MODULE_4_13_

BANKING &
INVESTMENT LAWS

CERTIFICATE COURSE

DEVELOPED BY
Corp Comm Legal

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MODULE - 4

INVESTMENT BANKING AND FDI

4.1. INTRODUCTION TO FOREIGN DIRECT investor in specific markets of a foreign state. As
INVESTMENT IN BANKING compared to an FDI, FII requires that the companies
only be registered with the stock exchange listings to
Foreign direct investments (FDI) are also known as be able to make investments, whereas a FDI is usually
investments in a business or any particular sector by regulated by the central supervising bank of that
investors from a foreign country in another country. country.
Generally, such investors have complete control over
the company they have purchased. According to the 4.1.1. Importance of FDI
Organization of Economic Cooperation and
Development (OECD), ‘control’ is defined as the FDIs as observed over the past couple of decades is
ownership of at least 10% of the business or more. an essential tool for the development of an emerging
Such International Investment can be divided into market in the international forum. Companies
four categories, require better exposure-oriented investments as
compared to local investments. This type of funding
▪ commercial loans; and expertise is required to expand their
▪ official flows; international sales. In India, FDI is one of the principle
▪ foreign direct investment (FDI), and monetary resource for economic growth and
▪ foreign portfolio investment (FPI). development. Foreign companies have known to
directly invest in fast growing Indian business, which
Foreign direct investment was introduced in India in they find advantageous due to the cheaper valuation
1991 through the Foreign Exchange Management of the business environment in India. As per the
Act (FEMA), which was presented by Finance Department of Industrial Policy and Promotion
Minister Dr Manmohan Singh. FDI, is when the (DIPP), “The total FDI that seeped into India during
investment is made by a parent company in a foreign April-September 2017 was at $33.75 billion, which is
country, as compared to FII or Foreign Institutional clearly indicative of the fact that the government’s
Investor, where the investment is made by an

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effort to improve and ease the process of doing investors to pool in finance and contribute to the
business in India and of relaxing the FDI norms is expansion of those factors
finally becoming successful.” This shows that FDI in
India is clearly like an ever-flowing stream of limitless Any lucrative FDI allows for the following solutions:-
investment, if only tapped right.
▪ Transfer of technology
4.1.2. Importance of FDI in the Banking Sector
Due to the impact of globalization, local banks have
The banking sector is usually one of the first now been given the same platform of competition as
recipients of any impact on the economy due to which global markets. Here, the element of innovation is the
a continuous investment in this sector is required for financial products provided by several multinational
unremitting revival. Some of the issues faced by the banks limits the development and success of local
Banking sector in India are: - banks. Which is why in wanting to maintain pace with
these banks, domestic banks ought to become
▪ Inefficient management technologically updated, or else it will result in the
▪ Financial instability loss of an investment opportunity. Banks have been
▪ Lack of innovative financial products and growing more prominent and prudent through the
rapid development of ‘consumers lending’, in both the
schemes domestic and the foreign markets. This therefore
▪ Inability to keep up with the technical requires the authorities in charge of the financial
stability to be aware of the appropriate technology to
development occurring in various other manage credit, debt and other factors that are
foreign markets involved in financial management. FDI provides this
▪ Non-performance of certain areas opportunity to them.
▪ Feeble market strategies
▪ Market conditions’ financial fluctuations ▪ Enhancing the Risk Management system

Which is why the FDI provides a streamlined mode of With an expansion in operation, the need for an ever-
investments into the voids created by the banking changing strategy to manage risk is also felt. “These
sector, especially in investment banking. FDI can strategies are meant to exert competitive pressures
solve the issue of any dearth in investment and demonstrate the effect on local institutions.”
opportunities, by opening a plethora of prospects for

