In his maiden press conference last week, Reserve Bank of India (RBI) governor D. Subbarao said the Indian central bank would review the norms on foreign banks’ role next year. This is no surprise as the first phase of the road map for foreign banks’ role in India, drafted by Subbarao’s predecessor Y.V. Reddy, ends in March 2009.
In the first phase, foreign banks in India have been allowed to convert their existing branches into wholly owned subsidiaries or set up such subsidiaries, but no one has done this so far. Foreign investment in private banks from all sources, including direct as well as portfolio investments, now cannot go beyond 74%, but a foreign bank can acquire a local bank, provided the banking regulator wants the foreign entity to play the role of a white knight. Between 2004 and now, there has been distress sale of five domestic banks and in at least three cases foreign banks approached RBI with acquisition plans but they did not get the regulator’s nod.
In August 2004, Global Trust Bank Ltd, crumbling under the burden of a huge exposure to stock market, got merged with New Delhi-based public sector bank, Oriental Bank of Commerce. In 2006, two old and weak private banks—Ganesh Bank of Kurundwad Ltd and United Western Bank Ltd—were merged with Federal Bank Ltd and IDBI Ltd, respectively.
Similarly, in 2007, ICICI Bank Ltd, India’s largest private bank, took over Sangli Bank Ltd, and Centurion Bank of Punjab Ltd (which subsequently got merged with HDFC Bank Ltd) took over Lord Krishna Bank Ltd.
Along with the road map for foreign banks in India, RBI also unveiled ownership norms for private sector banks and it was a remarkable balancing act by the former RBI governor Reddy. While foreign banks were asked to wait for four years before the acquisition game begins on the Indian banking turf, the private banking industry was served an ultimatum to put its house in order within the time frame. The regulator forced local players to raise their capital and reserves to make them strong and directed their promoters to dilute their ownership and bring in more stakeholders to ensure corporate governance. The objective was to prepare the domestic players to slug it out with deep-pocket, technology and product-savvy foreign banks when the sector opens up.
So, will the new RBI governor open up the sector in April 2009?
Subbarao admits that “financial sector reform is important”, but puts a caveat, saying: “We will draw from the lessons of global experience of the recent period.” He also says that financial sector reforms are not an end in themselves and they have meaning and relevance only if they are anchored in real sector objectives. Finally, financial sector reforms should promote inclusive growth through efficient and easily accessible financial services.
His first press statement also says, “It is heartening to note that the report on currency and finance put out by the RBI…finds improvement in the efficiency of the Indian banking sector, especially of the public sector banks.”
The report on currency and finance, edited by deputy governor Rakesh Mohan, is prepared by the department of economic analysis and policy of the Indian central bank and should not necessarily be interpreted as its official view but it certainly offers a peek into the Indian central bank’s thought process. The report claims RBI’s approach towards foreign banks operating in India is “non-discriminatory” and “very liberal” by global standards. Indeed, the number of foreign bank branches has increased significantly from 138 in 1990 to 272 in 2007. Similarly, foreign banks’ market share in banking assets has gone up from 5.6% to 10.1% during this period. Under the General Agreement on Trade in Services of the World Trade Organization, India needs to issue 12 branch licences to foreign banks every year, but RBI has been offering more branch licences. Between 2003 and 2007, it gave nod for 75 new foreign bank branches.
There are other signs of its liberalism, too. For instance, a foreign bank in India can always open a non-banking financial subsidiary to supplement its business. Moreover, unlike Singapore and a few other countries, where every branch cannot dabble in every banking business, India offers only a single class of licence which does not restrict the scope of banking operations. The cost of deposit insurance is uniform for both foreign and Indian banks, but when it comes to directed loans, foreign banks enjoy an advantage over their local peers. Under the banking law, domestic banks need to channel 40% of their loans to the so-called priority sector or farm loans and loans to small and medium entrepreneurs, while foreign banks’ exposure to such loans is only 32%.
The report does not contest the fact that increased presence of foreign banks will intensify competition and accelerate the consolidation process in India, but it raises two very critical questions. First, the subprime crisis, that has rocked the financial world and battered some of the world’s largest financial intermediaries, has turned the spotlight on “the risk management capability of these global banks, the efficacy of their corporate governance and transparency in their financial affairs”. One needs to see Subbarao’s keenness to draw from the lessons of the recent global experience in this context.
Similarly, the RBI report also dwells on the popular perception that foreign banks “do not deliver the benefits to the wider community” as they tend to focus on the urban pockets. It argues that foreign banks tend to focus on large industrial houses and avoid small and medium enterprises. Again, Subbarao’s emphasis on inclusive growth through efficient and easily accessible financial services needs to be seen in this context. It’s too early to celebrate on opening up of banking sector.
To read all of Tamal Bandyopadhyay’s earlier columns, go to www.livemint.com/bankerstrust
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as the Mumbai bureau chief of Mint. Please email comments to firstname.lastname@example.org