RBI caps leverage by holding companies

The Reserve Bank of India (RBI) on Wednesday issued a draft of regulations that would give it the power to regulate corporate group holding companies, or systemically important core investment companies (CICs) as the central bank describes them.

The draft regulations mandate CICs to register with the RBI irrespective of any exemption granted earlier and have prescribed minimum capital requirement and capped the amount these companies can borrow by stipulating a leverage ratio.

Most large industrial groups have holding companies, which hold stakes in group firms. These include Tata Sons of Tata group, TGS Investment & Trade and Pilani Investment & Industrial Corporation of Aditya V Birla group, Jamnalal Sons of Bajaj Auto group, Essar Investments of Ruias and Corbel Estate & Investments and Azrael Investments of Mahindra & Mahindra group.

Ashvin Parekh, a partner and national leader for global financial services at Ernst and Young, said, “The idea is to not let the holding company leverage too much on equity or debt. Many a time there is value multiplication by the holding company, which may not necessarily be the business the subsidiaries are doing.”

“With this, the RBI is being more aggressive, which is good,” Parekh added.

The draft regulations say CICs need to have a minimum capital ratio whereby its adjusted net worth shall not be less than 30 per cent of its aggregate risk weighted assets. CICs also won’t be allowed to borrow more than 2.5 times their adjusted net worth outside the group.

Parekh said the 30 per cent adjusted net worth is on a slightly higher side compared with other countries.

Adjusted net worth has been defined as aggregate of owned funds, 50 per cent of the revaluation reserves and 50 per cent of the appreciation in the book value of listed shares minus the diminution in the aggregate book value of quoted investments.

Pawan Agrawal, a director of Crisil Ratings, said, “An important highlight of the guideline is that companies will be allowed to factor in 50 per cent of the appreciated price of the listed shares of group companies in the adjusted net worth that these companies have to maintain.”

The RBI said CICs with asset sizes of Rs 100 crore or more would be considered as systemically important core investment companies and would be required to obtain certificate of registration from the central bank, even if these companies have been advised in the past that registration was not required.

The RBI said 90 per cent of total assets of systemically important CICs should be in equity, debt, or loans of group companies, provided the investment in equity shares of group companies for the purpose of holding stake in them is not less than 60 per cent of total assets.

CICs would not be allowed to trade in shares except for block sale to dilute or divest the holding and cannot accept or hold public deposits.

The RBI said CICs should not carry on any other financial activities except investments in bank deposits, government securities, loans to and investments in debt issuances of group companies, or guarantees issued on behalf of group companies.

The RBI said CICs would be exempt from maintenance of minimum net owned funds, capital adequacy norms and exposure norms that systemically important non-deposit taking non-banking finance companies are required to follow, if these companies follow the norms stipulated for them. This is in response to CICs contention that they cannot comply with net owned funds (NOF) requirements and exposure norms that NBFCs are subjected to in view of their peculiar business model.

The RBI said CICs would have to apply for a certificate of registration within six months from the date of notification of the regulations. It said, in order to operationalise this dispensation in a non-disruptive manner, companies that apply for registration within the stipulated time of six months could continue to carry on existing business till the disposal of their application.

Companies that at present do not meet the criteria for systemically important CICs but whose asset size would cross Rs 100 crore at a later date would be required to apply to RBI for registration within three months of crossing that limit.

CICs that do not meet the conditions will have to provide an action plan for compliance with these conditions, in order to avail the exemptions from net owned funds and exposure norms. RBI may examine the action plan of such CICs and impose such conditions and restrictions as it deems fit.

On whether holding companies can resist being regulated by the RBI, Parekh said, “These companies do not have any legal recourse to take it up as they are not already regulated by other entity like in the case of insurance companies. The Companies Act is silent on such issues and there won’t be any ground for a legal recourse.”

Financial Chronicle, New Delhi, 22-04-2010