An internal committee set up by Finance Minister Jaswant Singh has observed that foreign direct investment and foreign institutional investors' stakes in banks are distinct and has recommended that the two be treated separately.

This will mean that public sector banks, and more specifically the State Bank of India, can attract more foreign investment.

Total foreign investment in the State Bank of India is at present capped at 20 per cent. For all other public sector banks, too, the cap is 20 per cent.

The State Bank of India had earlier represented to the finance ministry not to club the FII stake with its global depository receipts in determining the overall foreign investment cap.

The internal committee, which was set up after the Budget for 2003-04 was presented, recently submitted its report to the finance minister. It is now awaiting Singh's approval.

Sources in the finance ministry said the interpretation of FDI in the banking sector was not clear.

"It is not explicitly specified that the FII stake should be clubbed with direct equity investment in determining the foreign investment ceiling," said a source.

The committee, headed by an additional secretary in the department of economic affairs, noted that FDI was about acquiring management control in a bank.

FII holdings, on the other hand, were investments made for the sake of generating returns. "The committee, hence, decided that FII stakes should be excluded from the FDI limit," the source added.

The sources said the issue was highlighted in the specific context of the State Bank of India, which sought to segregate FII investment from the FDI limit, which includes investment in the bank through global depository receipts.

While the Reserve Bank of India holds almost 60 per cent in the State Bank of India, the government holds a majority stake in all other public sector banks.

A Bill introduced in Parliament over two years ago, the Banking Companies (Acquisition and Transfer of Undertaking) Bill, which proposes to reduce the government equity in public sector banks to 33 per cent, is still pending.

This Bill, along with a decision to exclude FIIs from the overall foreign investment cap, will be a major liberalisation move in the banking sector and help the public sector banks to raise funds from both the domestic and overseas markets.

In the Budget for 2003-04, the finance minister had taken the first step by increasing the FDI limit in private banks from 49 per cent to 74 per cent.

This, he said, would help in the setting up of subsidiaries by foreign banks as well as in inviting investment in private banks.