India: RBI Introduces Master Directions For Regulating Major Shareholding In Banking Companies

On 16 January 2023, the Reserve Bank of India (RBI) issued the: (a) Reserve Bank of India (Acquisition and Holding of Shares of Voting in Banking Companies) Directions, 2023 (Master Directions) read with the Guidelines on Acquisition and Holding of Shares or Voting Rights in Banking Companies (Guidelines) with the twin objectives of ensuring that: (i) the ultimate ownership and control of banking companies are well diversified; and (ii) the major shareholders of banking companies are 'fit and proper' on a continuing basis (Twin Objectives).

The Master Directions and the Guidelines (together, "Directions") lay down the legal framework in relation to the manner of acquisition of shareholding / voting rights in banking companies and the various legal compliances required to be followed by the concerned acquirer and the banking company, prior to and pursuant to the acquisition of such shareholding in the banking company. Additionally, the framework also prescribes various reporting requirements to be complied with by the persons envisaging to acquire shareholding in a banking company, to ensure that the Twin Objectives are satisfied. By the issue of these Directions, the erstwhile master directions governing the various aspects relating to acquisition of shareholding / voting rights in private sector banks stands repealed (Erstwhile Directions).¹

In this Ergo, we will analyse certain salient features of the revised framework with a specific focus on the acquisition of shareholding in a banking company, as introduced by the Directions.

APPLICABILITY OF THE DIRECTIONS

The Directions are applicable to all "banking companies" (as defined in the Banking Regulation Act, 1949 (BR Act)), including differentiated and specialised banks such as Local Area Banks, Small Finance Banks and Payments Banks operating in India as against the Erstwhile Directions, which were applicable only to private sector banks. However, that the Directions will not be applicable to foreign banks operating in India whether as a branch or as a wholly owned subsidiary.

PRIOR CONSENT OF RBI FOR ACQUIRING "MAJORITY SHAREHOLDING"

In furtherance to RBI's powers to regulate the acquisition of shares or voting rights of a banking company² under the BR Act, the Directions stipulate that any person who intends to make an acquisition which is likely to result in such person holding 'major shareholding' in a banking company, is required to seek prior approval of the RBI.³

In order to determine the aforementioned 'major shareholding', the aggregate of both direct and 'indirect' holding (beneficial or otherwise) of shares or voting rights by a person, along with his relatives, associate enterprises and persons acting in concert with him, has to be taken into account. While the term 'indirectly' was not present in the Erstwhile Directions, this term has been specifically defined in the Directions, expanding the scope for prior approval requirement from the RBI.

Therefore, it could be understood that if any person acquires 5% or more of the paid up share capital or voting rights of a banking company either directly or indirectly, beneficial or otherwise, even along with his relatives, associate enterprises and persons acting in concert with him, then such person is said to acquire 'major shareholding' in a banking company and prior to such acquisition, the concerned person is required to obtain the prior approval of the RBI.

GRANT OF APPROVAL BY RBI

On receipt of the application and declaration from the applicant, the RBI may seek comments from the banking company (Target Banking Company) on the proposed acquisition. On receipt of the reference from the RBI, the board of directors of the Target Banking Company is required to conduct their due diligence based on the information provided by the applicant. The Target Banking Company is required to assess and deliberate on the proposed acquisition and assess the 'fit and proper' status of the applicant.

Further, the Directions prescribe that banking companies are required to put in place a board-approved criteria for assessing the 'fit and proper' criteria for major shareholders, which shall encompass, at a minimum, the illustrative 'fit and proper' criteria items mentioned in the Master Directions.

The list of illustrative fit and proper criteria mentioned in the Master Directions has been expanded to include, inter alia, the integrity of the applicant in 'non-financial matters' whereas the Erstwhile Directions only specified the applicant's integrity in financial matters. But, on the other hand the illustrative list has also been rationalized to omit certain vague items such as whether the acquisition of shareholding is in public interest, or whether the applicant is a well-established financial entity in good standing in the financial community.

Pursuant to assessing the 'fit and proper' criteria of the applicant, the Target Banking Company is required to furnish its comments along with a copy of the relevant board resolution and information in a form prescribed in the Directions to the RBI (Intimation).

On receipt of the Intimation from the Target Banking Company, the RBI would undertake its own due diligence to assess the 'fit and proper' status of the applicant and based on such due diligence, the RBI may decide to: (a) accord or deny permission to the applicant to acquire shareholding in the concerned banking company; or (b) accord permission for acquisition of a lower quantum of aggregate holding than that has been applied for. Such decision of the RBI shall be binding on the applicant and the concerned banking company. Additionally, the RBI may impose such conditions on the applicant and the concerned banking company as deemed fit (including a validity period for completing such acquisition) while according such approval.

