The global banking industry weathered turbulent times in 2007 and 2008. The impact of the economic slowdown on the banking and insurance services sector in India has so far been moderate. The Indian financial system has very little exposure to foreign assets and their derivative products and it is this feature that is likely to prove an antidote to the financial sector ills that have plagued many other emerging economies.
Owing to at least a decade of reforms, the banking sector in India has seen remarkable improvement in financial health and in providing jobs. Even in the wake of a severe economic downturn, the banking sector continues to be a very dominant sector of the financial system. The aggregate foreign investment in a private bank from all sources is allowed to reach as much as 74% under Indian regulations.
The insurance sector has also been fast developing with substantial revenue growth in the non-life insurance market. However, despite its enormous population, India only accounts for 3.4% of the Asia- Pacific general insurance market’s value. The cap on foreign companies’ equity stakes in insurance joint ventures is 26%, but is expected to rise to 49%.
The third quarter of 2008 saw the beginning of negative net capital inflows into the country. Notwithstanding this bleak scenario, the investment pattern with regard to foreign direct investment (FDI) and inflows from non-resident Indians remains resilient and FDI inflows into the country grew by an impressive 145% between fiscal 2006 and 2007 and by a respectable 46.6% between fiscal 2007 and 2008. However, owing to the economic downturn, the growth in FDI inflows in fiscal 2009 slowed to 18.6% from the previous fiscal.
Despite the surge in investments, the stringent regulatory framework governing FDI has proved to be a significant hindrance. However, FDI norms have been relaxed to a considerable extent with respect to certain sectors. Private banks, for instance.
Foreign investment, in addition to technological innovation and expertise, brings with it a plethora of risks. An unwarranted increase in the size of foreign holding in the banking and insurance sector will inevitably expose the country to risks not commensurate with those that an emerging market economy such as ours is equipped to grapple with.
At the same time, it is important to recognize that FDI in banking can address several issues pertaining to the sector such as encouraging development of innovative financial products, improving the efficiency of the banking sector, better capitalization of banks and better ability to adapt to changing financial market conditions.
Shanto Ghosh, Ipsa Mohanty and Anushree Ashokbhat are with Deloitte in India. Respond to this column at email@example.com