RBI has, through the recently announced wholly-owned subsidiary (WoS) guidelines, provided a framework for foreign banks to scale up their presence in India by converting their existing branches into wholly-owned subsidiaries. RBI has offered banks established before 2010 (subject to certain conditions) a choice between converting to a subsidiary or to continue operating as a branch. As such, it has allowed foreign banks to take a decision based on their overall business plans as well as their strategy with respect to India rather than mandating foreign banks to opt for subsidiarisation as is the case with certain regulators across Asia.
Current scenario
All the 43 foreign banks present in India operate as a branch of the parent bank. The branch mode is preferred by foreign banks given the greater flexibility afforded by the model with respect to capitalisation requirements and priority-sector lending targets despite there being restrictions on opening of branches.
Some foreign banks have a long history in India but their reach as a group is negligible with less than 0.5% market share in branches. This is mainly due to the fact that foreign banks have received very few new branch licenses given that RBI is obligated under WTO commitment to issue only 12 branch licenses per year, as the accompanying chart highlights.
In terms of business contribution, the foreign banks? market share is less than 5% of the total banking system’s advances and deposits. However, in terms of profitability, they fare much better, accounting for around 13% of the banking system’s net income.
New guidelines
The WoS guidelines facilitate the foreign banks in expanding their reach through liberal branch licensing norms, which are very similar to those applicable to domestic banks. Foreign banks, as such, have a strong motivation to expand their retail branch network as well as build-up a low cost savings deposit franchise should they have an embedded India strategy.
The foreign bank subsidiaries will also be allowed to acquire Indian private banks in due course giving a push to merger and acquisition prospects in the banking sector and enabling certain private sector banks (particularly, old private sector banks) to benefit from the high operating standards of a foreign banking partner. Also, the foreign banks stand to reap the brand loyalty associated with these banks in their regions. But, they will need to specifically make sure that the old banks? cultures are retained.
The foreign banks will be allowed to dilute their stake in Indian subsidiaries through domestic listing enabling these banks to tap local markets to meet the more stringent capital requirements as well as establish a strong foothold in Indian markets. They can also benefit from a lower corporate tax rate of 33% on a domestic subsidiary, compared to the 40% they pay on a branch.
Other considerations
RBI?s main purpose for incentivising the conversion of foreign bank branches into subsidiaries seems to be ring fencing the Indian operations of the parent in case of crises, and protecting the interest of the local depositers by ensuring adequate capitalisation and liquidity.
As foreign banks expand their presence in India, there would be increased competition for local banks. However, RBI has made sure that the foreign banks do not dominate the Indian banking sector by restricting entry of new foreign bank subsidiaries beyond 20% of the total capital and reserves of the banking system. For those foreign banks opting for the branch mode, RBI would deny new licenses when market share in assets (including off-balance sheet exposure) exceeds 15% of the banking system assets. This makes it imperative for foreign banks who wish to have an embedded India presence to firm up their plans at the earliest.
Also, RBI has ensured that the foreign bank subsidiaries would be more accountable with better corporate governance standards in the local unit by requiring more independent directors and Indian nationals on their boards. Other impositions include stricter capitalisation requirement of 10% (100 bps over that for the domestic banks) and a higher priority-sector lending requirement of 40% (with some transition period). A letter of comfort from the parent bank would also be required to ensure that the liabilities of the subsidiary are met.
Eleven foreign banks have commenced operations in India after 2010. These eleven banks are mandated to adopt the subsidiary model once their local operations become systemically significant (0.25% of the total banking system assets). Of these banks, four are Australian banks. The Australian regulator has mandated that Australian depositors have a priority claim instead of just relying on deposit insurance as is the case in other jurisdictions.
While such is the case with most new announcements, a lot of clarifications regarding eligibility and future operations will be required. The fact that RBI has been a facilitator of business rather than an imposer of regulation has clearly been established. It is up to foreign banks now to decide on their India strategy and plan. The fact that the share of foreign banks in the Indian banking sector is on the rise is a reality. The hope is that the ultimate beneficiary is the user of banking services who will benefit from extended reach and high quality service over time.
Abizer Diwanji
The author is partner and national leader, Financial Services, Ernst and Young India. Views are personal