Indian banks will have to adopt the Basel-II norms on capital adequacy by December 2006, and to this end, the Indian government has recently issued a press note relating to foreign investment in the banking sector and framed draft guidelines relating to ownership of private sector banks. Although the draft guidelines are well-intentioned, they need to be modified before finalisation.

No single entity or group of entities can own shares in, or otherwise control, any bank in excess of 10% of the bank’s paid-up capital, without prior RBI approval. As regards new private sector banks, the promoters will be given three years to bring down their shareholding to 10%. The proposed equity caps are very low and prevent ownership of any significance in a private bank. In case of an acquisition, especially when a buyer is paying a large sum of money, the buyer will seek an ownership percentage that has some parity to the amount being invested.

RBI approval is required for any allotment or transfer of shares that takes the shareholding of an individual or a group in a private bank to 5% or more. This provision is in addition to the SEBI Takeover Regulations (applicable to listed banks) under which there are various reporting requirements and the requirement to make a public offer if 15% or more shares are proposed to be acquired in a listed company.

Further, a new Competition Act, 2002 (the “Competition Act”) is on the anvil. Under the Competition Act, “combinations” that exceed laid down thresholds in terms of asset or turnover size may require the approval of the Competition Commission, which will have to evaluate whether such a combination may cause or is likely to cause an appreciable adverse effect on competition. Navigating three restrictive legal and regulatory regimes can cause serious delays in any bank acquisition.

Section 12(2) of the Banking Regulation Act, 1949 prohibits any shareholder in a company engaged in the banking business in India from exercising voting rights in respect of shares held by him, in excess of 10% of the total voting rights of all shareholders. The cap on voting rights can create obstacles to a bank merger in two ways. Firstly, passing the requisite resolutions may be difficult even where a large majority in value of the interested shareholders support an amalgamation. Secondly, this may be a disincentive particularly for foreign banks that wish to enter the Indian market through a merger or an amalgamation, as they would be subject to the voting cap.

One practical hindrance to both public and private bank mergers is the large accumulation of NPAs that accompany banks ripe for a merger. These make the transferor bank an unattractive acquisition, and the offered price an unattractive proposition. However, the government’s emphasis in bank mergers has moved from amalgamations to save banks in difficulty, to amalgamations of healthy banks to improve the resulting bank’s global competitiveness.

In conclusion, the regulatory regime needs to be streamlined in a practical manner so as to provide an impetus to mergers and acquisitions in the banking sector. The government will do well to liberalise the guidelines and make them less onerous.