Indian Banks’ Association
RBI Discussion Paper on Holding Companies in Banking Groups
– IBA’s Response on the Discussion Paper
Introduction
The Indian financial sector has broadened significantly in the last decade with the
opening up of the various segments such as insurance and asset management to new
participants, which in turn has facilitated the growth and penetration of financial services
in the country. This has also necessitated structural changes arising out of the capital
needs of the entities. This has led to the emergence of financial conglomerates or groups
of legal entities that offer a range of financial services.
Recognizing the possibility of systemic risks posed by financial conglomerates, the
initiation of discussion by Reserve Bank of India (RBI) on holding companies in banking
groups is welcome. The non-banking financial businesses, particularly insurance, are
expected to require substantial capital to support their growth. It is therefore necessary to
evolve a structure that takes into account the need to limit the exposure of bank
depositors to non-banking risks, while facilitating the desired increase in penetration of
the non-banking businesses, like insurance, as part of overall financial deepening in
India.
Ideal regulatory structures and challenges
As stated in the discussion paper, financial holding company (FHC) and bank holding
company (BHC) structures would be suitable in the Indian context, as banks and their
depositors would be effectively separated from the non-banking financial businesses in
the group. However, this would require examination of the legal and regulatory changes
necessary to facilitate creation, functioning and regulation of FHCs and BHCs. It may
need to be examined as stated in the RBI paper whether these would require a new statute
or may be achieved through specific amendments to the existing legal and regulatory
framework. It is suggested that it may be possible to constitute and regulate such entities
within the existing legal and regulatory framework, with certain amendments to extant
regulations rather than having a statute in place before allowing any model to develop.
Further, it is difficult to specify only one model in India especially when the intermediary
financial company is in the evolving stage. At the same time, taxation and stamp duty
issues may arise in case the creation of an FHC or a BHC for an existing conglomerate
requires transfer of shareholdings or assets between entities, which would need to be
addressed by each conglomerate.
Need for intermediate holding companies
While it is not possible to immediately constitute an FHC or BHC structure, the issue of
creating an appropriate structure for non-banking financial subsidiaries of banking
companies assumes immediate attention given the capital requirements of these
businesses, especially the insurance business. This is critical in the context of public
sector banks, which require capital not only to support the growth of the banking business
and meet the requirements of Basel II but also to meet the solvency requirements of the
rapidly growing insurance businesses, without diluting the government holding below
51%. The statutory requirement of majority government ownership in the parent public
sector bank reduces its flexibility in raising capital from the market.
In this context, it would be beneficial to permit intermediate holding companies in
banking groups, as an interim measure pending the move to an FHC or BHC structure
as it is evident that creating an FHC at one go is not possible and it is also time
consuming.
Intermediate holding companies would be formed only with the prior
approval of RBI and would be regulated by RBI within the extant regulatory
framework. Such entities in Indian banking groups would limit the exposure of the bank
and its depositors to the non-banking businesses, without unduly constraining the non-
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banking businesses. Further, the parent company need not have to approach the market
for raising capital for its non-banking entities frequently and thereby risking its balance
sheet if an intermediate holding company is there to take care of the capital needs of the
non-banking businesses.
Concerns relating to Intermediate Holding Companies
The discussion paper has raised several concerns relating to intermediate holding
companies. We give below some points to substantiate that the intermediate holding
company model can very well be accommodated within the existing legal and regulatory
framework.
a) General Concerns on Regulation
The paper points out that the multi-layering of corporate structure would impede
supervision by bank regulators. In this context it may be noted that intermediate or stepdown subsidiaries currently exist in corporate and bank groups in India. Step-down
subsidiaries are treated similar to direct subsidiaries under corporate law and under
accounting standards for consolidation. An intermediate holding company in banking
group would be licensed and regulated by RBI. The intermediate holding company could
be regulated as any other non-banking finance company. Further, at the time of
granting approval for formation of such a company, RBI can stipulate such
