Reserve Bank of India releases draft guidelines for on tap licensing of Universal Banks in the private sector

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1 11 May 2016 EY Regulatory Alert Reserve Bank of India releases draft guidelines for on tap licensing of Universal Banks in the private sector Executive summary In 2013, the Reserve Bank of India (RBI) came out with a policy discussion paper on Banking Structure in India The Way Forward, primarily pursuant to recognising the need for having an explicit policy on banking structure in India and thereby making a case (i) to review the current stop and go licensing policy, and (ii) considering a continuous authorisation policy, on the ground that such policy would increase the level of competition and bring new ideas in the system. Further to the above and based on the experience of licensing of universal banks, the RBI, on 5 May 2016, has released a draft regulatory framework for granting licenses to Universal Banks on a continuous basis (Draft Guidelines). This alert summarizes the key features of the Draft Guidelines. Suggestions and comments on the Draft Guidelines are to be provided by 30 June 2016.

2 Background The Reserve Bank of India (RBI) issued guidelines for licensing of new banks in the private sector on 22 February Subsequently, recognising the need for having an explicit policy on banking structure in India and with an intention to review the extant Indian banking structure, the RBI released a Discussion Paper Banking Structure In India-The Way Forward on 27 August 2013 (Discussion Paper). Of the various building blocks identified by the Discussion Paper for the revised banking structure, the Discussion Paper made a case for reviewing the current Stop and Go licensing policy and considering a Continuous authorisation policy for entry of new banks. While stating that such a policy would increase the level of competition and bring in new ideas in the system, the Discussion Paper highlighted that the entry norms for such policy should be stringent. Further, the first Bi-monthly Monetary Policy announced by the RBI on 1 April 2014, inter alia, indicated that the RBI will commence working on the framework for on-tap licensing as well as differentiated banking licenses. In view of the above, the RBI has, on 5 May 2016, issued draft guidelines for granting licenses for universal banks on a continuous basis (Draft Guidelines). The Draft Guidelines have been worked out based on the experience of licensing two universal banks in 2014 and granting in-principle approvals for Small Finance Banks and Payments Banks. Comments are invited on the Draft Guidelines by 30 June Salient Provisions of the Draft Guidelines Eligible Promoters Existing non-banking financial companies (NBFCs) that are controlled by residents 1 and have a successful track record for atleast 10 years. Individuals/ professionals who are residents, as per FEMA, and have 10 years of experience in banking and finance. Entities/ groups in the private sector that are owned and controlled by residents and have a successful track record for atleast 10 years. However, where such entity/ group has total assets of INR 50 billion or more, the non-financial business of the group should not account for 40% or more in terms of total assets/ of gross income. The promoters/promoter group 2 should meet the fit and proper criteria i.e. it should have a past record of sound financials, credentials, integrity and have a minimum 10 years of successful track record. 1 As defined in Foreign Exchange Management Act (FEMA) The terms promoter and promoter groups have been defined in an extensive manner to include subsidiaries, holding companies, joint ventures, related parties etc.

