India's plan to increase voting rights for shareholders in banks would improve management and corporate governance and draw more investment, but it falls short of lifting ownership restrictions or relinquishing the government's stranglehold on most lenders.

New Delhi's reluctance to shed some of its 50-plus percent stakes in state banks, which have a market share of 70 per cent and a bigger proportion of the sector's bad loans, means a big chunk of lending remains exposed to political interference.

"The biggest risk in India for banks is the political risk," said Juergen Maiar, an Austria-based fund manager with Raiffeisen Euroasien Aktien that owns Indian shares worth $300 million, including in public and private sector banks.

Still, in what is seen as a positive step towards reform, parliament is expected soon to approve amendments to banking laws that include raising the limit on shareholders' voting rights in public and private sector banks.

However, the current parliamentary session, which ends on September 7, has been paralysed by a furore over a state auditor investigation into coal block allocations, casting doubt over the timing of a vote on the bill.

If approved, the cap on voting rights for investors in private sector banks such as HDFC Bank and ICICI Bank would rise to 26 per cent from 10 per cent, and to 10 per cent for government banks such as State Bank of India from just 1 per cent now.

"Higher voting rights will be good for investors. It will help banks raise capital from investors. But in public sector banks where the government shareholding is high it may not make much difference," said R.K. Bansal, executive director at state-run IDBI Bank.

The voting rights proposal was a key cause of last week's two-day strike by roughly one million bank workers, mostly from state banks, who oppose the government ceding any control.

"The government is trying to increase the influence of MNCs (multinational corporations) over banks, both private and public sector," said Vishwas Utagi, secretary of the All India Bank Employees Association. "It's a threat for the banking sector and the country."

India has struggled for years to reform and liberalise key sectors such as banking, retail and insurance due to political opposition, including from within the ruling Congress party.

Left unchanged is the limit that caps any single investor from owning a minority stake of more than 5 per cent in an Indian bank, or 10 per cent with central bank approval.

The limit has deterred investment in an industry in need of capital to meet stricter buffer requirements for banks under the global Basel III rules.

"Foreign players may get a little more interested as ... it's a step in the right direction," said Abhay Gupte, senior director at Deloitte India, referring to the plan to raise voting rights.

STATE DOMINANCE

Advocates of reform say the increase in the voting rights limit should be followed by other long-pending measures, including cutting the government's holding in public sector banks and issuing new bank licences. The last new bank licence to a private firm was issued in 2004.

The government proposed in 2010 to issue more licences, including to corporate houses, in a bid to expand access to financial services in a country where more than half the billion-plus population don't have a bank account.

"To attract new foreign investment you will have to open the sector more," said Walter Rossini, a Milan-based portfolio manager for Gestielle India, which manages about $200 million.

A government panel recommended in 1998 that it reduce holdings in state banks to 33 per cent from more than 50 per cent.

The government's resistance to ceding its majority stakes was reinforced by the 2008 global financial crisis.

Doing so would help banks tap local and overseas markets to raise funds to meet the tougher new capital requirements and improve operational performance, analysts say.

The Reserve Bank of India estimates state banks need to raise about Rs 4 trillion of equity to meet Basel III capital rules by 2018, meaning India's deficit-strapped government may ultimately have little choice but to sell down some of its bank stakes.

MORE FORGIVING

Government dominance of state banks often leads to political pressure to lend to favoured borrowers, including farmers.

It has also been using ownership clout to exercise influence on operations including loan pricing and sectoral exposures.

State banks also tend to be forgiving when corporate borrowers get into trouble, and a RBI deputy governor recently said India's debt restructuring process is biased in favour of state banks and big borrowers. An RBI panel has proposed tighter rules around the process.

"Occasionally there are concerns about the government exercising its ownership rights not through the established channels which is the board mechanism but outside of the board," RBI Governor Duvvuri Subbarao said last month, responding to the government's influence over state banks.

"I don't think that's a good example of corporate governance."

A senior bureaucrat in the finance ministry's banking division did not respond to a request for comment.

Bad loans as a percentage of total loans was 3.2 per cent for state banks at the end of March, compared with 2.2 per cent for private sector banks, according to the central bank.

Soured loans at State Bank of India, the country's biggest lender, were nearly double expectations in the June quarter.

"With the government as its biggest shareholder and not much voting rights for investors, things like the waiver of farm loans will continue," Maiar said referring to state banks in general.

"The government even uses its power to tell these banks to lower their lending rates."