Foreign banks play a relatively minor role in the Indian economy, as reiterated in Global Development Finance 2008, an annual publication from the World Bank that was released last week.
This fact is relevant right now for two reasons. First, the Reserve Bank of India is likely to open up the Indian banking market further in April, or around 300 days from now. Two, the global credit crisis has shown how problems in Western banks can reverberate through financial systems in emerging markets.
The advantages of greater foreign bank participation are clear: They tend to increase the efficiency of the local banking system, bring in more sophisticated financial services and have the ability to nurse weak banks back to health. That underlies the case for greater freedom for foreign banks.
The credit crisis has brought the dark underside into focus. Global banks that boast of the best practices in the way they allocate capital and manage risks are also prone to make elementary mistakes, partly because of the imperfect nature of regulations and partly because bankers have perverse incentives to be loose with other people’s money.
So, which way should policy swing? It is tempting to conclude that India is better off with its current policy of caution about the entry of foreign banks. But that would be a mistake. While we agree that banking markets tend to be prone to crises and, hence, need tighter regulation than markets in goods and services, India needs more foreign bank participation.
The main contention—that foreign banks account for just 5% of India’s loan market—is misleading. Local banks have been on a borrowing spree abroad. They raised more than $12 billion between 2003 and 2006, which is one reason that India could support credit growth of 28.1% despite the fact that deposits grew at only 18.5%.
A lot of this overseas borrowing must have come from foreign banks operating in global financial centres. The question is: If regulators are comfortable getting resources from foreign banks indirectly through the global credit markets, what is the objection to more direct participation?
(Should foreign banks have more freedom in India? Write to us at email@example.com)