The Reserve Bank on July 2, 2004 placed in public domain a draft policy framework for ownership and governance in private sector banks. The draft is for discussion before finalisation.

The objective of the policy framework is to ensure good corporate governance is private sector banks. Banks are "special" as they not only accept and deploy large amount of uncollateralised public funds in fiduciary capacity, but they also leverage such funds through credit creation. They are also important for smooth functioning of the payment system.

The legal prescriptions for ownership and governance of banks laid down in the Banking Regulation Act, 1949 have been supplemented by regulatory prescriptions issued by the Reserve Bank from time to time. Recently, the Reserve Bank has laid down a comprehensive policy framework relating to ownership and governance in Indian private sector banks.

The broad principles underlying the policy framework would ensure that -

All banks in private sector should have a net worth of Rs 300 crore at all times. Where the net worth declines to level below Rs 300 crore, it should be restored within reasonable time.

(i) The Reserve Bank’s guidelines on acknowledgement for acquisition or transfer of shares of February 3, 2004 (see box on page 4) will be applicable for any acquisition of shares of 5 per cent and above of the paid up capital of the private sector bank.

(ii) In the interest of diversified ownership of banks, it would be ensured that no single entity or group of related entities has shareholding or control, directly or indirectly, in any private sector bank in excess of 10 per cent of the paid up capital of the bank.

(iii) Where ownership is that of a corporate entity, it would be ensured that no single individual/entity has ownership and control in excess of 10 per cent of that entity. Where the ownership is that of a financial entity it would be ensured that it is a widely held entity, publicly listed and a well established regulated financial entity in good standing in the financial community.

(iv) In case of a new licence for a private sector bank, promoter shareholding would be allowed to be higher to start with, but should be brought down to 10 per cent in a time bound manner normally within a period of three years.

(v) As per the existing policy, large industrial houses will not be allowed to set up banks but would be permitted to acquire by way of strategic investment, shares not exceeding 10 per cent of the paid up capital of the bank subject to the Reserve Bank’s prior approval.

(vi) Any private sector bank, including any foreign bank with presence in India, will be allowed to hold shares in any other private sector bank only up to 5 per cent of the paid up capital of the investee bank.

As announced by the Government of India in Mach 2004, the aggregate foreign investment in private banks from all sources, i.e., foreign direct investment (FDI), foreign institutional investors (FIIs), non-resident Indians (NRIs) should not exceed 74 per cent. The limit of 74 per cent would be reckoned by taking into account the direct and indirect holding. In other words, at all times, at least 26 per cent of the paid up capital of a private sector bank

Individual NRI portfolio investment in banks is limited to 5 per cent and the aggregate limit for all NRIs is restricted to 10 per cent. It could, howerver, be raised to 24 per cent with the approval of the board/general body.

The process of due diligence in all cases of shareholders and directors will involve reference to the relevant regulator, revenue authorities, investigation agencies and independent credit reference agencies.

Any allotment or transfer of shares which will take the aggregate holding (direct and indirect) of an individual or group to equivalent of 5 per cent or more of the paid-up capital of a private sector bank would require the Reserve Bank’s acknowledgement before the bank can effect the allotment/transfer of shares.

While deciding whether or not to grant acknowledgement, the Reserve Bank would take into account all matters that it considers relevant to the application, including ensuring that the shareholders whose aggregate holdings are above specified thresholds meet the fitness and propriety tests. The Reserve Bank may, if required, call for additional information and documents including shareholder agreements.

In determining whether the applicant (including all entities connected with the applicant) is fit and proper to be a shareholder of a private bank, the Reserve Bank may take into account all relevant factors, such as -

• The applicant’s integrity, reputation and track record in financial matters and compliance with tax laws.
• Whether the applicant has been the subject of any proceedings of a serious disciplinary or criminal nature, or has been notified of any such impending proceedings or of any investigation which may lead to such proceedings.
• Whether the applicant has a record or evidence of previous business conduct and activities where the applicant has been convicted for an offence under any legislation designed to protect members of the public from financial loss due to dishonesty, incompetence or malpractice.
• Whether the applicant has achieved a satisfactory outcome as a result of financial vetting. This will include any serious financial misconduct, bad loans or whether the applicant was judged to be bankrupt.
• The source of funds for the acquisition.
• Where the applicant is a body corporate, its track record of reputation for operating in a manner that is consistent with the standards of good corporate governance, financial strength and integrity in addition to the assessment of individuals and other entities associated with the body corporate.

