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Budget 2016- Financial Sector reforms

Abizer Diwanji     March 2, 2016

Abizer Diwanji
The budget seems to have thought through the bank capitalisation agenda well. Whilst on the face of it Rs 25,000 crore seems too small (market estimates capital requirements of Rs 2,50,000-3,50,000 crore by 2019), the finance minister has focussed on reforming the banking sector as envisaged in the economic survey. He has said that additional capital would be available if required.

I read that as successful implementation of 'Indradhanush' the PSU reform program. The first steps got taken a day before the budget with the formation of the Bank Board Bureau. I would have much preferred capitalising a bank holding company and levering it to meet further capital requirements. It is a more robust way to fund banks than to rely on budgetary support to fund 70 per cent of the banking system in an economy expected to grow at 7.5 per cent.

Asset Reconstruction Companies formed under SARFESI advocated wide shareholding to ensure that asset reconstruction business is better governed. However, ARCs were unable to get the requisite capital to fund its skin in the game, be it the minimum 15 per cent contribution or the 100 per cent asset purchase. The Budget permits 100 per cent FDI and Sponsor ownership on Asset Reconstruction companies. This is likely to boost the effectiveness of ARCs in resolution of distressed assets. The finance minister also indicated that the Bankruptcy code will be introduced during the year.

With this the finance minister has addressed the remaining two Rs of the Economic survey, ie Resolution and Reform whilst the RBI has played its role in recognition of the NPA issue.

The sceptic in me says that that whilst the framework is in place, the devil is in the detail. The level of autonomy and change that Indradhanush can get, the vigour with which PSU banks will help resolve assets and the pace at which reform will happen in terms of credit culture are the details that need attention. Banks should sell to ARCs realising the cost of capital gap that presently results in the price divide between then. Banks need to realise that they are better lenders than resolvers. The system should make sure that the delinquent asset rate remains low and credit is assessed better.

The sale of IDBI Bank stake to below 50 per cent is a clear sign that the government is keen to divest control in government banks. As IDBI is incorporated under the companies Act, divestment below 50 per cent is possible. The rest of the banks require an amendment to the PSU bank statue which given floor dynamics seems improbable in the near term. However, the sale of IDBI would be a first in many to come. I welcome this step and hope the government lets the market discover the price work towards a better build out of the bank in future.

FDI in Insurance has now moved to the automatic route than the FIBP route. This would cut down the process significantly especially given the protective rights incorporated in various agreements. Given that these were not defined well, two levels of approvals, ie at an IRDA level and at an FIBP level would lead to different interpretations. However, FDI in insurance will remain slack until the Insurance Act is amended to allow foreign control. That too, given floor dynamics is improbable now.

To Sum up, I think a prudent budget which lays the legislative and guiding principles on which to implement reform in the financial sector which could have been more effective had floor dynamics been in the favour of the finance minister. However, a lot more work needs to be done on the implementation as the DEVIL is in the DETAIL.

Abizer Diwanji, Partner and National Leader - Financial Services, EY LLP

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