R Gandhi: Structure of foreign banks for emerging nations - Indian case
Keynote speech by Mr R Gandhi, Deputy Governor of the Reserve Bank of India, at the
ASIFMA (Asia Securities Industry and Financial Markets) Annual Conference 2014
"Developing Asia's Capital Market", Singapore, 6 November 2014.
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Assistance provided by Shri S. Venkata Raman is gratefully acknowledged.
Ladies and Gentlemen!
1. It is a pleasure and privilege to be among the banking and finance industry
participants and fellow regulators in this ASIFMA Annual Conference on Developing Asia's
Capital Market. The theme of the Conference is very contemporary. Though the theme
relates to Capital Market, I also find that you had included credit and banking in the
discussions. And I find that one of the panel sessions was specific to India, besides many
other sessions which also have direct relevance to the Indian context. That panel discussed
opening up Indian capital market. I intend to talk about opening up foreign banking in India.
2. The foreign banks play a transformational role in influencing the host country
economies. On the one hand they act as a key vehicle in channelizing foreign investments;
on the other hand they bring in efficiencies and boost competitive spirit amongst the financial
sector entities, thereby, raising the efficiency bar of the domestic players. Structure of foreign
banks in a geography, which is a sub-set of banking structure, will be influenced by the
desirable form of financial architecture in an economy. The extent to which foreign banks are
allowed to play a role in the domestic sector depends upon the unique market needs of each
economy. The important consideration will be the confidence of the host regulator to maintain
resilience in the wake of destabilizing cross border capital flows. In the process, it always
remains a challenge to marry the expectations of international banks entering into a
developing economy and the expectations of the host country authorities on the role of and
deliverables from the foreign banks, while maintaining financial resilience. To an extent, this
challenge could be partly met by the authorities by devising an appropriate structure for
foreign banks and review the same at each stage of economic development to ensure that
opportunities are not lost for either side. Equally important is to put in place appropriate
policy responses to insulate the domestic economy from destabilizing capital flows.
3. India has a real long history of banking. According to the Indian Central Banking
Enquiry Committee (1931), money lending activity in India could be traced back to the Vedic
period, i.e., 2000 to 1400 BC. The existence of professional banking in India could be traced
to the 500 BC. Kautilya's Arthashastra, dating back to 400 BC contained references to
creditors, lenders and lending rates. After the independence of the country in 1947, keeping
in tune with the then economic policy, banking sector was highly regulated. In the aftermath
of a balance of payment crisis situation in 1991 and with the advent of economic reforms
India embarked upon financial sector liberalization in a phased manner. Banking industry
was deregulated by way of allowing entry of new private sector banks; ten new private Indian
banks were set up in 1993, followed by two banks in 2003. Other notable features towards
deregulation of banking sector included allowing 74% foreign investment in private sector
banks, doing away with licensing of branches of domestic scheduled commercial banks in a
phased manner, deregulation of interest rates, widening and deepening of financial markets,
etc.
4. Indian banking sector comprises of different types of institutions to cater to the
divergent banking needs of various sectors of the economy. There are typical commercial
banks which operate on all India basis. There are government owned banks, privately owned
banks and foreign owned banks. There are also small banks with limited areas of operation.
Credit cooperatives were created to cater to the credit, processing and marketing needs of
small and marginal farmers organised on cooperative lines. Cooperatives expanded also in
urban and semi-urban areas in the form of urban cooperative banks to meet the banking and
credit requirements of people with smaller means. Regional Rural Banks were created to
bring together the positive features of credit cooperatives and commercial banks and
specifically address credit needs of backward sections in rural areas. Further, there was an
experiment of establishing Local Area Banks, albeit on a smaller scale, to bridge the gap in
credit availability and strengthen the institutional credit framework in the rural and semi-urban
areas. Notwithstanding the development of various types of banks, Indian banking sector is
yet to meet the desired banking penetration and inclusion as witnessed in most advanced
and some of the emerging economies.