3 Corporate structure Non-Operative Financial Holding Company (NOFHC) is not mandatory in case of promoters being individuals or standalone promoting/ converting entities, who/ which do not have other group entities. Further, in a case where other group companies are proposed to be established after the bank is incorporated, the bank should move to the NOFHC structure. Any change in the 5% or more of the voting equity capital of the promoting/ converting entity, shall be with the prior approval of RBI. Conversely, where the promoters/ promoting entities/ converting entities have other group entities, the bank shall be set up only through a NOFHC satisfying prescribed conditions (discussed subsequently). Shareholding Individuals and companies, directly indirectly connected with large industrial houses 3 may be permitted to participate in the equity of a new private sector bank to the extent of less than 10% and shall not have a controlling interest 4 in the bank. Such shareholders shall not have any director on the board of the bank on account of shareholder agreements or otherwise. The limit of less than 10% would apply to individuals and all inter-connected companies belonging to the concerned large industrial houses on an aggregate basis. Only non-financial services companies / entities and nonoperative financial holding companies / core Investment companies / investment companies in the group and individuals belonging to the promoter group will be allowed to hold shares in the NOFHC. Shareholding to the extent of not less than 51% of the total voting equity shares of the NOFHC shall be held by promoters/ companies forming part of the promoter group. In case the shareholding is by companies of the promoter group, such companies shall preferably have a diversified shareholding. If required, the extent of 51% promoter group shareholding in the NOFHC may be held by individuals belonging to the promoter group. However, shareholding by such individual, along with his relatives 5 and along with entities in which he and/ or his relatives hold not less than 50% of the voting equity shares, shall not exceed 15 % of the total paid-up equity 3 For the purpose of these guidelines, a Group with assets of INR 50 billion or more with the non-financial business of the group accounting for 40% or more in terms of total assets / in terms of gross income, will be treated as a large industrial house. (In taking a view on whether the companies, either as promoters or investors, belong to a large industrial house or to a company connected to a large industrial house, the decision of the RBI will be final.) 4 The term controlling interest would mean the rights associated with control as defined in Companies Act, As defined in Section 2 (77) of the Companies Act, 2013 and Rules made there under

4 capital of the NOFHC. Shareholding to the extent of not more than 49% of the total voting equity shares of the NOFHC may be held by the non-promoters. However, shareholding by the single individual non-promoter along with his relatives and along with entities in which he and/ or his relatives hold not less than 50% of the voting equity shares, shall not be 10% or more of the total shareholding of the NOFHC. Any change in shareholding within the NOFHC as a result of which a shareholder transfers / acquires 5% or more of the total equity capital of the NOFHC shall be with the prior approval of RBI. Additional conditions for NOFHC The NOFHC shall be registered as a NBFC and shall be owned by the promoter/ promoter group to the extent of not less than 51% of the total paid-up equity capital. To ring fence the regulated financial services entities of the group, the NOFHC shall hold the bank as well as other financial services of the group regulated by the RBI or other financial sector regulators 6. Apart from setting up the bank, the NOFHC shall not be permitted to set up any new financial services entity for at least three years from the date of commencement of NOFHC. However, this would not preclude the bank from having a subsidiary or joint venture or associate, where it is legally required or specifically permitted by RBI. Minimum Capital Requirements Initial minimum paid-up voting equity capital for a bank shall be INR 5 billion; thereafter, the bank shall have a minimum net worth of INR 5 billion at all times In cases of conversion of NBFCs into banks, the converting entity and thereafter, the bank, shall have a minimum net worth of INR 5 billion at all times. The promoters/ promoter group/ NOFHC shall hold a minimum of 40% of the paid-up equity capital of the bank which shall be locked-in for a period of five years from the date of commencement of business of the bank. In the event of the bank raising further voting equity capital during the first five years from the date of commencement of business, the promoter/s and promoter group/ NOFHC should continue to hold 40% of the enhanced voting equity capital of the bank for a period of five years from the date of commencement of business of the bank. 6 Only those regulated financial sector entities in which the promoter/ promoter group has significant influence or control will be held under the NOFHC.