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This usually leads to a reassessment of the business 4.2. ADVANTAGES OF FDI
practices, including local lending practices due to
which the banking sector in its entirety very visibly There are several countries that still place tariffs on
requires a strategic policy for risk management. Here, import, which means accessing these countries
FDI plays a very important role, since the host through the means of international trade will be
countries will then become aware of the most difficult. Furthermore, certain industries require a
efficient management techniques and enable them to proper presence in the International market to
incorporate the same in their own. succeed, these industries are the ones that provide
FDI to similar industries in other countries, to
Example: The introduction of Basel II. Most local increase the presence of sales.
banks have developed this trend of incorporating the
Basel II strategy for a safer financial system. Several Parent enterprises are known to provide FDI
because they get tax incentives. Governments of
▪ Imposition of stable Financial Conditions certain countries have invited FDI because they
and Capitalization. receive additional expertise in technology and
products.
Most Host countries usually receive instant benefits
through FDI. Foreign banks re-capitalize struggling FDI reduces any disparity between cost and revenue,
local institutions almost immediately through foreign especially in terms of calculation pertaining to
entries. This process also provides the very much different currencies. Through a controlled enterprise
needed stability in the need for achieving a balance in in a foreign country, a company can ensure that the
the payment of finance. “More efficient allocation of cost of production can be incurred in the same
credit to the finance sector, enables better market, where the goods are ultimately sold.
capitalization and wider diversification of foreign
banks coupled with the access of local operations to The requirements and needs of international markets
parent funding. This may in fact reduce the sensitive varies with every country, each market has its own
nature of the host country’s banking system and set of preference and taste. By investing in a company
make them financially more stable”. in such a country, enterprises ensure that their

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business practises and products are able to relate to ▪ Automatic route
the need of the domestic markets.
In the automatic route, foreign entities are not
Though these factors are not that big, domestic required to seek any prior approval of the
markets usually prefer locally produced goods to government authorities, they merely have to inform
strengthen their sense of patriotism and nationalism, the RBI regarding the amount of investment that
which makes it all the more difficult for international would be made within the stipulated time period.
markets to penetrate them. FDI eases this process by
allowing these enterprises to burrow a tunnel into ▪ Government route
their markets and gain a footing there. From the
perspective of a foreign affiliate, FDIs have greatly In the government route however, investments can
benefitted them by enabling them to procure be made only after seeking the prior permission from
advanced resources and bringing additional capital to the government authorities. Investors would have to
their disposal. abide by the several conditions that are defined in the
consolidated FDI policy, which regulate the flow of
4.3. SETTING UP BANKS BY WAY OF FDI FDI to different sectors. They ought to be aware of
where FDI is prohibited and where it is not.
This chapter collectively discusses the two common
modes through which foreign banks, companies or FDI is permitted in the Banking sector through four
other entities set up banks in India via FDI by either distinct channels
establishing a joint venture with an Indian partner or
by establishing a fully owned subsidiary or controlling ▪ In Public Sector Banks: FDI is permitted with
it. a cap of 20% of equity.

In India, FDI is allowed through two routes, i.e. the ▪ In Private Sector Banks: FDI is permitted with
Automatic or the Government route. At one point, a cap of 74% of equity.
there used to be the Foreign Investment Promotion
Board (FIPB), which has now been phased out. ▪ Branches of Foreign Banks.
▪ Wholly Owned Subsidiaries of Foreign Banks.

Therefore, some banks are set up through FDI either

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by collaborating on a joint venture with Indian ▪ The RBI will read these applications in tantum
partners or by fully owning a subsidiary of the foreign with the Insurance Regulatory and
entities. Development Authority (IRDA);

4.5. RBI GUIDELINES REGARDING FDI IN THE ▪ All foreign banks who have branches in India
BANKING SECTOR are eligible for the FDI in the private sector
banks, after taking prior permission from the
To ensure that the domestic investment market RBI but are subject to the regular limitation of
doesn’t go out of business or becomes affected by an 49%;
unhealthy competition, the RBI has mandated the
following regulations: - ▪ Foreign investors are allowed to set up new
branches in the rural areas along with weak
▪ In private sector banks of India, FDI up to 49% banks with an investment of up to 74% by the
will be allowed through the automatic route RBI;
from different sources;
▪ FDI in the banking sectors may be permitted
▪ Fresh shares that are issued through the up to 74% but through the automatic route
automatic route will not be available to only 49% is allowed. FDI beyond 49% and to a
foreign investors have collaborated maximum of 74% is allowed only through the
technically or financially in the allied or government approved routes.
similar field. These categories of foreign
investors will have to take an approval from 4.5.1. Limitation placed on NRIs and FIIs under the
the FIBP (Foreign Investment Promotion Portfolio Investment Schemes (PIS)
Board)
▪ “Individual FII holdings cannot exceed 10% of
▪ With respect to the Insurance Act, 1938, the the overall paid-up capital and an aggregate
maximum investment that can be made in any limit for all FIIs can’t exceed 24% of entire
insurance company cannot exceed 26%. paid-up capital”. However, limitation can go
Application must be made to the RBI for up to 49% of the entire paid-up capital if a
making any foreign investment in an Indian resolution is passed by a bank’s board of
bank which has a joint venture with the directors.
insurance sector.
▪ Transfer of shares through FDI from
residents to non-residents must be done after

