RBI’s Bandhan Bank diktat: Here’s what investors need to know

Bandhan Bank, the youngest bank in India, attracted the regulator’s ire for non-complying with shareholding norms last week. Since the bank was not able to pare down the promoter’s shareholding to 40 percent as required under licencing conditions, the Reserve Bank withdrew its general permission to open new branches. The regulator also ordered freezing the remuneration of the bank's MD and CEO at the existing level till further notice.

The bank along with IDFC were the only two entities to be granted a banking licence by RBI in 2014. Accordingly, the microfinance company got converted into a full-fledged universal bank distinct from small finance banks (SFBs) and commenced operations on August 23, 2015.

Bandhan Financial Holdings (BFHL) is non-operative financial holding company (NOFHC) and acts as the promoting company for Bandhan Bank. The bank went in for an initial public offering (IPO) in March, after which its promoter holding fell to 82.28 percent from 89.62 percent.

The licencing norms require a bank to pare down its promoter holding to 40 percent within three years of starting operations, which ended on August 23 for Bandhan. Thereafter, banks are required to reduce their shareholding to 20 percent and 15 percent within 10 years and 12 years, respectively.

So, the question is what made Bandhan Bank sleep over the matter?

Seems that Bandhan Bank got entangled between the conflicting regulations of two regulators: Securities and Exchange Board of India (SEBI) and RBI.

As per SEBI rules, promoters have a mandatory one year lock-in period after the IPO. Since Bandhan Bank listed in March, promoters cannot sell shares till March next year as per SEBI’s rule. But this puts the bank in a tight spot as the promoter has to sell 42.28 percent stake to fulfil RBI’s licencing requirement. This one has turned out to be a curious case of overlapping regulations.

Bandhan Bank’s dilly dallying over the known requirement is surprising. Looks like the bank too tried its luck just like Kotak Mahindra Bank. While KMB tried using a very innovative way to avoid the equity dilution, Bandhan Bank displayed a wilful ignorance of clashing regulations to defer the dilution. But RBI’s message was very clear and consistent in both these cases. Earlier this year, it turned down KMB’s plan to dilute promoter shareholding by issuing perpetual non-cumulative preference shares. And now it has pulled Bandhan Bank over the same regulatory requirement.

In all fairness to Bandhan Bank, though BFHL’s holding (82 percent stake) appears concentrated, underneath it is a well-diversified. Bandhan Financial Services (BFSL), which is the parent company of BFHL, is widely held. The shareholders of its holding company are the two trusts (set-up for the underprivileged) and institutional investors like International Finance Corporation, Small Industries Development Bank of India (SIDBI), among others. The current CEO and MD, Ghosh, who is also the promoter, holds a minuscule stake (around 2 percent) and that too through the employee welfare trust. In essence, high promoter holding is an optical illusion. It is actually widely spread out, but entangled.

While we feel RBI is being too stringent with Bandhan Bank, it wants to set a strong precedent.

There are multiple ways through which the bank can comply with the regulations. It can consider change in the holding company structure or redefine promoter entities. For instance, one of the proposals being studied is the merger of the holding company (BFHL) with the bank. Giving shares of the bank to shareholders in exchange of their holding in BFHL would lower the promoter holding.

But this will require an active engagement and permission from RBI. Note that one of the guidelines for licencing of new private sector banks requires promoter to hold the bank through an NOFHC. Though dissolving the holding company structure could help achieve the objective, it will not be in true spirit of regulations. We guess Bandhan Bank will not like to circumvent the regulation but rather comply with it. Else, similar to KMB, it could end up with an embarrassment as RBI seems in no mood of going easy.

The most prominent option that lies before the bank is the inorganic route. As per media reports, Bandhan Bank explored acquiring PNB Housing Finance so that it could reduce its promoter holding but failed to conclude the deal. The management said it is open to an acquisition in the micro finance, affordable housing and micro, small and medium enterprise space.

As per the management, the restriction on branch opening will not impact its growth. The bank can continue to open branches with prior approval from RBI. Bandhan Bank had planned to open 1,000 branches by March next year and has 937 branches as of June-end. The maturing of current branches can cover growth for the next 2-3 years.

The biggest concern for an investor is that acting under pressure Bandhan Bank may end up acquiring an unrelated business or cough out valuation that turns out to be difficult to digest.

In a knee-jerk reaction, the stock price nosedived following RBI’s order. Though we don’t foresee any big challenge to the regular pace of its growth, the regulatory requirement of lowering the promoter holding will remain an overhang on the stock. We don’t expect a sustainable up move in the stock price and would like to wait for the next board meeting on October 10 for further updates.

There is an indirect but an important takeaway for investors from restrictions placed on Bandhan Bank.

RBI had granted a five-year extension to Uday Kotak, MD of KMB, over the original deadline of March 31, 2015. As per RBI’s rules, KMB has to lower the promoter holding to less than 20 percent by December and 15 percent by March 2020. Kotak currently holds around 30 percent stake in the bank.

The banking space is ripe for some large M&As due to RBI’s licensing requirement. Stocks of private banks, wherein the promoter needs to reduce its holdings, could be set for a wild ride. Investors need to tread water carefully.

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