5. A cross-country comparison using the World Bank Financial Sector Database with
several other economies, which have bank-dominated financial systems, reveals that
banking sector in India is yet to match the size and outreach of the banking sector as
prevailing in various other comparable economies. According to this World Bank report,1
India has around 11 ATMs and nearly 11 bank branches per 100,000 people as compared to
119 and 47 in Brazil; 182 and 38 in Russia; 38 and 8 in China; 60 and 10 in South Africa; 58
and 10 in Singapore; 124 and 24 in UK as against the world average of 34 ATMs and
12 branches per 100,000 people. But by other matrices such as ATMs/GDP, we are probably
better.
6. Structural changes in the banking sector have been periodically examined by
various expert committees in India. The committees favoured consolidation in the Indian
banking structure to create well-capitalised, automated and technology-oriented banks
through mergers and acquisitions; fostering competition in the banking structure through
permitting more private sector banks; setting up of small banks with local character to cater
to the requirements of rural and unorganised sectors; more active foreign banks participation;
strengthening of the existing structure through enhancing appropriate risk management
capabilities; and putting in place legal, insurance, resolution and prudential measures to
enable the banking structure to discharge its core functions in an efficient and inclusive
manner.
7. In India, the universal banking model is followed. As regards the structure of
universal banks, the conglomerate structure is bank-led, i.e., banks themselves are holding
companies which operate certain businesses through Subsidiaries, Joint Ventures and
Affiliates. The general principle in this regard is that para-banking activities, such as credit
cards, primary dealer, leasing, hire purchase, factoring etc., can be conducted either inside
the bank departmentally or outside the bank through subsidiary/ joint venture /associate.
Activities such as insurance, stock broking, asset management, asset reconstruction, venture
capital funding and infrastructure financing can be undertaken only outside the bank. Lending
activities must be conducted from inside the bank. Investment banking services are provided
by the banks as an in-house departmental activity or through subsidiary. However, limits on
equity investments, by a bank in a subsidiary company, or a financial services company
including financial institutions, stock and other exchanges, depositories, etc., which is not a
subsidiary restrict expansion of investment banking services and insurance business by the
universal banks. Consequently, India does not have large investment banking and insurance
activity within the banking groups.
8. Some countries have a differentiated bank licensing regime where differentiated
licenses are issued specifically outlining the activities that the licensed entity can undertake.
The criterion for differentiation for the purposes of issuing differentiated licenses could be on
account of capital conditions, as is practiced in Indonesia or to the activity as is the case in
Australia, Singapore and Hong Kong.
9. With the broadening and deepening of financial sector, a need is felt that banks
move from the situation where all banks provide all the services to a situation where banks
find their specific realm and mainly provide services in their chosen areas. As the economy
grows and becomes more integrated with the global economy, need would be felt for
sophisticated financial services and products which will require the presence of different
types of banks. Accordingly, differentiated banks serving niche interests are also
contemplated for India.
10. Much of the Indian population is still outside the purview of formal financial sector
and there is need to spruce up the institutional mechanism in this regard. Reserve Bank had,
accordingly, issued draft guidelines on small banks and payment banks in June 2014. Both,
payments banks and small banks are "niche" or "differentiated" banks; with the common
objective of furthering financial inclusion. While small banks will provide a whole suite of
basic banking products, such as, deposits and supply of credit, but in limited size, payments
banks will provide limited range of products, such as, acceptance of demand deposits and
remittances of funds, but will have a widespread network of access points particularly in
remote areas, either through their own branch network or through Business Correspondents
or through networks provided by others. The final guidelines on small and payment banks will
be released shortly.
11. The presence of foreign banks in India is seen to be one of the drivers to increase
competition, promote efficiency of the local banking system and also for bringing in
sophisticated financial services and risk management methodologies which can be adopted
by the domestic banks. Based on cross-country experience, some of the main drivers of
foreign banks would be the desire of banks to follow their home customers abroad,
opportunities in the host countries, the attractiveness of local profit, the absence or
elimination of barriers to foreign bank entry etc.