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taking the prior approval of the Government Banking Companies Act. (Portfolio
of India and the RBI. Investment and FDI);
▪ The procedures/ policies that are asked for by ▪ A cap of 20% is placed on investment which is
the RBI, SEBI, IRDA and the department of simultaneously applicable to all nationalized
company affairs will have to be met by the banks and associate banks; furthermore,
NRIs and the FIIs, in all modes of investment. there are several other conditions that
foreign banks ought to fulfil before being able
4.5.2. Foreign Banks setting up a subsidiary in India to set up a Wholly owned subsidiary (WOS).

▪ Foreign Banks are not allowed to set up 4.5.4. Eligibility of foreign banks
subsidiaries and branches together, they may
set up either but not both. ▪ All foreign banks will be subjected to the
supervisory regulations of their own state as
▪ They have to follow the guidelines set up by per the need of the RBI and must provide
the RBI to set up a wholly owned subsidiary of adequate proof of their compliance;
foreign bank;
▪ Any wholly owned subsidiary or a branch in
▪ Foreign bank’s subsidiaries will have to India must be done after taking the prior
comply with all the licensing requirements permission of their own state;
consistent with the policies of the private
sector banks; ▪ Other factors that decide the eligibility of the
parent bank will be considered on the
▪ Any application for the conversion of existing following grounds:
branches to subsidiaries or to set up new
subsidiary by the foreign banks will have to go ➢ “Economic and political relations between
through the RBI. India and the country of incorporation of the
foreign bank
4.5.3. Limitation placed on FDIs in the public-sector
banks ➢ Financial soundness of the foreign bank
➢ Ownership pattern of the foreign bank
▪ FDIs in the public-sector banks (India) cannot ➢ International and home country ranking of
exceed 20% through the government
approved mode which will be subject to the the foreign bank
➢ Rating of the foreign bank by international

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rating agencies All such entities that make FDI in private sector banks
➢ International presence of the foreign bank” will have to strictly comply with the requirement of
having a credit rating. The increase in FDI limits in the
4.5.5. Foreign banks investment in Indian Private banking sector at 74% will also include portfolio
Sector Banks investments [i.e. foreign institutional investors (FIIs)
and non-resident Indians (NRIs)], IPOs, private
Foreign banks or their wholly owned subsidiaries placement, ADRs or GDRs and acquisition of shares
which are regulated by a financial sector in their host from the existing shareholders.i This will again limit
country can invest up to 100% in Indian Private any increase made through an investment by the
sector Banks. An option of 100% FDI is only available subsidiary route.
to those banks which fulfil the condition of a
‘regulated wholly owned subsidiary of a foreign bank 4.5.6. Norms of entry that ought to be followed by
and not just any investment company’. Other foreign any foreign bank before setting up a wholly owned
Banks are however subject to the standard limitation subsidiary
of up to 74%, through the usual course of direct or
portfolio investment. The following categories may be allowed entry into
the Indian banking sector only if they set up a Wholly
Permission has also been granted to foreign banks by Owned Subsidiary
the government to set up wholly owned subsidiaries
in India. However, no decision has been taken on the ▪ Banks that are incorporated in jurisdictions
issue of raising voting rights beyond the limit of 10% that have legislations regulating the deposits
on shareholding. made/credited. These banks will have a
preferential claim to wind up within that
These norms are however not applicable to PSU jurisdiction;
banks, whereby the FDI limit is still set at 20%. Such
foreign investments made in private banks made ▪ Banks that do not provide adequate
through a joint venture or subsidiary in the insurance disclosures of their home jurisdiction;
sectors will be subject to the scrutiny of the RBI and
the IRDA to ensure that a 26% equity cap is still ▪ Banks that have a complex structure;
available for the insurance sector and is not ▪ Banks not widely held;
breached. ▪ If the RBI is not adequately gratified of the

