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Foreign bank subsidiaries get M&A, branch freedom

RBI's caveats: Curbs come in place if foreign banks exceed 20% of banking system's capital & reserves; half the directors must be Indian citizens

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India has just one branch of a foreign bank for every three million people. That could change dramatically, with Reserve Bank of India (RBI) Governor Raghuram Rajan delivering on his promise of unveiling a set of far-reaching regulations to let compete on a nearly equal footing with domestic banks, provided they set up wholly-owned subsidiaries (WOSes) in India.

In its guidelines released late on Wednesday, the said WOSes of foreign banks could acquire domestic private-sector banks, as well as set up branches anywhere in the country.

These WOSes might be permitted to enter into merger & acquisition (M&A) transactions with any private bank in India, subject to the overall foreign investment limit of 74 per cent, the central bank said.

While the current law permits foreign investors to hold up to 74 per cent stake in an Indian private bank, it does not allow a single entity to own more than five per cent share in a local lender. In the past, RBI did not allow any foreign bank to take over local lenders. In fact, the regulator had forced HSBC, which had picked up a 14.71 per cent stake in UTI Bank (now Axis Bank) to reduce its stake.

Industry analysts believe the move will encourage the foreign lenders aspiring to grow inorganically to opt for subsidiarisation. “It is a progressive move. This may trigger a few M&A transactions. So far, foreign banks could make only financial investments in an Indian bank. But many of those have deep pockets and will be interested in making strategic investments,” said a senior executive of a global consultancy firm.

Besides, choosing to create a subsidiary will ensure near-national treatment for foreign banks in opening new branches. Currently, foreign banks need RBI’s permission to open branches in the country. According to its commitments to the World Trade Organization, the central bank is required to allow only 12 new foreign bank branches in a year.

“As locally-incorporated banks, the WOSes will be given near-national treatment which will enable them to open branches anywhere in the country, except in certain sensitive areas where RBI’s prior approval would be required,” the central bank said.

The freedom could see an exponential rise in the presence of foreign banks. At present, 43 foreign banks have only 334 branches — mostly in cities — less than 0.5 per cent of the banking system’s total branch network.

A WOS will need to have an initial minimum paid-up voting equity capital of Rs 500 crore.

The banking regulator has also laid down stringent corporate governance norms for these entities. The new rules require separate boards of directors for each subsidiary. Two-thirds of the directors must not be executives of the bank, at least a third of them should be independent of the management of the subsidiary in India, its parent or associates and at least half of them must be Indian citizens.

The central bank has also allowed foreign bank subsidiaries to list on local stock exchanges.

So far as priority-sector lending is concerned, RBI has set the requirement on a par with that for domestic banks, at 40 per cent of net adjusted bank credit (of the previous year). However, adequate transition period will be provided to existing foreign bank branches converting into WOSes.

There are some other important caveats, too. RBI said it would impose limits if foreign banks gained too large a share of the domestic market through the subsidiaries. For example, it would put a stop on further entry of new WOSes of foreign banks or capital infusion when foreign banks in India exceed 20 per cent of the capital and reserves of the entire banking system.

That, however, is a long way off, as foreign banks’ share in Indian banking assets has remained static at 6-7 per cent for many years.

The wholly-owned-subsidiary route has not been mandated and foreign banks can continue with the branch mode, but those with complex structures and those not providing adequate disclosure in their home jurisdictions will be allowed entry into India only through the WOS route.

The foreign banks that commenced banking business in India before August 2010 will have the option of continuing with their banking business through the branch mode.

Some foreign banks, however, responded with caution to the new guidelines. A senior executive of a US-based foreign bank in India said he was a bit disappointed that RBI did not consider the request for dual licensing (that is, presence through both branch and subsidiary mode). “Also, we had requested some dispensations on stamp duty and taxes. The guidelines do not mention those points. We will have to study the guidelines in detail before we decide in what form we would like to continue our operations here,” he added.

Another executive with a European bank in India said subsidiarisation would give foreign banks the ability to expand their network in the country. But, at the same time, for banks that set up shop before August 2010, it is not mandatory. “We will evaluate the pros and cons before taking a decision,” he said.

The RBI guidelines said banks that were not widely held and those from jurisdictions where legislation gave preferential claims to home-country depositors in winding-up proceedings would also be allowed into India only through the WOS route.

A discussion paper released by the central bank in late August had said the main aim of allowing foreign banks in was to increase competition and efficiency in the local banking sector, spurring Indian banks to adopt more sophisticated financial services and risk-management techniques.

GUIDELINES AT A GLANCE

A MUST? Subsidiarisation not mandatory but foreign banks with complex structures and concentrated shareholding will have to create wholly-owned subsidiaries (WOSes)

WHEN? Foreign banks opting for branch presence must convert into WOSes when it becomes systemically important

LOCAL ACQUISITION? Foreign banks creating subsidiaries to be permitted to acquire local banks

RESTRICTIONS? To be placed on entry of new WOSes and capital infusion when capital & reserves of WOSes and foreign bank branches exceed 20% of the banking system’s capital & reserves

VOTING EQUITY CAPITAL? Rs 500 crore prescribed as initial minimum paid-up voting equity capital for a WOS

PRIORITY-SECTOR LENDING? Requirement for WOSes to be on a par with Indian banks — 40%

CORPORATE GOVERNANCE? Norms for WOSes to be stringent; two-thirds of directors must be non-executive

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