Bigger play for foreign banks easier said than done?

A policy framework for entry of foreign banks in a "big way" will be unveiled soon, but is the environment encouraging?

Could Raghuram Rajan’s announcement on letting foreign banks enter India in a bigger way, be easier said than done? At a time when there is literally no good news coming out of India, and the government is in no position to undertake big reforms in a pre-election year, the RBI seems to be initiating these bold moves in a bid to attract more capital into the country.

Rajan spoke about the need to allow for bigger participation of foreign banks during his inaugural speech as well, and he reiterated this objective in Washington yesterday saying the policy framework for entry of foreign banks in a “big way” would be unveiled in the next few weeks. 

 

“A lot is already on the table starting with the passage of the banking laws amendment bill enhancing voting rights cap in banks from 10-26%. Harmonizing ownership guidelines will be a pre-requisite to consolidation.

Further, changes have been proposed on conversion of branches into local subsidiaries, licensing of private sector banks, holding structure for banking groups, intra group transactions, factoring and restructuring of advances.

In addition, there are current committees and pilots on inclusion, electronic payments, NPAs. Achieving closure on these will create a clearer future path for banks and banking groups in India” said Shinjini Kumar, Director at PricewaterhouseCoopers.

 

Currently, 43 foreign banks operate through a network of 333 branches in India. All of them operate as branches of their foreign parents or as representative offices. The RBI wants to incentivize the existing foreign banks to convert to wholly owned subsidiaries to ease regulation, bring in more capital and ring fence operations from the overseas parent. The wholly owned subsidiary model is being adopted in a lot of geographies post the financial crisis and the RBI too had proposed this back in 2011 when it released a discussion paper on foreign banks’ presence. The governor has now stepped up his pitch saying if banks convert to a fully owned subsidiary, they will be allowed a lot of freedom and ‘near national treatment’. 

 

“One could even contemplate taking over Indian banks, small Indian banks and so on" Rajan said.  

 

“The attractiveness of the WOS (wholly owned subsidiary model) model is inherently because of the opportunities it provides for growth – either organically or inorganically” says Kumar. “But it comes with its own set of challenges, particularly on capital, costs and governance. Also, a more pragmatic approach is needed on priority sector guidelines and financial inclusion objectives for foreign banks, so that they can align the India priority goals with their internal risk goals. The current regime is very prescriptive and that is a challenge.” 

 

Foreign banks have been loathe to RBI’s revised rules on priority sector lending, which mandates a 40% revised target for those with more than 20 branches. A panel headed by Nachiket Mor is relooking at these rules and experts say the panel’s recommendations will be critical, if foreign banks are to be encouraged to play a larger role. 

 

Experts are also skeptical about Rajan’s statements on reciprocity where he promised near national treatment to foreign banks converting to the WOS model, if the bank’s home country allows the same treatment to Indian banks.

“There are a lot of restrictions to foreign banks being allowed a presence in countries like the US. I doubt whether these countries would be open to it. It won’t be easy” said a banking analyst not wanting to be named. 

 

The devil will lie in the fine print of the policy framework. Will the RBI merely tinker with the existing regime, or will it allow real incentives for foreign banks, to spruce up their presence, remains to be seen. Analysts say, most countries have usually been unconvinced about permitting significant presence of foreign banks, so if the RBI does indeed make a big bang announcement, it will be hotly debated in parliament. 

 

All the same, if Rajan’s statements are followed up with a favourable framework, competition will hot up in the Indian banking space. And that’s always a good thing from the customer’s point of view!