Banks have since ages been one of the vital props of any economy. They enable the streamlining of financial resources in a profitable way, and bridge the gap between their demand and supply. They also act as an intermediary in financial transaction besides providing an array of other services.
Although the roots of banking in India can be traced to Ancient Mauriyan age, banks as one understands today originated in India in the early parts of eighteenth century, and in the course of time several banks came up and got closed down. There are, however, still few banks that bear the footprints of pre independence days and the most significant among them are Reserve Bank of India formed in 1935 and the State Bank of India, successor to the Imperial Bank of India established in 1921.
Regulating the banks is important because banks are a keystone in the edifice of financial stability of the economy. A well regulated banking system also “enhances the allocative capacity of the financial system” and thereby adds to the growth of the economy. The banking regulative regime in India underwent various changes and crystallized in 1949 with Banking Regulation Act, 1949 (passed initially as Banking Companies Act, 1949 and changed subsequently to Banking Regulation Act, 1949.). Banking Regulation Act, 1949 in conjunction with Reserve Bank of India Act, 1934 empower the Reserve Bank of India (RBI) to superintendent the banking system of the country and to act its guardian.
The Indian banking or financial system constitutes of Commercial banks, Cooperative banks, financial institution, and non-banking financial companies. The Commercial banks involves public sector banks, private sector banks and foreign banks. .While the public sector banks are the creation of the enactments of parliament, private banks under the Banking Regulation Act 1949 are deemed as banking companies. Foreign banks are a recent addition to Indian banking system and their existence and operation are determined by RBI guidelines of February 2005.
Till recently, the banking scenario in the country has been dominated by Public sector banks. However, the adoption of LPG (Liberalization, Privatization, Globalization) model of development by the Congress government in the early 1990s has been a watershed for the entire Indian economy. Under this model, foreign capital has been invited to the country to aid its growth and development. Foreign capital in the form of foreign direct investment and foreign institutional investments are permitted in almost all the sectors of the economy.
Commensurate with this new development, FDI to the extent of 74% (raised from 49% to 74% in March 2004) in private banks and 20% in Public sector banks have been allowed. Besides, in keeping with India’s obligation World Trade Organization, foreign banks have also been granted licence to operate India.
Thus, post-liberalization, private banks and foreign banks, hitherto rather obscure terms increasingly gained acceptability in popular parlance and imagination. RBI issued its regulation regime for both private banks and foreign banks. Initially the guidelines for licensing of new banks in the private sector were issued by the RBI in January 1993 but the revised guidelines effective till date were issued in January 2001. As per these guidelines, initial paid up capital in private banks is to ` 200 crores which is to be increased to ` 300 crores within three years of the commencement of business. The apex bank also issued comprehensive guidelines on ownership and governance in private sector banks. They aim at ensuring diversity in the ultimate ownership and control of banks in the private sector.
Foreign investment, in keeping with the increased cap of March 2004, from all sources including FDI, FII, NRI is increased from 49% to 74%. However, voting right of the foreign investor is capped at 10%, thereby ensuring that local banks are not taken over by foreign banks.
For the foreign banks, the RBI issued in February 2005 “Roadmap for the presence of Foreign Banks in India”. The Roadmap is divided into two phases- the first phase spanning the period March 2005-March 2009 and the second phase beginning after a review of the experience gained in first phase.
In the first phase foreign banks wishing to establish presence in India for the first time can either choose to operate through branch presence or set up a 100% wholly owned subsidiary(WOS).
Foreign banks already operating in India are also allowed to convert their existing branches to WOS while following the one mode presence criterion. The WOS is to be treated on par with the existing branch of foreign banks for branch expansion in India.
Before granting licence to foreign branch under the provisions of Section 22 of the Banking Regulation Act, 1949, RBI may satisfy itself that the government or the law of the country in which it is incorporated does not in any way discriminate against banks from India. Foreign banks’ track record of compliance and functioning in the global market may also be considered. Further, bilateral and diplomatic relations between India and the country in which the bank is incorporated may also be taken into consideration.