supervisory arrangements or the market

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discipline of the company’s country of Indian financial markets. This legislation had eased
incorporation. the various foreign exchange restrictions, that
resulted in a significantly flowy set of investments in
4.6. REGULATION OF FDI THROUGH THE FEMA India in the past few decades. “This made India, one of
(FOREIGN EXCHANGE MANAGEMENT ACT, 1999) the most lucrative FDI destinations in the world”,
paving way for several Indian businesses to invest
The Foreign Exchange Management Act, 1999 overseas.
(FEMA) came into force in 2000, replacing the FERA
Foreign Exchange Regulation Act, 1973. With a rise in the inbound as well as outbound
investments, a need to understand the regulations is
4.6.1. Objective of the Act to be able to better decipher and regulate the capital
inflows and outflows. Any transaction that involved
Primary objectives of the old act FERA was to foreign exchange was brought under the purview of
conserve and properly utilize the various foreign the FEMA and was mandated to be read with the FDI
exchange resources present in the country. It policies. The newly incorporated FDI policy was
promoted and aimed to control aspects of conduct of issued by the government of India and brought in
several businesses that took place outside India, by several changes that were made to attract more FDI
Indian companies. It also sought to control foreign inflows into the country.
companies in India. Business enterprises that import
goods from other countries, or export their goods to 4.6.2. What does it do?
them, or make investments abroad usually deal with
deposits, credits and balances that are payable in Only authorized people are permitted by the FEMA
foreign currencies or secondly drafts, letter of credit to deal with foreign exchange/ foreign security.
or bills of exchange. These may be expressed or These authorized people as per chapter III, includes
drawn in Indian currencies but are payable in any authorized dealer, money changer, off-shore banking
foreign currency. unit or any other person for the time being authorized
by the Reserve Bank. Any person who deals ‘in’ or
FEMA, 1999 was the most important legislation of with the transfer of any foreign exchange or foreign
India that governed both inbound and outbound security to any person not being an authorized
investments. The extent and intricacy of FEMA ought person is prohibited under the Act, to make any
to be understood with respect to its influence in the

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payment to or for the credit of any person resident implemented by the DIPP;
outside India in any manner. They are not allowed to ▪ By imposing regulatory suggestions in
receive any payment through an order other than by
that of an authorized person, on behalf of any person discussion papers.
who may be any type of resident outside India.
FEMA provides for the following:
It regulates “the entry into any financial transaction
in India in the form of consideration for or in ▪ Transactions on current account are free but
association with acquisition or creation or transfer of will be subjected to a set of imposed
a right to acquire, any asset outside India by any reasonable restrictions;
person who is a resident in India, who acquires, holds,
owns, possesses or transfers any foreign exchange, ▪ Control by the RBI over the Capital Account
foreign security or any immovable property situated Transactions;
outside India.”
▪ Control over the export proceeds;
4.6.3. Administration of FEMA ▪ Control over the dealings in Forex through

FEMA is administered by the following authorities: - the authorised persons (The ones who fall
within the definition of the Act);
▪ The central government of India. The central ▪ Adjudication and Appeal as per chapter V;
government imposes “Rules” on the current ▪ The appellate provisions being directed to the
Account Transactions and any other Special Director and any Appellate tribunal
compounding proceedings; set up for that purpose;
▪ A directorate of enforcement;
▪ The RBI by issuing various “notifications” on
the Capital Account Transactions which is 4.6.4. FDI regulations
issued in general;
FEMA provides the necessary regulations that
▪ Directions that are provided by the prescribe to the mode of investments, manner of
Authorised persons (Directions) circulars [ receipts of funds, issue of shares/ convertible
A.P (Dir) Circulars] debentures and preference of shares and reporting of
the investments to the RBI. This FDI policy will be
▪ Through the various FDI policies formulated by the Central government.

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4.6.4.1. Persons allowed to make FDI as per FEMA 4.7. FOREIGN EXCHANGE MANAGEMENT
REGULATIONS, 2000 (TRANSFER OR ISSUE OF
▪ Any person who is a Resident outside India SECURITY BY A PERSON RESIDENT OUTSIDE OF
except for Pakistan INDIA)

