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Welcome foreign banks!

Mar 2, 2005

The much-debated issue of 'laying the red carpet' for foreign banks seems to have finally been sorted, with the Reserve Bank of India (RBI) laying down the roadmap for the entry of the foreign entities into the country. It may be recalled that the Government of India had, in March 2004, revised the aggregate foreign investment in private banks to a maximum of 74% of the paid up capital of the bank, while the resident Indian holding of the capital was to be at least 26%. It was also provided that foreign banks may operate in India through only one of the following three channels:

  • branches

  • a wholly owned subsidiary (WOS) or

  • a subsidiary with maximum foreign investment of 74% in a private bank.

But now, the RBI has gone a step ahead and given a clear roadmap for foreign participants in the Indian banking sector. The roadmap to operationalise the above guideline is divided into two phases.

Phase I: March 2005 to March 2009

New banks - First time presence

Foreign banks wishing to establish presence in India for the first time could either choose to operate through branch presence or set up a 100% wholly owned subsidiary. Also, entities applying to the RBI for setting up a WOS in India, must satisfy the RBI that they have the permission of their respective home country regulator and are subject to adequate prudential supervision in their home country (as per Basel standards). Some of the other factors to be considered for setting up a WOS are:

  • Economic and political relations between India and the country of incorporation of the foreign bank

  • Financial soundness, international and home country ranking of the foreign bank

  • Minimum start up capital of Rs 3 bn and capital adequacy ratio of 10%

Existing banks - Branch expansion policy

For the existing foreign banks, the limitation of setting up a maximum of 12 branches per year (as per WTO commitment) is to be relaxed and a more liberal policy for under banked areas will be adopted. Branch licensing procedure will, however, continue as per the current practice.

Conversion of existing branches to wholly owned subsidiaries

Permission for conversion of existing branches of a foreign bank into a WOS will be guided by the manner in which the affairs of the branches of the bank are conducted, compliance with the statutory requirements and the over all supervisory comfort of RBI. Also, for reckoning the minimum net worth (Rs 3 bn), the local available capital including the remittable surplus retained in India will qualify.

Acquisition of shareholding in select Indian private sector banks

In order to allow Indian banks sufficient time to prepare themselves for global competition, initially entry of foreign banks will be permitted only in the private sector banks that are identified by the RBI for restructuring. In such banks, foreign banks would be allowed to acquire a controlling stake in a phased manner. RBI will consider the application for acquisition of 5% or more stake in a foreign bank depending upon the reputation of the foreign bank, its desired level of presence in the country and the interest of the shareholders of the investee bank. RBI may also specify, if necessary, that the investor bank shall make a minimum acquisition of 15% or more and the period of time for such acquisition. The overall limit of 74% will continue to be applicable.

Phase II: April 2009 onwards

According 'full national treatment' to wholly owned subsidiaries of foreign banks

In the second phase, the removal of limitations on the operations of the WOS and treating them on par with domestic banks to the extent appropriate will be designed and implemented after reviewing the success of Phase I.

Dilution of stake in wholly owned subsidiaries

The WOS of foreign banks on completion of a minimum prescribed period of operation will be allowed to list and dilute their stake (by way of IPO or offer for sale) so that at least 26% of the paid up capital of the subsidiary is held by resident Indians.

Merger and acquisition of any private sector bank in India

After a review is made with regard to the extent of penetration of foreign banks in India and their functioning, foreign banks may be permitted, to enter into merger and acquisition transactions with any private sector bank in India subject to the overall investment limit of 74%.

Our view

The four year plan (2005-09) for the penetration of foreign banks on the Indian soil, although sounds enthusing, calls for concern when read between the lines. While PSU banks continue to be cushioned from competition, the private banks seem to be the 'likely victims' of the same. The well-heeled private sector entities, while on one hand are being deprived of foreign equity, will also feel the heat of the financial muscle of foreign entities taking stake in their weaker counterparts. The success of phase I, will thus, not only depend on how far the 'foreign presence' will revive the weaker private banks, but also how far the domestic private banking entities are able to counter competition. Phase II, needless to say, will take shape depending on the success of phase I. What therefore needs to be watched out is whether the foreign entities begin to feel 'unwelcome' at the turn of events!

However, all said and done, atleast there is some forward movement to banking consolidation and reforms.


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