The Hindu Business Line : Don’t hold up holding companies

The need for a holding company structure is apparently accepted by the RBI, though it cites various obstacles to the realisation of the goal. It is hoped the central bank shows a resolve to settle the various difficulties that may arise in the transition to a financial holding system, says S. VENKITARAMANAN.

The RBI recently published a discussion paper on bank holding companies. In a comprehensive analysis of the pros and cons of the holding company model, the central bank lists out various advantages and disadvantages. It cites the model of the financial holding company (FHC), which is prevalent in the US, as an alternative to the bank holding company (BHC).

The financial holding company, initiated in the US to enable banks to expand their outreach in respect of non-banking businesses, such as insurance, is a useful model.

The RBI visualises a series of changes in the statutes to enable the BHC or FHC model to come about. Further, experts point out that before such a new structure can house some of the existing investments of a bank or non-bank in insurance, asset management or broking, the entities will have to be demerged. This is a process that is time-consuming as well as costly.

ICICI Bank has, in effect, proposed an interim solution, a holding company of an intermediate type. It has gone ahead and even obtained approval of the Foreign Investment Promotion Board (FIPB) for foreign holding in the new entity. The RBI apparently feels that its turf has been encroached.

Arguments in favour

The arguments in favour of a holding company structure are straightforward. The holding company frees up the bank capital to the extent it directly invests in non-banking businesses.

The relief to the non-banking/bank company’s capital is substantial as in the case of insurance and the capital needs are quite large. Further, the present structure, in the absence of a holding company, puts the operating entity, be it a Bank or an NBFC, at a disadvantage as it deducts the invested capital from the net-worth and cripples the entity’s expansions.

The credit needs of a growing economy require further expansion of financial activities, be they lending, insurance, brokerage or asset management.

Any device that enables banks and non-banks to expand should be encouraged instead of being looked at in a negative way.

0Further, the initiative of ICICI Bank does enable the unlocking of value held in its subsidiaries. A part of the stake in the holding company can be sold to prospective investors.

I wonder whether the prospect of this leading to a fresh inflow of forex is behind the RBI’s niggardly approach to the ICICI initative.

Weak technical objections

There are some technical objections that are being put forward in the paper of the RBI. These seem to be rather weak. For instance, how can the FDI limit be fixed in the holding company when it includes insurance, banking and so on? Surely, it should not be beyond the ingenuity of the experts in the FIPB to proportionately ascribe the stake-holding in the holding company to various arms, such as insurance, asset management, etc.

Yet another weak objection is how to fix regulatory jurisdiction. In the absence of specific guidelines, the respective regulator, such as the IRDA, will regulate that part of the holding company that pertains to its respective jurisdiction.

Does the RBI’s reluctance to accept a holding company structure express its Freudian desire to become a single regulator, in effect, a Financial Services Authority? Be this as it may, in the US itself, the problem of multiple regulators exists and still FHCs and BHCs flourish. SEC, the insurance regulators as well as the State Insurance Commission, look after their regulatory functions without much obvious trouble.

The discussion paper clarifies that the bank holding companies are those that can own or control one or more banks.

In the US, these are regulated by the Federal Reserve. They were introduced in the US by the Banking Companies Act of 1956. These companies can make only limited investment in the non-banking sphere.

The FHC model is one that was introduced in 1999 by the Gramm-Leach Billey Act (GLB) as a way to expand the financial services activities of BHC. The Act permits banks, security firms and insurance companies to affiliate each other through the FHC structure.

An FHC can engage in activities other than banking as long as they are financial in nature. The most important amongst these are securities transactions, insurance underwriting, agency for insurance and merchant banking. FHCs need to have a bank in the financial set-up. Many leading financial services companies are now doing business as FHCs across sectors.

At present, there are more than 600 FHCs in the US. Most of them are BHCs that have elected to function under the GLB Act as FHCs. They control approximately 80 per cent of the entire banking system in the US.

Other than the US, Canada, the UK, Japan and France, as well as some emerging countries such as Taiwan, Korea and Singapore, have adopted the FHC as a model of organisation.

Interim solution

The need for a holding company structure is apparently accepted by the RBI. It cites various obstacles to the realisation of the goal but they are not such as cannot be overcome.

There is, however, an interim solution, which has been suggested by a number of participants in the debate. That is to set up an intermediate holding company, which will be a non-banking company falling within the RBI’s overall regulatory jurisdiction on its banking activities and that of the IRDA and SEBI insofar as the relevant functions are concerned.

This interim solution is eminently reasonable and the RBI can be satisfied that the new entrant cannot escape the regulatory clutch. Nor will it avoid regulation by the IRDA or SEBI. I would commend it to the RBI to look at the suggested solution in an instructive way.

Ultimately, India has to engage in expansion of financial activities, be they insurance, securities business or commodity trading.

There is no way the present structure, which limits banking activities to a certain extent, can help in the economy’s further development.

The central bank has to find a way round the problem and even as it looks suspiciously at the proffered alternative, it has to avoid the suspicion that it is blocking innovation and progress.

Public sector banks have special problems in adopting a holding company structure although it can be felt that the Government itself conforms to the ultimate holding company. The SBI’s attempted initiative to form a holding company is desirable innovation and should be approved as such.

Tackling practical problems

There are practical problems arising from the structure of a holding company and the legal measures needed to demerge the existing subsidiaries from an entity and housing them in an FHC or BHC.

These are issues of stamp duty, which should be resolved by an overarching amendment of the Stamp Act.

Further, there will be taxation questions arising from the holding of a holding company.

Dividend distribution tax on each stage of origination of dividends from the subsidiaries to the holding company can be accretive. The tax laws can be amended to exclude the dividend payable by a holding company’s subsidiary to its parent body.

The initiative of the RBI in putting forth its views on holding companies is welcome.

I hope it shows a transparent resolve to settle the various practical difficulties that may arise in the transition to an FHC structure rather than use them as excuses to postpone the transition.

In the interim, an intermediate holding company is a desirable solution. Hopefully, the RBI will find a way to adopt this solution.

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Inflation warning

Whither science and secularism?

Clueless in Iraq

Water management in Europe — Germany’s wellspring of resources

Don’t hold up holding companies

The great contradiction

Skilled workforce shortage: Hard realities

Power solutions