Archive for August 28th, 2007

Holding Companies in Banking groups

August 28, 2007

The morning newspapers are busy discussing  this concept paper from RBI on Holding companies in Banking groups.

There were a number of news items when both ICICI and SBI decided to set up holding companies in order to expand their business operations. SBI had applied to RBI and ICICI has received approval for the same.

What is a Holding company? Wikipedia explains:

A holding company is a company that owns part, all, or a majority of other companies’ outstanding stock. It usually refers to a company which does not produce goods or services itself, rather its only purpose is owning shares of other companies. Holding companies allow the reduction of risk for the owners and can allow the ownership and control of a number of different companies. Eighty percent or more of voting stock must be owned before tax consolidation benefits such as tax-free dividends can be claimed.

(A trivia from the same wikipedia link: Berkshire Hathaway is a holding company.Tata Sons is also an example)

So, the holding company does no business and its balance sheet shows a  few companies as part of its assets.

Holding companies have been there across sectors but it is in financial industry where it has become a concern. Why? The recent sub-prime crisis is an example. Banks themselves may have not given sub-prime loans but Banks supported entities did (HSBC, Lehman are examples). Similarly, Banks may not have invested in sub-prime mortgage backed bonds but Bank supported entities did (Macquarie and BNP are examples). In a nut-shell, Banks have these special entities which focus on a particular segment and if this segment goes into a problem, the impact is felt on the Bank as well. As banks are regulated by the Central Bank (like Fed in USA, RBI in India) or some other government agency (like FSA in UK), the entities are not regulated as mostly they are seperate companies and escape regulation. But as impact is felt on banks as well, it is raising concerns amongst regulators.

A question that comes to mind is – why do we need a holding company? Why can’t banks run seperate businesses like its subsidiaries? Answer- It frees up capital. If a Bank runs these various businesses as its subsidiaries, then there is a regulation in India which limits these investments to 20% of paid up capital and reserves of the bank. 

So say, if a Bank in India has Rs 100 cr (Rs 1 billion) of paid up capital and reserves, then it can only invest Rs 20 cr in the other businesses. Now, suppose Bank wants to expand these businesses only way it can is by raising capital itself.

And , businesses like insurance and asset management are increasingly becoming very capital intensive. So, the best way is, make a holding company, transfer these businesses into the holding company and let these businesses raise capital by listing, private equity etc.

The paper is quite a good one and explains all the nitty-gritties involved. It begins by explaining there are two kinds of Holding companies-

  1. Banking Holding Companies: The one which owns or controls one or more banks. This one is easy to regulate by a single regulator
  2. Financial Holding Companies: The one which owns or controls banks and non-bank financial companies(NBFC) as well. This one is difficult to regulate by a single regulator as each NBFC may come under a different regulator or may not have a regulator at all. For e.g. suppose there is a FHC in India, then Bank would be regulated by RBI, Asset Management Company by SEBI, Investment banking again by SEBI and insurance by IRDA.  

Clearly, the problems are most with a FHC that has a Bank and other non-banking financial company in its structure.

The paper then discusses various types of holding structures, comments on how these holding companies grew in USA (it was because of a legislation) and the issues for India of this structure and the way to resolve the same. It is a nice primer on the subject.

I have just given it a casual glance and cannot comment much on the paper. All I can say is RBI is not very comfortable with this emerging structure as it leads to regulatory arbitrage and is not in the best interests of the investors. Let me read some reference work and get back with my comments.

Meanwhile, one can see the various newspaper commentaries on the topic- BS, Bloomberg, ET, IE.

Assorted Links

August 28, 2007

1. Ajay Shah points to two articles on algorithmic trading. He also has a post on the recent SEBI move to do away with entry load. You might also like to see my post on the same. I have updated it.  

2. WSJ Blog has an excellent series of articles from top economsts – Larry Summers, Shiller, Jeff Sachs. Read all of them.

3. WSJ blog points to a paper which says US is crucial to world growth but not as much as we think it to be. Let me read the paper. IMF said more or less the same thing in its Outlook which I covered here.

4. Rodrik points to two papers on leadership in economics. I always believe leaders have a big role to play in development of nations.

5. PSD Blog points to a bang-on article from Arvind Subramanian:

“When celebrities such as Angelina Jolie or Bono highlight human tragedy to show that something can be done to alleviate it, the heart melts and the purse strings loosen. But the stars, alas, aren’t up on the economic literature. Research is increasingly questioning the benefits of foreign aid.”

6. PSD Blog also points to an Indian reality…growth is high but so is corruption.

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