The more the merrier

RBI opens up to wholly owned subsidiaries of foreign banks

The Reserve Bank of India (RBI) has announced a significant set of measures to open up the domestic market to foreign banks. While the differentiation between the branch and the wholly owned subsidiary modes of operation was always on the cards, the RBI has now clarified the exact nature of the benefits that banks operating through the latter route would be entitled to. It has been a long-standing position of the central bank that the wholly owned subsidiary mode is preferable, since it induces the foreign bank to maintain a domestic balance sheet and, importantly, a governance framework. In the absence of clear incentives for subsidiaries, foreign banks logically prefer the branch mode; but now, those who see India as a long-term growth opportunity have the basis for deciding between the two modes.

The two main operational advantages that a wholly owned subsidiary will now have are the increased freedom to open new branches, subject to the same requirements as domestic banks, and the ability to acquire domestic private banks. There are a number of wholly owned subsidiaries with reasonably sized branch networks, though these tend to be regionally concentrated. For an ambitious foreign bank, two or more regional acquisitions, along with a branch expansion strategy, will allow it to leapfrog into a functional national network. This approach will also enable it to deal with the one significant mandate that a new wholly owned subsidiary will have to deliver on: priority sector lending obligations on a par with domestic banks, currently set at 40 per cent. The other requirements, which may cause at least some foreign banks to think carefully about the transition, are the norms for governance; a minimum number of directors have to be Indian nationals as well as independent of the parent bank. While the parent bank will have to bring in the initial capital, they will be allowed to list the local entity on stock exchanges, should they choose to.

Overall, these are welcome measures and bring a reasonable degree of both concreteness and practicality to the environment within which foreign banks have to operate. The clear message is that if a bank wants to take advantage of the long-term opportunity, it has to reciprocate with appropriate commitments. From the financial development perspective, since the strategy itself is based on the premise of inadequate penetration, along with new domestic entrants into the market, it makes eminent sense for foreign banks to be given comparable space. More players mean more strategies being tested and, even though many will fail, a few successful ones can make an enormous difference to the spread, efficiency and quality of banking services. To the possible criticism that the combination of requirements is too onerous, which is most likely to come from the foreign banks themselves, the appropriate response is that only time will tell. For banks that decide to take the plunge, there will be a significant first-mover advantage as they zero in on the best acquisitions to complement their organic growth strategies. For those that decide to stay out, the niches that they currently occupy - particularly in terms of their global client relationships - will remain. The opportunity is there, the choice is entirely theirs, and from the economy's perspective, there are large potential benefits with virtually no downside.