conditions, as it considered appropriate. RBI’s regime for supervision of financial
conglomerates already covers all entities in the group, including step-down subsidiaries.
Hence it could be noted that current regulatory environment prevalent at present is
empowering enough to regulate an intermediate holding company model. It is therefore
suggested that additional complexity would not arise on account of an intermediate
holding company structure and concerns on impediments to regulation could be mitigated
by stipulating appropriate conditions for the formation and functioning of an intermediate
holding company in a banking group.
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The paper expresses concern that multi-layered structures in different jurisdictions would
result in weak control while increasing size would impose expectation of rescue by
regulator in the event of a crisis. It may be noted that the intermediate holding company
structures currently being proposed by market participants in India envisage an Indiaincorporated entity majority-owned by the parent bank and in turn owning shares in nonbanking financial businesses currently owned directly by the parent bank. All the entities
in the group including the existing banking and non-banking entities and the intermediate
holding company would be subject to regulation by their respective regulators as well as
by the principal regulator under the financial conglomerate supervision regime. It is
therefore believed that significant additional complexity would not arise on account of an
intermediate holding company structure.
Addressing the Investor’s concern
The paper notes that investors would have difficulty in risk assessment of conglomerate
structures consisting of intermediate holding companies. It may be noted that various
statutes and capital market regulations mandate the requisite disclosures to enable
investors to make informed decisions. For example, Indian regulations require
preparation of stand-alone and consolidated financial statements of the parent company
and stand-alone financial statements of each subsidiary, direct or indirect, on an annual
basis. The stand-alone and consolidated financial statements of the parent company must
be published and provided to all shareholders, while the stand-alone financial statements
of each subsidiary must at least be posted on the parent company website and also made
physically available to shareholders on request. Given the competition to attract capital
and the increasing sophistication of institutional investors, transparency would be an
essential pre-requisite for any banking group. It is also suggested that RBI may stipulate
such conditions as it deems appropriate regarding the activities of such entities and use of
capital by them.
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Capital Requirements
As rightly mentioned in the paper, the group-wide capital adequacy technique should be
used to eliminate the effect of intermediate holding companies and ensure that the capital
appropriate for all banking and other financial businesses is indeed maintained
irrespective of the presence or absence of an intermediate holding company.
The paper expresses concern on the use of leverage by the intermediate holding company
to capitalize its subsidiaries. It is suggested that this may be addressed by stipulating
minimum Net Owned Fund requirements at the intermediate holding company level to
ensure that it does not unduly leverage its capital base to invest in the equity of the nonbanking subsidiaries, and appropriate net capital is maintained on a group-wide basis.
Regulatory Burden
The paper mentions that intermediate holding companies would increase regulatory
burden and there would be a need for upgrade in judicial framework and accounting and
audit capabilities. As mentioned earlier, the intermediate holding company structures
currently proposed by market participants in India envisage an India-incorporated entity
majority-owned by the parent bank and in turn owning shares in non-banking financial
businesses currently owned directly by the parent bank. Subsidiary and step-down
subsidiary structures already exist and are dealt with under the extant legal, regulatory
and accounting framework.
De-risking the Parent Bank
The paper points out that intermediate holding companies would only partially insulate
banks from the capital burden of the subsidiaries. It may be noted that currently, there is
no insulation of banks from the capital burden of their subsidiaries. The intermediate
holding company structure would insulate the banks to a large extent from the future
capital requirements of other businesses as the intermediate holding companies would be
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able to raise capital independent of the bank. It would thus improve upon the current
situation. Full insulation of the banks from the risks of subsidiaries would only occur if
and when a migration to the FHC model takes place.
Concern on “unregulated entities”
The paper expresses concern on the systemic risk posed by the presence of unregulated
entities in banking groups. Based on an analysis of extant regulations, it is believed that
an intermediate holding company in a banking group would be regulated by RBI. This
analysis is set out below:

