Mumbai: Large foreign banks operating in India are resisting a move by the banking regulator to increase the loans they have to make to the so-called priority sector—agriculture and small-scale industries.
Till recently, the 40% priority sector loan norm was applicable to local banks; for foreign banks it was 32%. Even within this, 12% could have been given as export credit.
Accepting the recommendations of an expert panel chaired by former Union Bank of India chairman M.V. Nair, the Reserve Bank of India (RBI) recently revised the target for priority sector loans for foreign lenders with 20 or more branches to 40% and abolished the export credit option. Only export credit given to agriculture and small industries will be treated as priority sector loans.
Foreign banks are not willing to accept the new norm, which will only come into effect in August 2018, as they say profitability will be eroded.
Under RBI rules, any bank that fails to fulfil the priority loan norm is required to keep money with the National Bank for Agriculture and Rural Development (Nabard) for rural infrastructure development. Earnings on this are much lower than what a bank will get from giving loans.
The Reserve Bank of India recently revised the target for priority sector loans for foreign lenders with 20 or more branches to 40% from 32%. Is this the central bank’s way of forcing large foreign banks to pursue local incorporation?
One banker, who did not want to be named, said this could be the central bank’s way of forcing large foreign banks to pursue local incorporation. RBI wants these banks to operate as wholly-owned subsidiaries of their overseas parents and not as branches, as they do now. Banks are reluctant to do so as this has tax implications.
The central bank has not yet finalized its guidelines on wholly owned subsidiaries.
In its January 2011 discussion paper on foreign banks’ expansion in India, RBI had strongly favoured a subsidiary route for foreign banks to operate in India.
All new foreign banks in the Indian banking space will have to locally incorporate themselves, and the existing ones, particularly those that are systemically important, will be encouraged to go in for local incorporation and act as subsidiaries of foreign parents, RBI had said.
Systemically important foreign banks are those whose assets are at least 0.25% of the total assets of all commercial banks, according to the central bank.
Going by this definition, 15 foreign banks, including Standard Chartered Plc, Citibank NA, HSBC Holdings Plc, Royal Bank of Scotland Plc (RBS) and Deutsche Bank AG, need to become wholly-owned subsidiaries of their overseas parents.
Though RBI had offered to “incentivize” those foreign banks that will convert operations to subsidiaries, including “a less restrictive branch expansion policy”, foreign lenders are not keen to set up local subsidiaries due to the capital gains tax they will have to pay, when transferring assets in branches to wholly-owned subsidiaries.
“These norms are not the final norms, so we have to wait and watch. We are still in consultations with RBI on priority sector and are confident of our India prospects,” said Sunil Kaushal, regional chief executive (India and South Asia) for Standard Chartered.
Emails sent to HSBC and Deutsche Bank did not elicit any response. Citi declined to comment.
India had 33 foreign banks in the country with 316 branches at the end of March 2011. They constitute 0.41% of the 76,696 total bank branches in India. In terms of assets, foreign banks constituted 7% of the total banking industry, as of end-March 2011.
StanChart, Citi, HSBC and RBS have more than 20 branches and will need to follow the 40% priority loan norm.
RBI governor D. Subbarao on Tuesday admitted that the regulator is taking another look at priority sector norms. If they are revised, it will be a rare instance of the central bank changing policy under pressure from a particular set of banks.
“Foreign banks have a predictable problem. If they go above 20 branches, their cost-benefit calculation changes,” Subbarao said. “Banks have brought to our notice these issues and we have an open mind on this.”
Viren Mehta, a partner at audit firm SR Batliboi and Co., said, “Till such time there is clarity on the tax issue, it will be very difficult for foreign banks to locally incorporate. On conversion of assets to subsidiaries, the tax burden is very high on them and this offsets the advantage of local incorporation.”
There is a one-time exemption for such a transfer under a section of the Income-Tax Act, but it prohibits the parent from diluting its stake in the subsidiary for eight years. If it fails to do so, it needs to bear the tax liability.
“A change in this situation can happen only if the tax laws are amended,” said Sudhir Kapadia, national tax leader at Ernst and Young India.
Former finance minister Pranab Mukherjee in his February budget had said the government would take care of the tax issue. However, the process will be completed only after the central bank finalizes its scheme.
While this may take time, the new priority sector norm is one way of goading foreign banks to locally incorporate, as if they do so, they will be treated almost on par with local banks. Without being a wholly-owned subsidiary, meeting the new priority norm will be difficult for these banks.
Under the current tax laws, a branch of a foreign bank in India is treated as a foreign company. If a foreign bank has to set up a subsidiary for local incorporation, it will have to acquire the business of the branches, requiring the parent to pay capital gains tax for the transaction. Mint could not independently verify this tax provision.
Apart from capital gains tax, foreign banks will also have to pay stamp duty while transferring assets to the newly formed subsidiaries.
Senior foreign bankers agreed that those foreign lenders aspiring for a broader scale of operations will have to locally incorporate in the backdrop of the new rules. “Those foreign banks which have plans to roll out universal banking operations in India will have to locally incorporate,” said Sanjiv Bhasin, chief executive officer of DBS Bank India.
Under a World Trade Organization agreement, RBI needs to give 12 new branch licences to foreign banks every year, but the Indian banking regulator has all along been allowing foreign banks to open more branches, going beyond its commitment. “Foreign banks will be more careful in expanding in India and could become reluctant to open more than 20 branches. They could prefer to have just correspondent relationships with their main offices,” said Suresh Ganapathy, head (financial research team) at Macquarie Capital Securities India Pvt. Ltd.