This effectively shelves plans by the country's largest two banks, State Bank of India and ICICI Bank, the country's largest and second-largest bank, respectively, to form subsidiary holding firms for their insurance and mutual fund businesses.
In a discussion paper on holding companies in banking groups circulated today, the RBI said, "It will be desirable to avoid intermediate holding company structures (a structure in which a bank owns a holding company for various non-bank businesses)."
The discussion paper, which will be open for public feedback, has been prompted by applications filed by ICICI Bank and the SBI to set up holding companies, in which the banks hold the majority stakes, for the insurance and mutual fund businesses and in which foreign investors will take stakes.
ICICI Bank had even obtained approval from the Insurance Regulatory and Development Authority and the Foreign Investment Promotion Board on its new structure in which Goldman Sachs and other foreign investors were to take a 24 per cent stake. Its application is pending with the RBI.
The banking regulator has suggested a bank holding company or a financial holding company model in which bank and non-bank subsidiaries in a banking group will be owned by the holding firm. This is also an ownership structure specified under Basel II, the revised capital adequacy framework for banks.
ICICI Bank and the SBI had considered setting up the holding companies to ensure a smooth flow of capital to subsidiaries. An ICICI Bank spokesperson declined to comment on the RBI's suggestion.
Kalpana Morparia, the bank's chief strategy and communications officer, had said earlier, "Both these (insurance and asset management) companies need a fair amount of capital for growth. Beyond a point, the bank cannot put in more capital." The central bank has put a limit of 20 per cent of a bank's net worth on investments in financial services companies.
A senior SBI official said the RBI discussion paper had come as a surprise, but added the bank still had room to fund the growth of its life insurance subsidiary.
The RBI paper also pointed out that an intermediate holding company would not fall within the regulatory purview of the Reserve Bank of India Act, being a company that confines its activities to investing in group companies.
The paper also said a holding company that would own a bank and other companies in the group would help separate a banking entity from other group companies and hence the responsibility of funding the growth of subsidiaries.
It added that the law should ensure that no unregulated entities were present within the structure. The RBI said the presence of any unregulated entity within a banking group might prove to be a "weaker link" in the structure providing scope for regulatory arbitrage.
Another possible complication, the RBI paper said, could arise because of legal restrictions on foreign holding in subsidiaries like insurance companies. In insurance companies, direct or indirect foreign holding cannot exceed 26 per cent.
However, according to IRDA regulations, when the Indian promoter company is a banking company, the proportion of foreign holding in such a banking company would not be considered for the purpose of calculating the 26 per cent foreign holding limit in an Indian insurance company. The paper said this exemption would not be applicable to an intermediate holding company.