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D Subbarao's view on 'Financial Holding Company Structure' or subsidiaries of financial companies

Corporate governance for subsidiaries of banks
D Subbarao, Reserve Bank of India Governor views on financial subsidiaries: Corporate Governance under Financial Holding Company Structure.

As we all know, the prevalent model for financial conglomerates in India has been the bank subsidiary model as opposed to the more popular financial holding company (FHC) model around the world.

The risks of a bank subsidiary model are quite well known. First, the burden of corporate management of the bank as well as of equity infusion in the future will fall on the bank, and that may stretch its managerial competence and financial capacity. Second, a concern from the regulatory perspective is that the losses of subsidiaries will impact the balance sheet of the bank and even jeopardize the interests of the depositors of banks. Third, a bank typically has access to implicit subsidy by way of safety-net, deposit insurance, access to central bank liquidity and access to payment systems. The bank subsidiary model opens up an avenue for leakage of the subsidies to the non-bank subsidiaries raising a moral hazard issue. Finally, there will also be the problem of resolution if the bank, or any of its subsidiaries, gets into trouble.

It is interesting that in the recent global financial crisis, financial conglomerates suffered equally irrespective of under which model they were structured. While the post-crisis reforms do not specify a preference for either model, the focus with respect to structure is on strengthening capital requirements at the consolidated level, reducing complexities of structures to enable efficient resolution in case of a problem, and separation of investment banking from commercial banking.

The Shyamala Gopinath Working Group appointed by the Reserve Bank has recommended that the financial holding company model should be pursued as a preferred model for the financial sector in India. We must recognize that regardless of the corporate structure, banks cannot be totally insulated from the risks of non-banking activities of their affiliates. In moving to a new regime, we must also contend with legacy issues relating to existing conglomerates. Any framework to harmonise them under the FHC model will require a new legislation and new regulatory architecture.

Story first published: Tuesday, August 23, 2011, 15:49 [IST]
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