bank, the voting right does not exceed 19 per cent. The only exception has been made in case of ICICI Bank's holding in Federal Bank, where the voting right is in conformity with actual holding (20 per cent or so).

This is because the erstwhile ICICI -- the earlier avatar of ICICI Bank -- stepped in as a white knight to rescue the bank at the instance of the regulator. Two successive Budgets spoke about the removal of the cap in voting rights but nothing has been done yet.

Even if Finance Minister P Chidambaram removes this cap in the forthcoming Budget, there may not be blanket withdrawal, because the RBI wants the cap to continue for the foreign banks' holding in a domestic bank.

This is natural, considering foreign banks are unlikely to be allowed to hold more than 10 per cent stake. Meanwhile, the voting rights in PSU banks continue to be capped at 1 per cent and nobody's talking about it. The numbers game continues.


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