Under the foreign investment law of India, the limit for foreign investment in an Indian private sector bank is 74%, through foreign direct investment (FDI) or portfolio investment. On February 16, 2017, the Reserve Bank of India (RBI) lifted a ban on foreign portfolio investors (FPIs) buying shares of HDFC Bank after foreign ownership in the bank fell below 74% of its paid up capital. This enabled foreign investors to buy HDFC shares from the open market. The value of HDFC Bank shares rose by approximately 8-9% the following day, owing to increased foreign investor demand. A large number of shares were bought by foreign investors on the floor of the exchange on that day. RBI issued a notification reportedly around 1.38 p.m. on February 17, banning further FPI investment because the foreign shareholding breached the permissible 74% limit. RBI also directed brokers who had punched in trades for foreign clients after its 1.38 p.m. notification to take the trades on their books. Reportedly, such trades amounted to Rs. 8000 – Rs. 10,000 crore (Rs. 80 – 100 billion) in value.
Usually when the foreign shareholding in a bank reaches 72% of paid up capital of the bank, a trigger warning is sent to RBI, which puts such scrip on its watch list. Any further trades by FPIs are required to be pre-approved. RBI’s interference in this manner, i.e., trying to restore ceiling during market hours, is unprecedented. The incident has thrown several issues that require immediate attention between various parties, including the finance ministry, sectoral regulators, stock exchanges and depositories. RBI’s unilateral measures on noticing a breach has created considerable confusion. Given the high speed at which most trades occur, even the small time gap between RBI issuing the notification and actual implementation of the direction would be significant. There is uncertainty regarding the fate of the trades that happened immediately after RBI’s notification. Should the trades be annulled? Should they be made proprietary trades for the brokers? What would be the impact on market integrity? The unfairness of the RBI diktat is obvious. The exchange itself cannot be aware of intra-day limit breaches as the days positions are netted off end of day and therefore no one can know the breaches till the end of the day. Penalising brokers who had no way of knowing such intra-day breaches cannot be adequately condemned. In any case, the urgency of RBI in stopping the orders during the day is improper. There is no major policy or economic impact of such breach, and a notification the next day limiting foreign purchases till such time limits go down would have been the non-disruptive and fair way of handling the situation.