▪ Any entity that is incorporated outside The RBI imposed the FEMA (Transfer or Issues of
Pakistan and Bangladesh securities by a person resident outside India)
Regulation, 2000 and then later notified the 2017
▪ Any person who is a resident of Bangladesh or changes, which includes various provisions
entities that are incorporated there, may be “pertaining to restrictions on investment, permission
allowed to make an investment in India in the for making investment, acquisition shares, issue of
form of shares or convertible debentures but shares and convertible notes, pricing guidelines,
with the proper permission of the RBI. taxes and remittance of sale proceeds, reporting
requirements, forms, downstream investment,
▪ The RBI has generally granted permission prohibited activities for investment by a person
under the FEMA, with respect to proposals resident outside India”. The primary objective of this
that are approved by the government. notification was for the Reserve Bank to make
However, if any Indian company has been regulations to prohibit, restrict or regulate, transfer
getting foreign investment after an approval or issue security by a person resident outside India.
from the FIPB route, they wouldn’t require
any further clearance from the RBI to receive 4.7.1. Provisions
any inward remittance or for the issuance of
shares to a foreign investor. ▪ It makes a prohibition on any Indian entity,
investment vehicle, venture capital fund, any
▪ However, all companies are required to notify firm or association of persons, or any
the concerned Regional office of the RBI proprietary concerned to receive any
about the receipt of any inward remittance investment in India from a person who is a
within 30 days. They must also file the resident outside India or record such an
required documents with the respective investment in its books without the prior
Regional offices of the RBI within 3 days after
the issuance of the shares to the foreign
investors/ NRIs.

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approval of the RBI. outside India. Any other investment made by a
▪ It further provides for any investment made person who is a resident outside India will be subject
to the conditions of the government and the
by any person resident outside India to be compliances of sectoral conditions that are laid down
subject to the entry routes, sectoral caps or in these regulations.
investment limits;
Entry routes for foreign investments are as follows: The notification allows for the following-
▪ The automatic route- As explained earlier in
this paper, it is an entry route where an ▪ The issuing of capital Instruments such as
investment is made by a person who is a ➢ Equity Instruments, which can be in the
resident outside India which doesn’t require form of equity shares, debentures or
the prior permission of the RBI or the preference shares, that are now clubbed
government. under “Capital Instruments”;
▪ Government route- As explained earlier in ➢ FDI, is defined to include all investments
this paper, in this route, any investment made made through a capital instrument by a
by a person residing outside India will have to person who is a resident outside India, is a
go through RBI scrutiny and government part of an unlisted Indian company, or has
approval. All foreign investments made a share of more than 10% in a listed Indian
through this route will have to abide by the company.
provisions made under this notification. ➢ FPIs would include any investment made
by a person who is a resident outside
Example: “All aggregate foreign portfolios India, whereby such an investment would
investments are capped up to 49% of the paid-up be less than 10% of the post issue paid-up
capital on a fully diluted basis or the sectoral/ share capital on a fully diluted basis of a
statutory cap, whichever is lower, will not require listed Indian company.
Government approval”ii or even compliances with the ➢ As per the earlier regulation, general
sectoral provisions. This is allowed only if such an permission was available for the issuance
investment does not result in the transfer of of shares on mergers or demergers,
ownership or the control of the resident Indian amalgamation, which was subject to the
company from a resident of India or transfer the prescribed conditions. Under the current
ownership/ control to persons who are resident

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revised regulations, Indian companies can ▪ Transferring Capital Instruments (permitted
now issue any capital instrument under the automatic route
pursuant to merger/ demerger/ ➢ Any transfer made by a non-resident of
amalgamation, subject to prescribed India or OCI to any person who is a
conditions. resident outside India through a sale or
➢ The fixed period of issue of capital gift will be subject to the conditions
instruments have been aligned with the stipulated under this regulation.
Companies Act, 2013, where the fixed ➢ Transfer by a person who is a resident
time period was 180 days. In case of non- outside India to any other person who is
issuance of capital instruments within 60 also a resident outside India pursuant to
days, money will be required to be liquidation, merger, demerger,
refunded within 15 days.iii amalgamation of foreign companies.
➢ Furthermore, it also clarifies that any
foreign investment that has to be ▪ Other regulations incorporated
calculated under a fully diluted basis i.e. ➢ Foreign investment that are made in
the total number of shares that would be commodities spot exchanges have been
outstanding if all possible sources of permitted up to 49% in the automatic
conversion are exercised. route;
➢ To compute the limits that are applicable ➢ The definition of ‘downstream
to FPIs (i.e. less than 10%), the investment investment’ was amended to include the
to be made by investor groups will be concept of ‘investment by limited liability’
considered. partnership (LLP)/ Investment vehicle in a
downstream Indian company or an LLP.

i https://www.rbi.org.in/fiilist/index.html iii
https://rbi.org.in/scripts/FS_Notification.aspx?Id=11200&Mo
ii What is a Fully-Diluted Basis? (December 22, 2009) available de=0&fn=5
at https://startuplawyer.com/venture-capital/what-is-a-fully-
diluted-basis.

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