The governor of the Reserve Bank of India (RBI), Raghuram Rajan, stirred a debate when he announced, during a recent visit to the U.S., that the RBI might finally allow foreign banks to take over Indian banks. It was, in his words (and as reported by the Press Trust of India), “…going to be a big, big opening because one could even contemplate taking over Indian banks, small Indian banks and so on.”
Foreign banks have been demanding for many years that they be allowed to acquire Indian banks. Many visiting ministers and politicians from several countries have persistently lobbied with the Indian government and the RBI, without much success. In December 2003, HSBC did acquire a stake in one of the new private banks – UTI Bank, later renamed Axis Bank – but the RBI asked it to stay away.
Rajan’s invitation should therefore be welcomed by foreign banks. However, not many foreign banks may be queuing up anytime soon, given not only the existing policy environment but also because the reasons for the governor’s offer may actually be beyond the realm of business logic.
But Rajan’s statement has given a fresh impetus to the continuing debate on the status of foreign banks. It is thus important to examine the conditions prompting his new position, as well as weigh that articulation against the existing policy landscape.
The first vector influencing Rajan’s Washington proclamation seems to be the surprise sprung on Indian policy-makers by three foreign banks. Goldman Sachs, Morgan Stanley, and UBS AG surrendered their banking licences earlier this year. Banking licences are highly coveted, so the decision by these institutions seemed to be counter-intuitive. It raised questions about India’s banking model and whether the playing field had got so unviable that it even justified surrendering banking licences, with the full knowledge that it might be difficult to obtain another one at a later date.
It could well be that the banks chose to opt out because their parent institutions are facing a capital famine. But, at a time when the country is battling perceptions about corruption, mounting bureaucratic hurdles, a difficult business environment, and a slowing economy, the news of these banks expressing no-confidence in the Indian banking system has further reinforced prevailing impressions.
It did not help matters when some Indian finance companies withdrew their applications for a banking licence – indicating that they no longer find the licence attractive. Mahindra Finance did this in June 2013. Tata Sons did the same, though it withdrew subsequent to Rajan’s Washington visit and without mentioning any external reasons for the decision. To that extent, the RBI governor’s statement seems designed to instil confidence among foreign investors.
The three heavyweights apparently stepped out because of India’s onerous banking model, which docks around 27% of a bank’s lendable resources through mandatory reserve requirements, and forces banks to give a percentage of their loans to specific sectors, such as agriculture. It may be argued that these three banks knew what they were getting into: these regulations have been around for many years. However, what seems to be changing is the shape of the playing field.
This brings us to the second point. The RBI has been examining the prospects of converting the status of foreign banks in India. Currently, all foreign banks legally operate in India as “branches” of their parent banks. This became necessary when the RBI felt that if a foreign bank failed in India, the branch status would make it legally contingent on the parent bank to compensate for any losses.
In the aftermath of the 2008 financial crisis, however, the parents themselves had to scrounge around for capital to survive the meltdown. Therefore, the central bank felt that it made sense to convert foreign banks in India to wholly-owned subsidiaries, so that the bank’s local capital (provided originally by the parent) could be ring-fenced during a financial emergency.
It is not known if this impending shift influenced the exits. What is definitely known is that the status conversion does change playing conditions. The policy unequivocally spells out that foreign banks starting operations after August 2010 (and meeting some other conditions) have to convert to wholly-owned subsidiaries which would invariably involve a higher capital commitment (Rs. 500 crores versus $25 million under the current dispensation, or Rs. 153 crores as per the RBI’s reference rate on December 11), and allocation of a larger percentage of funds for directed lending (40% compared to 32% now), among other measures. [1, 2]
In return, they would get “near-equal” treatment with Indian banks or the same freedom in opening branches. Currently, the branch expansion of foreign banks is circumscribed to the extent of India’s multilateral and bilateral agreements. Converting to a wholly-owned subsidiary will give foreign banks a modicum of freedom. But, on the other hand, it will also make it mandatory for them to open 25% of their branches in un-banked rural areas.
This leads us to the third issue: a small proviso in the governor’s message. His open-door announcement included the condition of reciprocity. Rajan said that foreign banks would be welcome, provided their home countries also accorded Indian banks a similar status. This is a potential deal-breaker. Indian central bank governors have repeatedly made the point that the RBI’s policies for foreign banks are not only compliant with India’s World Trade Organisation commitments, but also far more generous than the policies of other countries when seen through the lens of reciprocity. [3]
The RBI’s annual Report on Trend and Progress of Banking in India for 2012-13 states: “As at end-March 2013, there were 43 foreign banks operating in India with 331 branches. As against this, there were 24 Indian banks with 171 branches abroad.” However, the argument of reciprocity is not transparent because few details are available in the public domain about the mechanics of such a give-and-take policy.
Beyond these three arguments exists a fourth undercurrent, which perhaps is a better key to decoding the governor’s message. When Rajan made his statement in Washington D.C. on October 13, he was part of a delegation accompanying Indian Finance Minister P. Chidambaram to the annual International Monetary Fund-World Bank meetings. This delegation’s visit to Washington was preceded by Prime Minister Manmohan Singh’s trip. The prime minister met U.S. President Barack Obama on September 27 and the two reportedly discussed a host of issues – including India’s foreign investment climate – amid mounting apprehensions of a chill in trade and diplomatic relations.
Two weeks later, as part of his itinerary, Chidambaram met U.S. Treasury Secretary Jacob Lew on October 13 for the fourth annual meeting of the India-U.S. Economic and Financial Partnership. A joint statement said: “We discussed the importance of investment for driving economic growth and job creation in our economies and ways to improve our enabling environments to mobilize investment, especially for the financing of infrastructure. We noted that President Obama and Prime Minister Singh have reaffirmed their commitment to concluding a high-standard Bilateral Investment Treaty that will foster openness to investment, transparency, and predictability, and thereby support economic growth and job creation in both countries.” [4]
Clearly, Rajan’s declaration on the same day looks like an attempt to talk up the policy environment and alter existing perceptions. So will the foreign banks accept the RBI’s invitation? None of them has as yet, and going by press reports, they are likely to wait for some clarity about the next government at the centre before making any moves.
Rajrishi Singhal is Senior Geoeconomics Fellow, Gateway House: Indian Council on Global Relations.
This article was exclusively written for Gateway House: Indian Council on Global Relations. You can read more exclusive content here.
For interview requests with the author, or for permission to republish, please contact outreach@gatewayhouse.in.
© Copyright 2013 Gateway House: Indian Council on Global Relations. All rights reserved. Any unauthorized copying or reproduction is strictly prohibited
References:
[1] Reserve Bank of India, (2013). Scheme for setting up of Wholly Owned Subsidiaries (WOS) by foreign banks in India. Retrieved from Reserve Bank of India website: http://www.rbi.org.in/Scripts/bs_viewcontent.aspx?Id=2758
[2] Reserve Bank of India, (2011). Discussion paper- Presence of foreign banks in India. Retrieved from Reserve Bank of India website: http://www.rbi.org.in/Scripts/bs_viewcontent.aspx?Id=2313
[3] Bank for International Settlements, (2007). V Leeladhar: The evolution of banking regulation in India – a retrospect on some aspects (BIS Review 137/2007). Retrieved from Bank for International Settlements website: http://www.bis.org/review/r071127d.pdf?frames=0
[4] U.S. Department of State, Bureau of International Information Programs (IIP). (2013). U.S.-India economic and financial partnership joint statement. Retrieved from U.S. Department of State website: http://iipdigital.usembassy.gov/st/english/texttrans/2013/10/20131013284701.html