Tuesday, December 13, 2011

Bank Investments in Non-Financial Services Companies

The Reserve Bank of India (RBI) has tightened the control over investment by banks in other companies that do not operate in the financial services sector. The rationale has been set forth in a new set of guidelines issued yesterday:
Banks’ investments in companies which are not subsidiaries are governed by Section 19(2) of the Banking Regulation Act, 1949 (B.R. Act). There is no requirement, at present, for obtaining prior approval of RBI for such investments except in cases where the investee companies are financial services companies. It is, therefore, possible that banks could, directly or indirectly through their holdings in other entities, exercise control on such companies or have significant influence over such companies and thus, engage in activities directly or indirectly not permitted to banks [Section 6(1) of the Act ibid deals with the activities permitted to banks]. This would be against the spirit of the provisions of the Act and is not considered appropriate from prudential perspective.
Consequently, banks are permitted to invest in non-financial services companies only up to 10% of the investee company’s paid up share capital or 10% of the bank’s net worth, whichever is less. Any investment beyond this limit would require the prior approval of the RBI. Through these guidelines, the RBI has effectively narrowed the scope of investment opportunities that banks can otherwise freely undertake under section 19(2) of the Banking Regulation Act, 1949, subject to the overall limit of 30%. By this, the RBI seems to take the position that a bank can potentially control or exercise influence over an investee company with a 10% shareholding, which is an extremely low threshold going by the conventional understanding of “control” or “influence”.

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