India: Bane Of Policy Uncertainty – Now In Financial Services

Foreign direct investments drive the growth of financial markets of a country. While interest rate regulations and other financial indicators are essential ingredients for increasing the volume of foreign direct investment in a country, the legal regulatory regime also provides an impetus to the inflow of foreign investments. Ambiguity in the legal regulatory framework can act as a deterrent in a country's ability to attract foreign investment. Therefore, certainty and predictability in law can work towards strengthening the stability of foreign investment inflows in a country.

Reserve Bank of India (RBI) regulates foreign investment into India. Investments are routed through the 'automatic' and 'government' routes. Investments under the 'automatic' route are not subject to prior approval of any governmental authority and are permissible subject to compliance with the pricing guidelines and sectoral caps.

Investments which are permissible under the 'government' route require prior approval of Foreign Investment Promotion Board (FIPB) or Ministry of Finance or Department of Industrial Policy and Promotion (DIPP), as the case may be. The amount of investment proposed to be made will determine the governmental authority from which one needs to seek an approval.

In sectors/activities not listed in the Foreign Direct Investment (FDI) policy, FDI is permitted up to 100% under the automatic route, subject to applicable laws/ regulations.

However, FDI policy 20131 permits foreign investment only into financial services which are specifically identified. Investments into the entities providing financial services not identified by the FDI policy require prior approval of the Government. This condition was introduced in the consolidated policy issued by the DIPP in October, 2011. The following financial services have been identified under the FDI policy:

  1. Asset Reconstruction Company;
  2. Banking, (private and public);
  3. Commodity Exchange;
  4. Credit Information Companies;
  5. Infrastructure Companies in the Securities Market;
  6. Insurance; and,
  7. Non Banking Financial Companies.

Investments into the above stated services are subject to conditions and caps specified under the policy.

As noted above investment into any entity engaged in/providing financial services not identified above will require prior approval of the Government. In light of this, it is crucial to ascertain what would constitute 'financial services'. Financial services as a term has not been defined under the policy. Hence we need to examine the extant regulations and laws to understand the import of the term 'financial services' as investment into this sector will require government approval.

S. 45I (c) of the Reserve Bank of India Act, 1934 defines 'Financial Institution' as any non-banking entity which carries on any of the following activities:

  1. making loans or advances or similar activities;
  2. acquiring shares, stock, bonds, debentures or securities etc.;
  3. letting or delivering of any goods to a hirer under a hire-purchase agreement as defined in clause (c) of section 2 of the Hire-Purchase Act, 1972:
  4. the carrying on of any class of insurance business; or,
  5. carrying on chit fund activities etc.

General Agreement on Trade in Services (GATS)2 defines 'Financial services' to include all insurance and insurance-related services, and all banking and other financial services such as financial leasing, money brokering, asset management etc.

Black's Law Dictionary3 also defines the term 'Financial Institution' as:

A business, organization, or other entity that manages money, credit or capital, such as a bank, credit union, savings-and-loan association, securities broker or dealer, pawnbroker, or investment company.

The definitions listed above clearly indicate that the activities which are considered to be traditionally carried on by banks or insurance companies only would in fact qualify as financial services. In this background it is interesting to note that the FDI policy recognizes entities such as credit information companies, infrastructure company in securities market etc. under the financial services sector. These are entities which do not provide the financial services as understood from the above listed definitions.

These entities i.e. stock exchanges, depositories and clearing corporations lend ancillary services only and can be viewed as only meant to enable the carrying on of the financial activities.

We can turn to the approvals issued by FIPB so far to look at the issue at hand. An analysis of the entities that have sought the regulator's approval clearly shows that only such entities which are regulated by a financial regulator have sought for prior approval of FIPB before accepting FDI. In light of this, one could argue that only such institutions/ organizations which are bound to be registered with a financial regulator i.e. SEBI, RBI or IRDA would be deemed to be a financial institution and hence any FDI into such entities would require prior approval of the FIPB.

It would however, be pertinent to note that the draft of the Indian Financial Code Bill which is intended to consolidate the law relating to the financial sector in India gives the term 'financial services' a broader meaning. The bill defines 'financial service' to include activities such as selling or buying or safeguarding financial assets or advising on purchase of financial product, infrastructure institutions such as exchange, depository, etc.

The wide connotation of the term 'financial services' and a lack of a cohesive definition in the existing legislation add to the prevailing confusion. Additionally, given the regulatory climate of the country, every foreign investor will be forced to exercise utmost caution while investing in financial services whether regulated or unregulated. This means that every investment into financial services whether regulated or not will be forced to seek governmental approval adding to the regulatory delays and dampening investor interest. This uncertainty will lead to erosion of investor confidence. So far, the services sector which includes Financial, Banking, Insurance, Non-Financial / Business, Outsourcing, R&D, Courier, Tech. Testing and Analysis, attracts the highest FDI inflows in the country.4 In order to ensure that this trend survives, the government needs to clarify what will amount to 'financial services' which clarification will go a long way in easing regulatory hurdles for future investments. If the proposed definition under the Indian Financial Code Bill sees light of day and if the same is adopted under the FDI policy, every entity providing financial service and those lending ancillary services would come under the purview of the definition of 'financial service' thereby requiring government approval without regard to the fact that same may not be regulated by a financial regulator. A more realistic and practical definition other than the one currently proposed needs to be considered to bring more certainty and predictability to FDI into financial services sector.

* Authored by Suneeth Katarki, Partner and Pallavi Kanakagiri, Senior Associate. The views expressed in this article are the personal views of the authors and do not reflect the views of the Firm.


1 Consolidated FDI policy 2013, Department of Industrial Policy and Promotion, available at

2 Para 5(a), Annex on Financial Services, general agreement on trade in services available at

3 Bryan A Garner, black's law dictionary, 7th edn, West Group


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