Subsequent to such acquisition, if at any point in time the aggregate shareholding of the applicant had reduced to below 5% of of the paid-up share capital or total voting rights of the Target Banking Company, such applicant would be required to seek fresh approval from the RBI if such applicant intends to again raise its aggregate holding to 5% or more of the paid-up share capital or total voting rights of the Target Banking Company. Furthermore, the Directions stress on the compliance with the fit and proper criteria for the major shareholders on a strictly continuing basis, in addition to compliance with the same during acquisition.

FINANCIAL ACTION TASK FORCE COMPLIANT JURISDICTIONS ("FATF")

The Directions stipulate that persons from FATF non-compliant jurisdictions shall not be permitted to acquire major shareholding in a banking company. This prohibition would apply even if the funds for acquiring major shareholding in a banking company are routed through a FATF compliant jurisdiction. However, the Directions clarify that existing major shareholders from such FATF non-compliant jurisdictions will still be allowed to continue with their investment, but they would not be allowed to acquire any further shareholding in the Target Banking Company without prior approval of RBI in accordance with the Directions.

LIMITS ON SHAREHOLDING

The Directions prescribe that the approval of the RBI to acquire shares or voting rights in a banking company shall be subject to the following limits:

• Non-promoter shareholding: The Erstwhile Directions had prescribed a three-tier long run shareholding limit for non-promoter shareholders as captured in the below table. This three-tier limit has been rationalised into just two limits currently.

We note that one of the impacts of the Directions is that the higher threshold of 40% for the erstwhile third category of non-promoter shareholders, has been curtailed to 15% currently.

• Promoter shareholding: The Erstwhile Directions had restricted the promoters' stake in the long run (15 years from the commencement of business) to 15% and currently, this limit has been increased to 26%. However, during the period prior to the completion of the 15 years, the promoters of banking companies may be allowed to hold a higher percentage of shareholding as part of the licensing conditions or as part of the shareholding dilution plan submitted by the banking company and approved by the RBI with such conditions as deemed fit.

The Directions also stipulates that the RBI may permit higher shareholding than the limits prescribed hereinabove, on a case-to-case basis depending on the circumstances.

LOCK-IN REQUIREMENT

The Directions stipulate that where any person permitted by the RBI to have a shareholding between 10% and 40 % of the paid-up equity share capital, the shares acquired are required to remain locked-in for the first 5 (five) years from the date of completion of acquisition. However, where any person is permitted to have a shareholding of 40% or more of the paid-up equity share capital of the banking company, only 40% of paid-up equity share capital would remain locked-in for the first 5 (five) years from the date of completion of acquisition.

Furthermore, the Directions stipulate that the shares which are locked-in, shall not be encumbered under any circumstances and upon completion of the lock-in period, there is no requirement for any minimum shareholding in the Target Banking Company.

CEILING ON VOTING RIGHTS

Lastly, the Directions incorporated a previous notification of the RBI⁵ to clarify the current position on the ceiling on voting rights that could be exercised by a shareholder of a banking company (which would be 26% of the total voting rights of the banking company). It also clarified that the holding of such voting rights by the shareholders will be subject to the same requirement of prior approval from the RBI for acquiring major shareholding, as mentioned in the Directions.

KHAITAN COMMENTS: The Master Directions brings in much needed clarity in the manner of acquisition of shareholding / voting rights in banking companies. The authors feel that these Master Directions are a step forward towards what has always been the consistent approach by the RBI vis-à-vis ensuring diversified ownership and control over the affairs of a banking company.

Footnotes

1. Ref: (i) Master Direction No. DBR. PSBD. No. 56/16.13.100/2015-16 on the subject 'Prior approval for acquisition of shares or voting rights in private sector banks' dated 19 November 2015; (ii) Master Direction DBR.PSBD.No.95/16.13.100/2015-16 on the subject 'Issue and Pricing of Shares by Private Sector Banks' dated 21 April 2016; and (iii) Master Direction DBR.PSBD.No.97/16.13.100/2015-16 on the subject 'Ownership in Private Sector Banks' dated 12 May 2016.

2. Ref: Section 12B of the Banking Regulation Act, 1949.

3. The Master Directions define the phrase "major shareholding" as "aggregate holding" of 5% or more of the paid-up share capital or voting rights in a banking company by a person.

4. Natural person FI means natural persons, non-financial institutions, financial institutions directly or indirectly connected with Large Industrial Houses and financial institutions that are owned to the extent of 50% or more or controlled by individuals.

5. Ref: DBR.PSBD.No.1084/16.13.100/2016-17 dated 21 July 2016.

The content of this document do not necessarily reflect the views/position of Khaitan & Co but remain solely those of the author(s). For any further queries or follow up please contact Khaitan & Co at legalalerts@khaitanco.com