RBI issues a single class of banking licence to all banks and thereby does not place any limitation in the operation of foreign banks. In other words, foreign banks can conduct both retail and wholesale banking. In addition, the norms for foreign banks’ capital adequacy, in come recognition and asset classification vis-à-vis Indian banks are by and large same.
Private banks and in particular foreign banks are generating enormous return from their operations in India. The net profit per branch for the foreign banks in India 2005-06 was Rs. 11.99 crore as against the corresponding figure of Rs. 0.33 crore for the public sector banks. Further for the year 2006-07 the Return on Asset of the foreign banks was 1.65% while the Return on Equity 14.02% as against the corresponding figure of 0.82% and 13.62%for the Public sector banks. The success and recognition that these banks enjoy can be attributed to the fact that they adopt international best practices in order to stay competitive. Such practices include risk management technique, technology upgrades, more efficient capital allocation tools, strong branding, product innovation, better customer service etc. The main result of such improved atmosphere of operation in banking system is higher efficiency levels in the banking system in terms of more optimal capital allocation, better profitability, prudent risk management and a greater competition which ultimately benefits the end-customer through new products and services at affordable prices. It needs a mention here that one of the main aims of inviting foreign enterprises in India was to infuse the zeal of competition in our traditionally laggard Public sectors. And it has been seen that the presence of the multinational companies in the same segment has indeed made our Public sectors companies competitive. Presence of these foreign banks is already inspiring the banks in the public sector to compete with the former and if the protective shield is removed a little further, it will instill even more contestability among the public sector banks.
However, in recent times, the RBI has been giving dubious signals as regard its intention about the prospects of the proliferation of foreign banks and the admissibility of foreign capital in the banking sector. As per the roadmap for the presence of foreign banks in India, the revision of presence of foreign banks in India was due in April 2009. However, global financial market at that time was in turmoil and uncertainty plagued the financial strength of the banks around the world.
Accordingly, RBI’s Annual Policy Statement of April 2009 indicated the intention to continue with the current policy and procedure governing the presence of foreign banks in India and to review its roadmap after due consultation with the stakeholders, once there was greater clarity regarding the stability and recovery of the global financial system. Accordingly the Annual Monetary Policy 2010 directed to prepare a discussion paper on the mode of presence of foreign banks through branch or WOS by September 2010.
During the first phase of their operation, foreign banks have been given the option by the RBI to convert their branch operation into wholly owned subsidiaries without the branch licensing available to their domestic counterpart. No bank, however, came forward to avail this option and according to reports, the discussion paper to be released this month again favours the subsidiary route for fresh entry of foreign banks into the country. One RBI official is said to have said “If u adopt the subsidiary route then you will have better control on foreign banks in terms of capital and liquidity management” However, Experts believe that most foreign banks desirous of extending their business to India may not prefer the subsidiary route which requires them to shell out more capital for the entry, with no commensurate benefit. Unless they are given national treatment, branch expansion in India would remain circumscribed, regardless of whether the branch –only or the WOS route is employed. A compulsory listing in Indian stock exchange in case of the adoption of the subsidiary route also worries the foreign banks.
It is a strange Indian tendency to distrust anything foreign. After all what are the factors that inhibit the RBI to allow foreign banks to expand in India? Is it a fear that these banks with their humungous capital and global expertise will push the Indian banks to oblivion? Is it that these banks with their emphasis in exclusive banking rather than on inclusive banking will choke the flow of credit to agricultural and small and medium enterprise sector?
