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Proposed New Private Bank Licensing Rules

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Following promises made last year by the Indian Finance Minister,  the Reserve Bank of India (RBI) is actively considering granting new private banking licenses. To that end, the RBI has invited comments on a set of proposed guidelines for licensing additional private banks. 

As has been widely anticipated by industry watchers, the draft licensing guidelines published by the RBI propose to remove the previous prohibition that precluded 'industrial houses' from promoting or controlling Indian banks. The guidelines also propose to allow non-banking financial companies the option of converting themselves into banks. 

However, various checks and balances have been built in to limit financial risk spreading from the other business activities of new bank promoters. For instance, promoter groups and entities will need a succesful ten-year track record of operating their businesses before they can apply for a bank license, and even then, they would be ineligible to receive a license if in the last three years, 10% or more of their income or assets are connected with real estate or capital market activities. Again, in order to ring-fence regulated financial activities from other businesses, the promoters will have to incorporate a "non-operative holding company" (NOHC) that will own the bank and all other promoter-group owned financial services companies that are regulated by the RBI or other financial regulators. For similar reasons, at least 50% of the directors of the NOHC will have to be completely independent of the promoters and there will also be caps on the bank's exposure to promoter group entities.

Under the new rules, private banks will require a minimum paid-up capital of Rs. 5,000 million. The NOHC will have to hold at least 40% of the initial paid up capital. If the NOHC holds more than 40% of the paid up capital, it will need to bring its holding down to 40% within two years—by which time the bank will also have to be publicly listed. Conversely, if the bank raises any further capital (through public issues or private placements) during its first five years, the NOHC will have to maintain its shareholding at 40%. In addition, these banks will require RBI approval to raise capital beyond Rs. 10,000 million (i.e., for every additional block of Rs. 5,000 million).

Foreign investment will be permitted in the newly licensed private banks. However, the foreign shareholding will be capped at 49% during the first five years. Not just that, the promoter groups will also have to be both owned and controlled by Indian residents. Foreign shareholding in the banks can be raised after five years based on the then applicable foreign investment rules. (The current foreign investment rules allow up to 74% foreign investment in private banks with prior government approval.) 

In any event, no single non-resident shareholder or group will be allowed to hold more than 5% of the paid-up capital of any bank. Even resident individuals, entities and groups, i.e., other than the NOHC, will require prior RBI approval to hold more than 5% of the bank's paid-up capital. 

Various provisions from the current bank licensing rules will continue to apply under the new rules. For example, the promoter holding will be locked in for five years from the date of the bank license, the new banks will be subject to the same priority sector lending targets as other domestic banks, and at least 25% of the new bank's branches will have to be located in unbanked rural centres. 

Comments on these new draft licensing guidelines have to be sent in to the RBI by October 31, 2011.

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