The Reserve Bank suggested lowering the foreign investment limit in new private sector banks to below 50 per cent from 74 per cent currently, in order to strengthen the local banks.
"This would enable foreign capital to be used in the promotion of domestic banks ... and allow for foreign technical collaboration in setting up domestic banks," RBI said in a discussion paper.
RBI released the paper on issuing new banking licenses to foster greater competition and expand the banking system. It listed pros and cons of various norms such as minimum capital requirements and caps on promoters as well as foreign shareholding.
"Since the objective is to create strong domestic banking entities and a diversified banking sector ... Aggregate non-resident investment including FDI, NRI and FII in these banks could be capped at a suitable level below 50 per cent and locked at that level for the initial 10 years," the central bank said.
In the paper, 'Entry of new banks in the private sector', RBI said that the downstream investment of banks would not be an issue for monitoring indirect foreign investment, if the foreign investment is below 50 per cent.
The paper did not say whether the 50 per cent cap on foreign investment in private sector banks should apply to the new units only, or will hold true for the existing ones as well. Industry experts said the new cap could be for all.
"It is not clear. However, it is possible that even the existing banks will have to comply with the new cap over a period of time for a level playing field," said KPMG Financial Services Tax Leader Punit Shah.
Among the 'cons' of lowering the limit, RBI said it will constrain foreign capital willing to invest in banking or to promote banks in India, and raising additional capital mainly from domestic sources may pose a problem.
"This would be in contrast to the present FDI policy which allows 74 per cent foreign equity in private sector banking ... Banks may not be able to use the innovative approaches brought in by foreign promoters," it added.
While industry experts have appreciated the discussion paper for being comprehensive, taking into account all issues and considering internationally accepted norms, it did not support RBI's view on the foreign investment limit.
"The discussion paper's proposal on FDI in the banking sector is surprising. It is an incorrect view ... We would in fact like the FDI limit to be scrapped and 100 per cent foreign investment allowed in the sector," Shah said.
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