Discussion Paper on Presence of Foreign Banks in India: Emkay

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Banking

Discussion Paper on Presence of Foreign Banks in India

n     Wholly own subsidiary route chosen as way for foreign banks to be present in India. Top five foreign banks like - StanC, Citibank, HSBC, ABN Amro etc. may have to convert into WOS

n     Foreign banks to be treated almost at par with new private banks which could get entry once the new licensing norms are implemented

n     WOS to have same freedom as SCBs for opening branches except from national security areas. WOS need to adhere to PSL norms but agri subtarget at 10%

n     Key negatives for foreign banks - NIMs to compress due to higher PSL requirement, will need to bring in more capital, have to form local management boards

The RBI on Friday, 21 Jan 2011, floated a discussion paper on the mode of

presence of foreign banks in India. In the discussion paper the RBI chose wholly own

subsidiary route as way for foreign banks to be present in India. The RBI cited easing of

resolution process, tighter regulatory control and comfort to host jurisdiction as the

reason for the above stated proposal. Under existing framework foreign banks can

operate in India through only one of the three channels, namely (i) branch/es (ii) a

Wholly owned Subsidiary or (iii) a subsidiary with an aggregate foreign investment up to

a maximum of 74 per cent in a private bank.

Earlier guidelines for foreign banks

The RBI under the “roadmap for presence of foreign banks in India” released in Feb,

2005, permitted foreign banks to establish presence by way of setting up a wholly

owned banking subsidiary (WOS) or conversion of the existing branches into a WOS.

The guidelines covered the eligibility criteria of the applicant foreign banks such as

ownership pattern, financial soundness, supervisory rating and the international ranking.

However none of the foreign bank approached RBI, for setting up a subsidiary, due to

lack of incentives.

Made mandatory to convert into subsidiary mode of presence

As earlier measures failed in the stated objective, the RBI has now proposed some

more incentives for foreign banks to opt for subsidiary form of presence. However the

RBI has mandated the entry for following category of banks in India only by way of

setting up a Wholly Owned Subsidiary (WOS)

§ Banks incorporated in a jurisdiction that has legislation which gives deposits made/ credit

conferred, in that jurisdiction a preferential claim in a winding up.

§ Banks which do not provide adequate disclosure in the home jurisdiction.

§ Banks with complex structures,

§ Banks which are not widely held, and

Moreover if the foreign bank’s become systemically important by virtue of their balance

sheet size. i.e if their total assets reach 0.25% of the total assets of all SCB’s in India,

then also they are mandated to opt for subsidiary mode of presence.

The RBI proposed the following incentives for foreign banks to opt for

subsidiary form of presence

§ They will be allowed to raise rupee resources through issue of non-equity capital instruments

in the form of IPDI, Tier I and Tier II Preference shares and subordinate debt as allowed to

domestic private sector banks.

§ WOS to have same freedom as SCBs for opening branches except from national security

areas as they can now be able to open branches in Tier 3 to 6 centers. Moreover their

application for setting up branches in Tier 1 and Tier 2 centres would also be dealt with in a

manner and on criteria similar to those applied to domestic banks.

§ Proposed to withdraw the current stance of permitting larger number of branches than the

commitment under WTO of 12 branches each year incentivise the foreign banks with branch

mode of presence to move to WOS structure

§ For WOS, by virtue of their local incorporation, would be better placed than the foreign bank

branches operating in India but less then that of domestic banks.

§ The WOS of foreign banks would be treated at par with the new private sector banks in regard

to minimum capital requirement.

Negatives/ Issues in the proposed guidelines for foreign banks

Higher Priority sector lending norms

The foreign banks are required to extend lending to the priority sector (total) to the extent of 40%

(inline with domestic banks) of Adjusted Net Bank Credit (ANBC) or credit equivalent amount of

off-balance sheet exposure, whichever is higher. However their agri exposure would be subtargeted

at 10%.

Higher capital requirement and lesser operational flexibility

A subsidiary model will have lesser operation flexibility and reduced lending capacity as the loan

size limits will be based on subsidiary’s capital and not on parent’s bank capital which is the case

in branch model.

Taxation

Taxation would be a key issue in the proposed framework as transfer of property, goodwill and

other assets of capital nature to newly incorporated subsidiary in India will attract capital gain tax.

Our view

§ The discussion paper if implemented will increase the competition for private sector banks, as

the new proposal treats the foreign banks almost at par with new private banks Hence

negative for HDFC Bank, ICICI Bank, AXIS Bank and Yes Bank

§ The proposal also not only restrict the lending capacity of foreign banks as they no longer will

be able to leverage on their parents large capital base, but also will effct the margins due to

directed lending.

§ Banks like J&K bank and United bank which operate in the security sensitive areas like North

East or J&K may not be impacted at all.