The central bank issues draft guidelines

The Reserve Bank of India on Wednesday issued draft guidelines stipulating the prudential limits to regulate the investment of banks in subsidiaries and other companies engaged in forms of business other than financial services.

The RBI said that banks could — through their holdings in companies — exercise control or have significant influence over them and thus, engage indirectly in activities not permitted to banks.  It is, therefore, “necessary to limit such investments so as to ensure that banks do not indirectly undertake activities not permitted to them.”

Equity investments in companies engaged in non-financial services activities would be subject to a limit of 10 per cent of the investee company's paid-up capital or 10 per cent of the bank's paid-up capital and reserves, whichever is lower. For the purpose of this limit, the RBI said that equity investments held under the ‘Held for Trading' category would also be reckoned. “Such investments within these limits would not require prior approval of the RBI.”

Bank's request for investments in excess of 10 per cent of such investee company's paid-up capital would be considered by the RBI if the investee company is engaged in activities permitted to banks in terms of Sec. 6(1) of the Banking Regulation Act, 1949. It is reiterated that banks are permitted to set up subsidiaries for undertaking activities which are conducive to the spread of banking in India or useful or necessary in public interest in accordance with the provisions of Sec.19(1) (c) of the said Act. For example, banks setting up IT subsidiaries catering to banking sectors' IT requirement may fall in this category. A bank's equity investments in subsidiaries and other entities that are engaged in financial services together with equity investments in entities engaged in non-financial services activities should not exceed 20 per cent of the bank's paid-up share capital and reserves. The cap of 20 per cent would not apply for investments classified under the ‘Held for Trading' category and are not held beyond 90 days.

Equity holding in excess of 10 per cent of the investee company's paid-up capital would be permissible without RBI's prior approval if the additional acquisition is through restructuring/CDR. The RBI said that while these measures would limit the investments of banks in non-subsidiary companies engaged in non-financial services activities, it is possible that even with limited investment, banks may exercise control or significant influence in companies through other arrangements such as having more than half of the voting rights indirectly through subsidiaries/joint ventures/associates or having control over the composition of the board of directors. These companies would under such circumstances be actually subsidiaries or associates or joint ventures of banks. “Such arrangements may result in banks' indirectly undertaking activities not permitted to them under the Banking Regulation Act. Banks should, therefore, desist from exercising control or significant influence over such companies,” said the RBI

In determining whether an entity is a subsidiary, associate or joint venture of a bank, the definitions given in the Accounting Standards would be used, which use two tests: (a) Ownership and (b) Control. While applying the ownership test, the holdings of the bank, its subsidiary/ies and associates and joint ventures (not the proportionate holding) would be aggregated since ownership by the bank and its subsidiaries, associates and joint ventures denies that level of ownership to others. As regards control, the holdings of the bank and its subsidiaries only may be aggregated since the bank does not control the associates and joint ventures.

The RBI informed that comments/feedback on the draft circular may be sent before July 22 to the Chief General Manager-in-Charge, Department of Banking Operations and Development, Reserve Bank of India, , Mumbai.

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