5 The promoter group shareholding shall be brought down to 30% within a period of 10 years and 15% within a period of 12 years from the date of commencement of business of the bank. The bank shall be required to maintain a minimum capital adequacy ratio of 13 per cent of its risk weighted assets (RWA) for a minimum period of three years after the commencement of its operations subject to any higher percentage as may be prescribed by RBI from time to time. 22 February The bank is precluded from having any exposure to its promoters, major shareholders who have shareholding to the extent of 10% or more of paid-up equity shares in the bank, the relatives of the promoters as also the entities in which they have significant influence or control. The bank cannot invest in the equity of other NOFHCs. Other important conditions for the bank The bank shall get its shares listed on the stock exchanges within six years of the commencement of business by the bank. Foreign shareholding in the bank Foreign shareholding in the bank would be as per the existing foreign direct investment (FDI) policy (currently, 74%) subject to the minimum promoter shareholding requirement. The bank shall open at least 25% of its branches in unbanked rural centres 7. The board of the bank should have a majority of independent directors. No single entity or group of related entities other than promoters/ NOFHC, shall have shareholding or control, directly or indirectly, to the extent of 10% or more of the paidup voting equity capital of the bank Key prudential and exposure norms The bank shall comply with the provisions of Banking Regulation Act, 1949 and the existing guidelines on corporate governance and prudential norms as applicable to scheduled commercial banks. The NOFHC shall also comply with guidelines on capital, prudential and exposure norms as per the RBI guidelines for Licensing of New Banks in the Private Sector dated The bank shall maintain arm s length relationship with promoter/ promoter group entities, and the major suppliers and major customers of these entities. The bank should be fully networked and technology driven from the beginning with all modern infrastructural facilities. The bank should have a high powered customer grievance cell to handle customer complaints. 7 population up to 9,999 as per the latest census

6 Banking being a highly leveraged business, licences shall be issued on a very selective basis to those who conform to the above requirements, who have an impeccable track record and who are likely to conform to the best international and domestic standards of customer service and efficiency. Therefore, it may not be possible for RBI to issue licences to all the applicants just meeting the prescribed eligibility criteria. Additional conditions for NBFCs promoting / converting into a bank The promoters/ promoter groups with an existing NBFC that is controlled by residents, if considered eligible for a bank licence, will have two options: (a) Promote a bank, or (b) Convert the NBFC into a bank. Under both the above options, the NOFHC / the bank or both, as the case may be, should comply with all the requirements laid down in the guidelines. Further, under both the above options, the promoters will have to set up a NOFHC if they have other entities in their group. The NOFHC and the bank set up under it should comply with all the requirements laid down in the guidelines. promoter shareholding. RBI will consider allowing retaining existing branches of the NBFC which is converting into a bank, as bank branches, with prior approval and subject to conformity/ compliance with the extant guidelines on branch authorization. Procedure to obtain approval The licensing window will be open on-tap, and the applications in the prescribed form along with requisite information (i.e. business plan, shareholding pattern, project report, etc.) could be submitted to the RBI at any point of time. At the initial stage, the applicants will be screened by the RBI and will then be referred to a Standing External Advisory Committee (SEAC) to be set up by the RBI. The Committee will submit its recommendations to the Reserve Bank for consideration. The SAEC will set up its own procedures for screening the applications The decision to issue an inprinciple approval for setting up of a bank will be taken by the Reserve Bank. If the existing entities have diluted the promoter shareholding to below 40%, but above 26%, due to regulatory requirements or otherwise, RBI may not insist on the promoters minimum initial contribution and the lock-in period of 5 years will apply to 26% The validity of the in-principle approval issued by the RBI will be 18 months from the date of granting in-principle approval and would thereafter lapse automatically. The RBI s decision in this regard

7 will be final. In order to ensure transparency, the names of the applicants for bank licences and the names of applicants that are found suitable for grant of in-principle approval will be placed on the RBI s website periodically. Comments Indian banking system has been evolving and going through a dynamic phase with RBI swiftly acting on various recommendations made by committees which have been set up for having implicit banking structure in India. An applicant who has not been found suitable for issue of license will be advised of the RBI s decision. Such applicants will not be eligible to make an application for a banking license for a period of three years from the date of that decision. Applicants aggrieved by RBI s decision can prefer an appeal to the RBI s Central Board of Directors, within one month from the date of receipt of communication from RBI relating to the application no being considered. The grant of universal banking licenses, differentiated banking licenses and now making universal banking license on tap would not only effectively promote the broad level objective of financial inclusion but also revolutionise the financial system in India. The release of the on-tap licensing frame-work (once finalised) is a welcome move and could open the window of opportunity for those eligible applicants keen on entering the banking sector. The prescribed forms in which the application is to be made to the RBI have been annexed to the draft guidelines.

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