Column: Banking on India

Written by Madan Sabnavis | Updated: Nov 9 2013, 07:19am hrs
What could be the response of foreign banks to the new set of RBI guidelines which gives them greater scope for expansion if they convert their Indian operations into subsidiaries This follows up on the guidelines released by RBI earlier and seeks to provide some momentum to India's expanding banking sector in the manner that was followed for private banks. While offering sops like greater number of branches, the guidelines include several caveats to buffer the system against any risk that could emerge from the opening up of the sector as well as eschew domination by foreign banks.

It is necessary to evaluate and grasp the importance of these banks for our financial set-up. Foreign banks were considered models to be emulated when we went in for liberalisation in the nineties which led to the creation of new private banksIndian private banks, in a way, were much like the one abroad, bringing in all the goodies offered to the masses. This was in the form of more products and technology which helped to unleash competition. As on March 31, 2013, there were 43 foreign banks with 334 branches in a total of 92,114 in the sector. Their share in the net worth of the banking sector was 15.3% while it was 2.3% for employment. Quite clearly, these are technology-driven banks with deep pockets that rely less on headcount. However, they are better pay masters with the staff cost being 18.2% of the total expenditure as against the 13.0% average for the entire sector.

In terms of business, they accounted for 3.9% of deposits, 4.5% of credit and 8.7% of investment, which is not bad given their number. In terms of operations, they do better than the rest of the sector primarily because their perimeter of operations is limited. Their cost of funds is lower at 4.05% as against 6.12% for the sector, while the return above the cost of funds is higher at 5.50% (4.21% for the sector). The return on assets was higher at 1.94% (1.03%) and their net NPAs were lower at 1.01% (1.68%). Quite clearly, in case these became benchmarks that are emulated, the sector would be healthier provided this

is scalable.

What could be the level of interest of these banks in becoming subsidiaries Looking at this list of 43 banks, there are only 6 which are significant players. Out of them 2 have over 50 branches, 2 around 40, and the remaining 2, between 10-20 branches. These 6 banks accounted for 81% of deposits of foreign banks and 75% of credit. Quite clearly, there will be limited interest for the remaining 37 banks in this new deal unless they fall in the mandatory category which was set up after August 2010. Also if these six banks were to become wholly-owned subsidiaries (WoS), they need not bring in more capital to begin with as their new worth is already above R500 crore (only one bank has equity of less than R500 crore).

The basic issue is whether these banks are really seeing a viable business model in expanding into non-metros/large urban centres. There are arguments on both sides. While the present set-up has worked in terms of maintaining the market shares over the years, the model will not help scale up the business in any big way unless there is movement to the relatively lesser banked areas. On the other hand, becoming a WoS and getting national-level status will provide access in terms of geography but the contingent obligations of priority-sector lending and opening of branches in unbanked Tier-5 and -6 cities would be a consideration that will come in the way. Here, RBI is insisting on brick and mortar branches rather than access through the internet.

At the operational level, these banks have not had any experience in this segment on account of the branch expansion restrictions. Hence, getting into rural banking will mean setting up a new establishment in terms of hiring laterally to get the right people to create business. Even today, on the account of perceived entry-barriers into these branches, the masses are not on their network in urban centres. Now, getting into the rural areas would necessarily mean a change in approach which will also increase the costs as all such inclusive banking means keeping accounts that hold low-level deposits. Therefore, it will really be an individual call for a foreign bank to take on how much it would like to compromise depending on how important India would be in its global plans.

However, it does look like that if foreign banks prefer the WoS route and enter in big numbers, the gains for the country would be more than that would probably be for the banks themselves as they have to give themselves several years before breaking-even in these territories. RBI has put up a fence around possible foreign domination of the sector by fixing the point of no-further-entry for foreign banks at the point when their net-worth reaches 20% of total. It is already around 15% today.

Two interesting clauses are in respect of ownership issues. They could get listed within the FDI limits or even look at M&A activity. The first step would help in pushing up valuation as these banks are certainly more profitable as a group which will command value on the bourses. The other step would be a way out in adhering to the norms laid down by RBI with respect to number of branches and priority-sector lending. RBI will have to spell out its policy on this aspect more clearly because the decision of a foreign bank to become a WoS would make more sense if there could be an acquisition as part of the deal.

The new policy on foreign banks is hence progressive considering our own tryst with deeper financial liberalisation, though the individual banks will have to take a call on whether they would really like to get their fingers wet. It would depend on the time horizon that they are working with, and plain vanilla entry, prima facie, does not really look appealing. It is unlikely that more than a couple of the large banks would find the terms attractive as the latter stand at the moment. Add listing prospects or M & A options, spelled out clearly by RBI, and the possibilities multiply and look much better.

The author is chief economist, CARE Ratings. Views are personal.