Where acquisition or investment takes the shareholding of the applicant to a level of 10 per cent or more and up to 30 per cent, the Reserve Bank would also take into account other factors, such as -(a) Source and stability of the funds for the acquisition and the ability to access financial markets as a source of continuing financial support for the bank (b) Business record and experience of the applicant including any experience of acquisition of companies (c) The extent to which the corporate structure of the applicant would be in consonance with effective supervision and regulation of the bank (d) In case the applicant is a financial entity, whether the applicant is a widely held entity, publicly listed and a well established regulated financial entity in good standing in the financial community.

Acknowledgement for transfer of acquisition or investment exceeding the level of 30 per cent would be considered also taking into account that -

• The acquisition is in public interest;
• A diversified ownership of the bank is desirable;
• The applicant’s plans for the future conduct and development of the bank’s business are sound and feasible;
• Shareholder agreements and their impact on control and management of the bank.

The Reserve Bank’s acknowledgement would be subject to the applicant’s compliance with other applicable laws and regulations, such as, those issued by the Securities and Exchange Board of India, Department of Company Affairs and Insurance Regulatory and Development Authority.

Voting rights restrictions and other related provisions of the Banking Regulation Act would continue to be applicable as appropriate.

(i) Existing private banks which do not fulfill the minimum net worth requirement of Rs. 300 crore would be required to submit a time bound programme for capital augmentation to the Reserve Bank for approval.

(ii) Where any existing shareholding of any individual entity/ group of entities is 5 per cent and above, due diligence outlined in the Reserve Bank’s guidelines of February 3, 2004 would be undertaken to ensure fulfillment of fit and proper criteria.

(iii) Where any existing shareholding by any individual entity/group of related entities is in excess of 10 per cent, the bank would be required to indicate a time table for reduction of holding to the permissible level.

(iv) Any bank having shareholding in excess of 5 per cent in any other bank in India would be required to indicate a time bound plan for reduction in such investments to the permissible limit.

(v) Banks would be required to undertake due diligence of directors and chairman/chief executive officer and provide all the necessary certifications/information to the Reserve Bank.

(vi) At the time of considering any new induction or renewal of terms of directors, banks should ensure that not more than one member of family, close relative or associate is on the board.

Persons to be appointed as directors of private sector banks, would now be required to fulfill specific criteria prior to their appointment. Pursuant to the recommendations of Ganguly Group Report, the Reserve Bank has advised all private sector banks to-

(i) Undertake a process of due diligence to determine the suitability of the person for appointment/continuing to hold appointment as a director on the Board, based upon qualification, expertise, track record, integrity and other ‘fit and proper’ criteria. Banks should obtain necessary information and declaration from the proposed/existing directors for the purpose in the prescribed format.

(ii) Undertake the process of due diligence at the time of appointment/renewal of appointment of the directors.

(iii) Constitute nomination committees to scrutinise the declarations.

(iv) The nomination committees should, based on the information provided in the signed declaration, decide on the acceptance and make references, where considered necessary, to the appropriate authority/persons, to ensure their compliance with the requirements indicated.

(v) Obtain annually as on March 31, a simple declaration that the information already provided has not undergone change and if there is any change, the requisite details would be furnished by the directors forthwith.

(vi) Ensure in public interest that the nominated/elected directors execute the deeds of covenants every year as on March 31.

With a view to ensuring smooth transition to Basel II norms, the Reserve Bank has advised banks to phase the implementation of capital charge for market risk over a two year period as under: a) Capital for market risks on securities included in the ‘Held for Trading’ category, open gold position limit, open foreign exchange position limit, trading positions in derivatives and derivatives entered into for hedging trading book exposures by March 31, 2005, and b) In addition to (a) above, capital for market risks on securities included in the ‘Available for Sale’ category by March 31, 2006.