India’s public banking sector and the regulatory regime with which the RBI guardian it is hailed as one of the best in the world. During the recession of last few years Indian public sector banks’ sturdy fundamentals have come in for hefty praise from the international circles. Thus it is a little absurd to expect that the public sector banks will crumble in the face o stiff competition form the foreign banks. On the other hand, often what few of these banks crave for in order to compete with the foreign banks is a liberty to adopt the foreign banks’ modus operandi. Tarashankar Bhattacharya, managing director of India’s largest bank, the state bank of India laments that the public sector banks are constantly reined in from competing effectively with the foreign banks because they cannot pay market-linked salaries. Expect in rare cases they are unable to create or hold on to the best talent. They cannot acquire other banks without lengthy and often unsuccessful bureaucratic wrangling. And along with the rest of the Indian Industry they cannot downsize at will. Thus what these government owned banks privately desire for is to transform themselves into a commercial institution in the real sense of the term and not just be an instrument of social policy.
However, the social goals of the country can also not be soft peddled. But every time anything novel is sought to be introduced in the economy, they should not be projected as an impediment to that. The Indian public sector banks are strong enough to compete with the foreign banks. But what they might be deficient in is scale, volume of capital, technological and human resources. Thus what is required to empower these public sector banks to take the foreign banks head on is merger and acquisition. The Ministry of Finance is also in favour of merger and acquisitions. Speaking at the centennial celebrations of the Bank of India the finance minister said,”A country as large as India cannot be content with the one large bank (referring to state bank of India). India, perhaps, do not need 27 PSBs with numerous branches all over the country. A number of them can be merged to craft banks that can take the international giants.
The foreign banks have been clamoring for the expansion of their branches. One of the reasons as to whey their requests are not acceded to is because these banks tend to concentrate their operation in cities. The RBI has recently decided to allow the public sector banks to start new branches in tier III –tier VI cities without its prior approval. This scheme can in a limited way also be extended to the Foreign Banks. This will leave them with few options but to expand in small cities and at the same time will bring out their actual intention as to where they want to invest their money.
One also does not need to be so calamitous in his reaction to the idea of allowing an iota of level playing ground to the foreign banks. After all it is not going to sweep away the entire economy. On the other hand the possible changes that such a development will ensue will only be in the benefit of the entire country. If one can recollect when the mobile phone came to India, it used to be the exclusive privilege of the rich and wealthy, a status symbol. At that time both the incoming and the outgoing calls were charged. No one in those days could ever think that the mobile communication would one day become so affordable that persons from all sections of the society would treat it as a necessity. This happened because the communication network companies realized that an enduring and profitable business in India is not possible unless its villages where bulk of its population lives are also targeted. Similarly when KFC (Kentucky Fried Chicken) came to India it was feared that it will eliminate small businessmen dealing with chicken. But nothing of that sort, however, happened. What has happened on the other hand is that KFC in order to attract Indian customers has started selling its product at economic price. It would thus not be too wide off the mark to say that given some time and space the foreign banks would also discern this fundamental fact about Indian market and lose their penchant for big and the rich.
RBI has recently in “Discussion paper on the entry of new banks in the private sector” suggested that the foreign investment in private banks be capped at below 50%. It says that the Press Notes 2,3,and 4 issued by the government of India in February 2009 indicate that banks with foreign shareholding of more than 50% would be treated as non-resident –owned –banks.” Thus an Indian bank that receives foreign investment of more than 50% would become non Indian in ownership. In this sense both ICICI and HDFC are no longer Indian owned bank because the change in the way in which foreign investment is calculated has made foreign investment in these entities in excess of 50%. RBI claims that this move will “create strong domestic banking entities and a diversified banking sector” It needs to be emphasized here that there will not any change in the character of the bank because the voting right for any entity in the private banks has been restricted to 10%. So all that RBI is seeking to foreground by diversity of banking system is banks with different nomenclature.
By Hemant Batra
Lead Partner, Kaden Boriss Legal LLP, India
Vice President, SAARCLAW
Chairperson, IICLAM, Singapore
Advisory Board Member, OIC, USA
By Hemant Batra Lead Partner, Kaden Boriss Legal LLP, India Vice President, SAARCLAW Chairperson, IICLAM, Singapore Advisory Board Member, OIC, USA
