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Home» Opinion» Economy» Rbi googly to foreign banks

RBI’s googly to foreign banks

Virendra Parekh | December 06, 2013, 02:04 PM IST
rbi googly to foreign banks

Mumbai : “For foreign banks, the opportunity is theirs to choose. For the economy, there are large potential benefits with virtually no downside.”

Even as Sachin Tendulkar was preparing to play his last Test, the RBI Governor Dr. Raghu Ram Rajan bowled a googly to foreign banks. He offered to let them compete on a nearly equal footing with domestic banks, provided they set up wholly-owned subsidiaries (WOSes) in India. In its recent guidelines, the RBI said WOSes of foreign banks could acquire domestic private-sector banks, as well as set up branches anywhere in the country.

Unlike Tendulkar, however, the foreign banks have not come out on the front foot. They are studying the guidelines before making up their minds. And for good reasons.

Currently, foreign banks operate in India solely through branches of their parents incorporated in abroad. This has given these banks greater freedom in disclosure requirements or usage of funds — even to the extent of privileging home country depositors in any settlement claims — it has severely constricted their growth. The 334 branches of 43 international banks now account for just 3.9 per cent of the total deposits and 5.8 of outstanding advances and investments of all scheduled commercial banks in India.

It has been a long-standing position of the central bank that the wholly owned subsidiary mode is preferable. Branches of foreign banks are not separate legal entities. Local incorporation makes their asset and liability base easier to assess and gives them their own board of directors. More importantly, this model brings foreign banks under the firm regulatory control of the RBI and leaves no doubt as to the legal jurisdiction appropriate to them.

However, in the absence of clear incentives for subsidiaries, foreign banks logically preferred the branch mode. But now the RBI has clarified the exact nature of the benefits that banks operating through the latter route would be entitled to.

A wholly owned subsidiary of a foreign bank will have two operational advantages: ability to acquire domestic private sector banks and greater freedom to open new branches, subject to the same requirements as domestic banks. It can also be listed on local stock exchanges.

The WOSes would be permitted to enter into merger & acquisition (M&A) transactions with any private bank in India, subject to the overall foreign investment limit of 74 per cent. At present, a foreign bank cannot acquire a domestic bank. Also, while foreign investors can hold up to 74 per cent in an Indian private bank, no single entity is allowed to own more than five per cent stake in a local lender. In fact, the regulator had forced HSBC, which had picked up a 14.71 per cent stake in UTI Bank (now Axis Bank) to reduce its stake.

Moreover, foreign banks which convert to the WOS model would have easier conditions for opening new branches. Currently, foreign banks need RBI’s permission to open branches in the country. According to its commitments to the World Trade Organization, the central bank is required to allow only 12 new foreign bank branches in a year. However, a wholly owned subsidiary of a foreign bank would be permitted to open branches in Tier 1 to 6 centres (except at certain sensitive locations) without having the need to take prior permission from RBI in each case. This freedom could see an exponential rise in the presence of foreign banks.

On the flip side, WOSes will have to comply with priority sector lending norms at par with domestic banks: 40 per cent of net adjusted bank credit (of the previous year). However, they will be given adequate transition period.

The banking regulator has also laid down stringent corporate governance norms for these entities. The new rules require separate boards of directors for each subsidiary. Two-thirds of the directors must not be executives of the bank, at least a third of them should be independent of the management of the subsidiary in India, its parent or associates and at least half of them must be Indian citizens.

There is a caveat. Restrictions will be placed on entry of new WOSes and capital infusion if and when capital & reserves of WOSes and foreign bank branches exceed 20 per cent of the banking system’s capital & reserves. This is unlikely to happen anytime soon, since the proportion has been stagnant around 6-7 per cent for many years.

There is no compulsion. Foreign banks which came to India before August 2010 could choose between the branch model and the WOS model. However, those that came after August 2010 are mandated to convert to the WOS model, if they have complex structures, do not provide adequate disclosure in their home jurisdiction, are not widely held, belong to jurisdictions having legislation giving a preferential claim to depositors of home country in a winding up proceeding. About 10 banks have come to India after August 2010. These include Japan’s Sumitomo Mitsui Banking Corporation, South Korea’s Woori Bank and Sberbank which is Russia’s largest commercial bank.

Apparently, what constitutes a complex structure is at the RBI’s discretion. Experts say reciprocity is one of the key criteria that RBI would be using to vet applications for WOS. Foreign banks in India will be treated in a similar manner as to which Indian banks are treated in their home countries.

The guidelines have received cautious welcome from foreign banks. Most of them have said they need clarification on some important issues before taking a decision. Some of them are disappointed that their request for dual licensing (to have both branches and subsidiary) has not been heeded.

The key question, left unaddressed by the guidelines, pertains to the tax implications: capital gains tax and stamp duty. Once the assets of the branches are shifted to a wholly owned subsidiary, the value of the assets may be higher than when it was put in the branch. Therefore, such gains are taxed.

Now, the RBI does not have the authority to offer tax incentives to foreign banks for creating subsidiaries. A year ago, the finance ministry had agreed to offer tax neutrality for subsidiarisation of foreign banks, but lenders had also demanded tax deduction for the cost incurred on conversion, as well as relief from payment of stamp duty. So far, there is no clarity on whether the government will agree to these demands.

How effective the incentives for subsidiarisation are going to be is an open question. Greater freedom to open branches, for instance, will be tempting only if foreign banks aim to expand in the retail segment. Currently, foreign banks like HSBC and Citibank seem more invested in trade and corporate finance. They may not regard liberal branch expansion rules as a game changer for them.

As regards takeover of domestic private sector banks, the WOS will have to meet all criteria including priority sector lending and prove their credentials before the central bank allows them to take the merger and acquisition route. Moreover, the sort of banks that are available as targets are very specialist, very intense in terms of their regionalisation. Foreigner banks may be cautious in taking them over.

However, banks that decide to take the plunge will have a significant first-mover advantage as they zero in on the best acquisitions. Others may decide to stay out and remain in the niches that they currently occupy. The opportunity is there, the choice is entirely theirs, and from the economy's perspective, there are large potential benefits with virtually no downside.

 

To read in Gujarati, Click here...


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Virendra Parekh

Virendra Parekh

Virendra Parekh is Executive Editor of Business fortnightly Corporate India , published from Mumbai.

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