Section 45-I of the RBI Act defines the business of a non-banking financial
institution to include the business of investing in shares, and defines a nonbanking finance company (NBFC) to include a non-banking institution which is a
company. Section 45- I A of the RBI Act mandates all NBFCs to seek registration
with RBI. Only certain types of NBFCs, such as companies in the business of
insurance, housing finance, stock-broking and merchant banking have been
exempted from registration with RBI. Thus, an NBFC engaged in the business of
investment, even if only in-group companies, is required to register with RBI.
Hence an intermediary holding company could be regulated by RBI under this
Section of the Act.

Under the RBI Master Circular on para-banking activities, a banking company is
required to take RBI’s approval for forming a subsidiary, which would apply to an
intermediate holding company. At this stage RBI can impose such conditions or
stipulations as it may deem fit and thus create a framework for the regulation of
the intermediate holding company.
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
RBI prescribes a regime for supervision of complex financial conglomerates,
which includes capturing of intra-group transactions and inter-regulatory
exchange of information. This regime even covers non-financial enterprises
forming a part of the group. The proposed intermediate holding company would
fall within the ambit of this framework.

RBI’s guidelines specifically regulate non-deposit taking NBFCs with an asset
size of Rs. 100 crore or more (categorised as “systemically important non-deposit
taking NBFCs”), including prescribing a capital adequacy ratio for such NBFCs.
Intermediate holding companies in banking groups would likely fall within this
criteria.
The paper expresses the concern that the intermediate holding companies within the bank
subsidiary model being followed in India would increase the risks to the parent bank. It
may be noted that the intermediate holding company would not pose additional risk and
would in fact mitigate risk for the parent bank, for the reasons set out below:

Banks would continue to be subject to the limit of 20% of capital and reserves, for
all their investments in non-banking financial entities including the intermediate
holding company and would have to obtain RBI’s approval for any fresh
investment.

The creation of an intermediate holding company which can independently raise
capital for the non-banking business would mitigate the risk for the bank and its
depositors. In the absence of such a structure, the bank could continue to invest in
non-banking subsidiaries within the para-banking guideline limits, by raising
capital itself and thereby actually increasing the exposure of the bank and its
depositors to the non-banking business risks.

There could be a concern that leveraging of its capital by an intermediate holding
company may have a negative impact on the financial profile of the group. This
may be addressed by stipulating minimum Net Owned Fund requirements at the
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intermediate holding company level to ensure that it does not unduly leverage its
capital base to invest in the equity of the non-banking subsidiaries, and
appropriate net capital is maintained on a group-wide basis.

There may also be a concern that risks such as reputation risk may be enhanced
due to rapid growth of the non-banking businesses. It may be noted that each of
these businesses is subject to regulatory supervision and oversight over their
growth and operations. Further, the financial conglomerate supervision
framework also provides a mechanism for regulating inter-related banking and
financial entities, including sharing of information between regulators.
The paper also mentions the lack of clarity regarding exemption in respect of indirect
foreign ownership in subsidiaries. It may be noted that:

Under current regulations (namely the FDI Policy and related press notes), 100% FDI
is permitted in an investment company in the services sector; and, unless FDI in such
a company is not more than 49% and the management of the company is with Indian
owners, the foreign shareholding in the company would not be considered for the
purpose of determining foreign shareholding in its investee companies. Any
intermediate holding company in a banking group wherein the bank owns 51% or
more would fall within this criteria, and as such could raise capital from foreign
investors without any impact on the foreign shareholding level permitted at the
investee company level.

The regulations governing insurance companies provide that investment by foreign
institutional investors other than the foreign promoter in the Indian promoter need not
be considered in computing foreign ownership in the Indian insurance company.
Thus, the absence of exemption referred to in the discussion paper applies only in case of
holding by the foreign partner in an insurance venture, in the intermediate holding
company. In other non-banking businesses such as brokerage and asset management,
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100% foreign ownership is currently permitted. The position on foreign ownership can be
suitably clarified by the concerned authorities, and need not be a pre-condition for
permitting intermediate holding company structures.
Conclusion
In summary, while the eventual objective for financial conglomerates in India would be
to move towards FHC or BHC structure, in the interim, intermediate holding company
structures in banking groups would serve to limit the additional capital investment and
resultant risk-bearing by banking entities in non-banking financial businesses, allowing
such businesses to grow as required for overall financial deepening. Extant regulations
require RBI approval for formation of such an entity and its registration as an NBFC, and
empower RBI to stipulate conditions while granting such approval and registration.
Extant regulations also provide for regulation by RBI of all NBFCs and indeed all entities
in a banking group. Thus, a regulatory framework is already in place to facilitate the
formation of intermediate holding company structures.
Given the fact many banks have ventured into different non-banking activities and are
having subsidiaries and are seeking ways to raise capital for funding their subsidiaries,
the time is ripe for developing an intermediary financial company to meet the growing
needs of the non-banking activities. In the case of Public Sector Banks, augmenting the
capital is a major area of concern given the 51% cap of the government holding.
Considering all these aspects, it would be worthwhile for RBI to facilitate growth of
home-grown financial conglomerates through intermediate holding company structure, as
an interim solution, pending the end-state of FHC or BHC model in the system.
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