Subsidiary route for foreign bank expansion not perfect: RBI

The Reserve Bank of India (RBI) today said that even though it prefers the subsidiary route for foreign banks doing business in the country, it is not a surefire way to insulate the economy from global shocks, since lenders facing a crisis overseas could very well abandon their Indian concerns.

Addressing the annual Bancon 2010 banking conference here today, RBI Governor Duvvuri Subbarao said the recent crisis has made it amply clear that the subsidiary route for foreign banks doing business in the country was not free of risks, as the overseas parent could expand rapidly in boom periods by cutting into domestic lenders' margins and then pull out in a time of crisis.

"Post-crisis, we know that mandatory subsidiarisation is not a surefire method of protecting domestic interests, since foreign banks facing a crisis at home could very well abandon their subsidiaries. A good illustration of this tendency is what we saw happen in the EU in the wake of the sovereign debt crisis.

"It was only after very concerted efforts that the EU could pressurise or persuade foreign banks to maintain support to their EU subsidiaries. Even so, credit supply was seriously impaired," the Governor told bankers in his keynote address at the conference this morning.

Even though the RBI is in favour of the subsidiarisation route for foreign bank expansion -- as opposed to the branch mode -- when it issues more bank licences, as announced in the Budget this year, overseas lenders have complained that they either need to be incentivised or provided a level playing field for this model to be viable.

Admitting that local incorporation of foreign banks involves substantial costs, the governor said, "A possible downside risk of subsidiarisaton route is that foreign banks will dominate the domestic banking system. This could have systemic implications during normal times, which would amplify in times of crisis."

He said that many countries where foreign banks have a dominant presence witnessed aggressive expansion in boom times, but equally vigorous retrenchment in crisis situations, which has been the experience in varying degrees of all emerging economies, including India, where foreign banks are presently permitted to operate only in the branch mode.