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12 NIVESHAK Article Cover of the Story Month Interestingly, SEBI has no regulations in place for IBs. There was no demand for such services in an essentially underdeveloped economy, and hence the regulator (which was itself a novice in this field) felt no need to put up the necessary regulations. The need for IB was not really felt because of the largely embryonic capital markets in the country. The developing country is now on the fast track of development and is now seeing fast development of these sectors. The manacled and demonized capital markets are now taking roots. With this background, the need has never been more urgent to bring in reforms in the regulatory framework of the RBI or maybe even a complete overhaul of the system. SEBI rules have to be drafted from the scratch for standalone investment banks. Future Roadmap The first question that the RBI needs to answer is whether to continue with the BHC structure or to embrace the FHC one. The advantages of the latter are numerous. The first of which would be the unshackling of the IB industry, as the capital constraints would no more be relevant. In the FHC model, a holding company has subsidiaries that undertake banking, non-banking operations. Hence, commercial banking divisions would be protected from the risks emanating from the riskier activities. The risks arising from the losses of subsidiary IBs would be borne by the FHC. The responsibility of infusing capital into the subsidiaries would also lie with the FHC and not the bank. Lastly, the FHC structure would be beneficial in the event of winding up, as the resolution of different entities would be easier. As a clear demarcation would exist between the different components of the group. In the past, liquidation of the parent bank usually meant the liquidation of the subsidiary also. With a stronger FHC structure, this wouldn’t be the case anymore. Regulatory oversight could also be more efficient. Various studies commissioned by the RBI indicate a strong shift of the revenue pool from the traditional banking to investment banking. The acceptance of the FHC model could see the IB industry rise manifold, as the equity investment limits in the IB subsidiaries should not be as restrictive as the existing regulations. The first question that the RBI needs to answer is whether to continue with the BHC structure or to embrace the FHC one. The advantages of the latter are numerous. The first of which would be the unshackling of the IB industry, as the capital constraints would no more be relevant. Regulatory oversight could also be more efficient. NOVEMBER 2014
NIVESHAK 13 Article Cover of the Story Month Studies suggest that the IBs would grow 10 times by 2020. The lessons from the crises of 2008 will have to be inculcated. A comprehensive study of various enactments in Europe, America must be undertaken. Recommendations of the Volcker, Liikanen, Vickers committees, aimed at reducing risks, while not inhibiting growth should be implemented, suitably tweaked for Indian environs. A regime of differentiated banking licenses could be initiated. A license would be issued to an entity to undertake a specific, limited activity. Niche banking players could capitalize on their specialized knowledge. Clear prescriptions must be provided for in the event of banking failures such as closure, restructuring, M&A, bridge bank. The objective of this exercise would be to transfer activities deemed as too risky to different entities (banning them outright could be counterproductive). With public guarantees limited only to the commercial arm to prevent contagion. A global debate is going on on this issue. A robust system based on strong checks and balances should emerge in India, enabling the expansion of IBs in the country. Conclusion Investment banks are a novelty in India. Their growth has been stunted due to regulatory restrictions. Changing environs mean investment banking is going to grow tremendously in the coming years. Regulatory restrictions could be lifted. The deepening of capital, wholesale debt markets could see the explosion of investment banking activities, as more and more corporates demand these services. India has the BHC framework in place, replacing it with the FHC model could be on the anvil. The future holds tremendous promise. However recent events suggest that it won’t be as easy as a walk in the park. The financial crisis and the ensuing regulations must be studied and inculcated in the pursuance of liberalization policies in India. © FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG
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