Banker’s Trust | New regime for foreign banks?

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Reserve Bank of India (RBI) governor Raghuram Rajan’s recent statement in Washington that the Indian banking regulator would soon release norms for a larger role by foreign banks in India and that it could be one “big, big opening” as “one could even contemplate taking over Indian banks”, led to two things last week. Shares of small and mid-sized private banks surged on expectations that foreign banks may soon be able to take over local lenders. Also, senior executives of some large foreign banks have seriously started discussing their game plan in the new regime.

Under a World Trade Organisation (WTO) agreement, RBI is required to give foreign banks 12 new permits to open branches every year, including those given to new entrants and existing lenders, but the Indian regulator has been liberal all along in its policy. Despite this, foreign banks’ share in Indian banking assets has remained static at around 6-7% over the years even though under a 1997 WTO agreement, total assets of foreign banks in India can go up to 15% of the banking system.

If indeed RBI allows foreign banks to acquire local banks, the landscape of banking will change dramatically in the world’s tenth largest economy. The regulator has been rather protective about the sector. Although up to 74% of a bank’s stake can be held by foreign investors—both through foreign direct investment (FDI) as well as portfolio investment—no single entity can own more than 5% stake in a local bank.

RBI rushed to put in place the 5% cap norm after private equity fund Newbridge Capital wanted to have a majority stake in public sector Global Trust Bank in 2004, which was sinking under the burden of bad assets. It also wanted to pick up a large stake in another new private bank, Bank of Punjab, but RBI did not let that happen. The regulator also forced Hongkong and Shanghai Banking Corp. Ltd (HSBC), which had picked up a 14.71% stake in UTI Bank Ltd (the earlier avatar of Axis Bank Ltd) to pare its stake. And, in 2006, when an old private bank in Maharashtra, United Western Bank, was put on the block, Standard Chartered Bank’s bid was not entertained; IDBI Ltd got it.

Six years after first laying down the road map for foreign banks in India, RBI in a 2011 discussion paper envisaged almost doubling their role in the Indian banking system, saying it will “incentivize” foreign firms to operate through wholly owned subsidiaries, but nothing has been done since then. Some 43 foreign banks now have 334 branches, mostly in cities, less than half a percentage point of the banking system’s total branch network.

Going by the 2011 discussion paper, all new overseas entrants will have to locally incorporate themselves, and the existing lenders, particularly the systemically important ones, will be encouraged to go in for local incorporation and act as subsidiaries of foreign parents. Systemically important banks are those whose assets are at least a quarter percentage point of the total assets of all commercial banks. Those foreign banks that will follow the wholly owned subsidiary route are supposed to get incentives in the form of being allowed to raise rupee resources as non-equity capital and there is supposed to be a “less restrictive branch expansion policy” for them in semi-urban areas. Those foreign banks who will opt for the wholly owned subsidiary route will be treated virtually on a par with their domestic peers in terms of branch expansion. This is critical as RBI, despite being more liberal than what WTO norms stipulate, has been following a restrictive branch licensing policy.

Standard Chartered started its Indian operations by opening its first branch in Kolkata in April 1858, a year after India’s first war of independence which began when sepoys of the British East India Company’s army rebelled against their officers. With around Rs.93,000 crore of assets, Standard Chartered now has 100 branches.

In 1959, HSBC acquired Mercantile Bank of India, London and China, which was founded in Mumbai with an authorized capital of Rs.50 lakh in October 1853. By 1855, Mercantile Bank had offices in London, Chennai, Colombo, Kandy, Kolkata, Singapore, Hong Kong, Guangchow and Shanghai. With close to Rs.81,100 crore in assets, HSBC currently has 50 branches in India. Citibank, which has the biggest asset base among all foreign banks in India, is 110 years old. It has 43 branches across 29 centres. Among other foreign banks, Deutsche Bank AG has 17 branches and DBS Bank runs 12.

While foreign banks await RBI’s new norms, if the regulator continues to insist on being reciprocated as a precondition to the opening up of the sector, things will not change dramatically unless overseas watchdogs change their stance. For instance, if US is not ready to welcome Indian banks with open arms, Citibank cannot make it big in India to cash in on the opportunities that a burgeoning middle class and increasing rural consumption offer.

Meanwhile, while seizing the new opportunity, the foreign banks should also show more innovation in terms of products, particularly in retail. Indeed, the foreign banks have introduced Indian consumers to cash machines and credit cards, but ever since new Indian private banks made their appearance in the mid-1990s, the foreign banks have not done much in this space. They have doing well in corporate banking, managing cash, raising money for Indian firms looking for investments overseas and connecting them with a global clientele and consumers, but beyond corporate clients and urban consumers, they have not done much in India to encash the enormous opportunities in a country of 1.2 billion population, with 50% of them lacking access to banking services.

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