Banking Bill gives RBI all it wants

The year-end holiday spirit will certainly be missing this year at the Reserve Bank of India's headquarters on Mint Road.

For Finance Minister P Chidambaram has just taken away the RBI's last reason to delay the final guidelines for new banking licences. In fact, the Banking Laws (Amendment) Bill, which the Lok Sabha passed on Tuesday and the Rajya Sabha is due to vote on Thursday, has given the central bank everything it asked for: greater regulatory oversight over banks, the ability to overrule boards and the power to inspect the books of associate companies of the promoter group -- its preconditions for new licences.

Though it's debatable whether power to supersede bank boards can adequately safeguard against the problems created by banks promoted by those with interests in other industries, the finance ministry has at least shed its reluctance to bulldoze the Reserve Bank of India.

The RBI can also take comfort from the ministry's decision to drop the clause allowing banks to trade in commodity futures.

The central bank was always uncomfortable with allowing speculative funds to flow into commodity derivatives when the regulator concerned lacks capacity and statutory powers.

The Bill, in fact, has left something on the table for all stakeholders.

Though the government has diluted its earlier proposal to allow voting rights in proportion to the investment of each shareholder, the increased cap for private banks takes away one long-standing grouse of investors: that they don't have their say over operations even

if they make large investments.

There isn't any doubt that banks in India need money to expand their operations and meet tougher global capital requirements.

But many foreign investors have been hesitant to increase their stake in local banks due to restrictions on voting rights.

Some even expect the Bill to lead to increased investor interest in smaller private sector banks.

And in the case of foreign banks, the Bill accepts their long-standing demand that they be allowed to convert their Indian operations into local subsidiaries or transfer shareholding to a holding company of the bank without paying stamp duty.

Under current laws, they have to pay 20 to 30 per cent tax as capital gains and stamp duty when transferring branches to a new legal entity.

Foreign banks now operate in India by setting up branches (all foreign banks together have about 400 branches in India), a strategy that makes expansion difficult because the RBI gives only a limited number of branch licences to them each year.

Finally, the Bill could pave the way for consolidation in the banking space with the entry of some large players.

For far too long has India lived with the notion of competition squeezing margins and forcing banks to seek and accept excessive risk to generate returns for shareholders.

There is just no reason to disagree with the Narasimham Committee's suggestion (not once, but twice) that India needs a few world-sized banks.

For that to happen, consolidation is indeed a must in the smaller banking space.

Disclosure: Kotak Mahindra and associates are significant shareholders in Business Standard Limited