Amendment is good news for private sector banks

The Banking Laws (Amendment) Bill, 2012, was recently passed by the parliament of India and received the assent of the president of India on 5 January 2013 (the Amendment). The Amendment has been heavily debated since it was first introduced in May 2005 and has undergone extensive changes in the course of seven and a half years. In addition to strengthening the supervisory powers of the Reserve Bank of India (RBI), the Amendment seeks to make investments in Indian private sector banks more attractive for prospective investors.

Voting rights

In terms of section 12(2) of the Banking Regulation Act, 1949 (BR Act), a shareholder of a private sector bank is not permitted to exercise voting rights on poll in excess of 10% of the total voting rights of all shareholders of the bank. The Amendment has raised the ceiling on voting rights from 10% to 26%, which would be implemented in a phased manner as determined by the RBI.

It is worthwhile to note that the earlier draft of the Banking Laws (Amendment) Bill, 2012, had proposed a complete removal of the voting rights ceiling, thus allowing a bank’s shareholders to exercise voting rights in proportion to their shareholding. The Standing Committee on Finance, however, reiterated that the legislative intent behind the 10% ceiling under the BR Act was to address concerns associated with the concentration of management control of banks in the hands of a single entity or conglomerate. In an attempt to balance the above concern with the objective of attracting further investment from investors, the Standing Committee on Finance recommended that the ceiling on voting rights be raised to 26%.

Preference shares

In terms of the BR Act, the share capital of a private sector bank could consist of equity shares only or of equity shares and any preference shares which had been issued prior to July 1944. This Amendment allows private sector banks to issue preference shares in accordance with guidelines framed by the RBI. Such guidelines are likely to cover the extent and class of preference shares issued and the terms and conditions attached to such shares.

The holders of preference shares of private sector banks will have the right to vote on any resolution directly affecting the rights attached to their preference shares. However, the Amendment clarifies that if any part of the dividend due on cumulative and/or non-cumulative preference shares remains unpaid for the periods specified in section 87(2)(b) of the Companies Act, 1956, the holders of such preference shares will not be entitled to exercise voting rights in the manner set out in section 87(2)(b) of the Companies Act.

Regulatory powers

While under the BR Act, the RBI could remove a director or any other officer of a bank, this Amendment empowers the RBI to supersede the board of directors of a bank for up to 12 months and appoint an independent administrator to exercise the powers of the board and the powers exercised in the bank’s general meeting during such a period. To limit the arbitrary exercise of this power, the Amendment requires the RBI to consult with the central government. In addition, the Amendment empowers the RBI to call for any information and inspect the business of an “associate enterprise” of a bank.

The way forward

This Amendment is a positive step forward and demonstrates the central government’s intention to promote investments in the private sector banking business. Increased investor interest will help private sector banks in meeting additional capital requirements under the Basel III norms, which are proposed to be implemented in India in a phased manner from 1 April 2013.

However, the Amendment must be followed by swift regulatory action aimed at attracting investment given that some of the key provisions of the Amendment are subject to further directions from the RBI. The investor community will have to wait for the RBI to provide guidance on the increase in ceiling on voting rights and to formulate guidelines on preference share issuances, in order to assess the impact of the Amendment.

It is also important for the RBI to ensure that the exercise of its enhanced regulatory powers does not adversely affect the sentiments and interests of financial investors.

More avenues of fund-raising may also be explored by the central government and the RBI in order to aid private sector banks in enhancing their capital base without concentrating management control in a few hands. Issuance of non-voting shares is one such avenue which has been proposed by the Standing Committee on Finance and merits further consideration.

Ravindra Bandhakavi is a partner and Parnika Malhotra is an associate at Amarchand & Mangaldas & Suresh A Shroff and Co, New Delhi. The views expressed in this article are those of the authors and do not reflect the position of the firm.