Banks get new rules for downstream investments

Investments by banks in the share capital of other corporate entities are governed by the provisions of section 19 of the Banking Regulation Act, 1949, and the Master Circular on Para Banking Activities dated 1 July 2011.

While establishment of subsidiaries by banks and investing in the equity capital of such subsidiaries is guided by section 19(1) of the act, section 19(2) deals with the investments that a bank can make in companies other than its subsidiaries. On 12 December, the Reserve Bank of India (RBI) issued a circular with further guidelines on investments by banks (which took effect immediately), with the intention of limiting the exposure which banks can have in the share capital of companies which are carrying out “non-financial services”.

Previous framework

Previously, banks could hold shares aggregating up to 30% of the paid-up share capital of any investee company or 30% of its own paid-up share capital and free reserves, whichever was less. Section 19(2) does not differentiate such investment by banks based on whether the investee company is engaged in financial or non-financial business.

Companies carrying out activities such as lending or advancing of money, dealing in securities, credit information, securitization and asset reconstruction, operation of a depository, insurance, brokerage, underwriting and investment advisory services, managing pension funds, etc., would all be considered “financial services companies” for the purposes of such investment.

Revised framework

The RBI now seeks to distinguish between investments made by banks in financial services companies and non-financial services companies through the circular. The ceiling for investments by banks in the share capital of a financial services company (other than their subsidiary) remains at 30% of the investee company’s paid-up share capital or 30% of the bank’s paid-up share capital and free reserves (whichever is less).

Additionally, in line with the provisions of the para banking master circular, the circular specifies that investments by banks in their subsidiaries and “financial services companies” should not exceed 20% of the bank’s paid-up share capital and reserves. However, shares of the investee company held by the bank for its treasury operations (classified under the “held for trading” category) and which are not held for more than 90 days are exempt from the 20% limit.

As for investments by banks in non-financial services companies, the RBI has reduced the limit to 10% of the paid-up share capital of the investee company or 30% of the bank’s paid-up share capital and reserves (whichever is less).

Departing from the provisions of the para banking master circular, the RBI has stipulated that all equity investments held by a bank under the “held for trading” category would also be considered for the purposes of determining the 10% limit.

The circular stipulates that the shareholding of a non-financial services company held directly or indirectly by a bank (or through its subsidiaries, associates, joint ventures or mutual funds of asset management companies under its control) should not exceed 20% of the paid-up share capital of the investee company.

A bank may exercise such “control” by having more than 51% of the voting power in relation to the subsidiary, joint venture or associate company, or the power to control the composition of the board of directors of the entity concerned.

Some exceptions

Subject to the overall limit of 30%, as provided by section 19(2), a bank may hold more than 10% of paid-up share capital only with the prior approval of the RBI. However, a request for exposure beyond the 10% limit would be considered by the RBI only if the investee company is engaged in any non-financial activity that a bank may undertake in terms of section 6(1) of the act.

Additionally, a bank may, without the prior approval of the RBI, exceed the 10% limit for non-financial services companies if the acquisition is pursuant to a bilateral debt restructuring scheme or a scheme under the corporate debt restructuring (CDR) forum established by the RBI, subject to the 30% ceiling prescribed under section 19(2).

The circular also stipulates that banks which acquire additional shares pursuant to bilateral debt restructuring or CDR schemes must indicate a time frame to the RBI within which such additional shareholding is proposed to be divested to ensure compliance with the provisions of the circular.

Banks whose existing shareholding in non-financial services companies exceeds the limits prescribed under the circular have been directed to divest of the excess shareholding or seek approval from the RBI in this regard.

Ameya Khandge (Ameya.Khandge@trilegal.com) is a partner at Trilegal in Mumbai where Abhijeet Das (Abhijeet.Das@trilegal.com) is an associate. Trilegal is a full-service law firm with offices in Delhi Mumbai, Bangalore and Hyderabad and has over 140 lawyers.