12. The share of foreign banks in total assets of the banking sector in India is 6.5 per
cent. The operations of foreign banks are skewed and mainly concentrated in urban and
metropolitan areas. Out of the total of 318 foreign bank branches, 315 are in urban and
metropolitan areas. Foreign banks account for less than one per cent of total branches of
commercial banks in India.
13. Currently, foreign banks presence in India is in the form of branches or
representative offices. For the branch form, Reserve Bank of India issues a single class of
banking licence for conducting all type of banking business, ranging from retail, wholesale,
forex and derivative products, credit cards, etc. There is no restriction as to the type of
business to be conducted through branches unlike in some other countries where restrictions
are placed on acceptance of retail deposits, conducting business in local currency, types of
clientele, region, availability of deposit insurance, access to clearing and settlement systems
etc. As on October 31, 2014, there are 44 foreign banks in India operating through a network
of 318 branches. Also, 45 foreign banks have presence in India in the form of representative
offices.
14. Foreign banks are present in India in the branch mode since mid-nineteenth century.
Also, foreign banks were allowed to set up a wholly owned subsidiary (WOS) in India. To
operationalise the FDI guidelines, the Reserve Bank released the roadmap for presence of
foreign banks in India on February 28, 2005. The roadmap was divided into two phases - the
first phase spanning the period March 2005 to March 2009 and the second phase beginning
after a review of experience gained in the first phase.
15. In the first phase, foreign banks already operating in India were allowed to convert
their existing branches to WOS while following the 'one-mode presence' criterion and the
WOS was to be treated at par with the existing branches of foreign banks for branch
expansion in India. During the first phase no foreign bank came forward to set up or convert
their branches into WOS in the absence of adequate incentives. As the time came to review
the experience gained in the first phase, global financial markets were in turmoil and there
were uncertainties surrounding the financial strength of banks around the world. At that time
it was considered advisable to continue with the current policy and procedures governing the
presence of foreign banks in India.
16. Building on the lessons from the financial crisis, Reserve Bank issued a Discussion
Paper in January 2011 on the mode of presence of foreign banks in India. Taking into
account the feedback received on the Discussion Paper, the framework for setting up of
wholly owned subsidiary (WOS) by foreign banks in India was released in November 2013.
Those foreign banks which have commenced banking business in India through a branch
mode after August 2010 shall convert into a wholly owned subsidiary if they meet the set
conditions and prescribed regulatory thresholds. The conditions would be, such as, foreign
banks incorporated in a jurisdiction having legislation giving a preferential claim to deposits of
home country in a winding up proceedings; foreign banks that do not have adequate
disclosure requirements in their home jurisdiction; foreign banks with complex structures;
foreign banks which are not widely held could have maiden presence only by way of WOS.
Also, if the Reserve Bank of India is not satisfied with the adequacy of supervisory
arrangements (including disclosure arrangements) and market discipline in the country of
their incorporation or Reserve Bank of India considers necessary for subsidiary form of
presence of the bank or if a foreign bank, which has set up its presence in India through
branch mode after August 2010, is considered by RBI as being systemically important by
virtue of the size of its business, such banks would have to operate through a WOS.
However, in case of foreign banks which are operating in India before August 2010 shall
have the option either to continue their banking business through the branch mode or to
convert those branches into a WOS.
17. Foreign banks have evinced interest on WOS structure in India and are deliberating
internally their strategy on form of banking presence. The initial minimum paid-up voting
equity capital for a WOS shall be INR 5 billion (nearly USD 82 million). In the case of an
existing foreign bank having branch presence in India, which desires or is required to convert
into a WOS shall have a net worth of INR 5 billion. WOS would be permitted to open
branches in any centre, except at certain sensitive locations from the perspective of national
security, without having the need to take prior permission from Reserve Bank of India in each
case, subject to their opening 25% of branches in a year in unbanked centres. In the case of
foreign bank branches, they may have to seek prior approval of Reserve Bank for branch
expansion in India.
18. Financial intermediation in India mainly happens through banks. With a view to
improve upon the credit disbursement to certain sectors of the economy which requires
stimulus through support from formal financial sector, priority sector lending was introduced
in 1970s. The objective was to achieve a wider spread of bank credit, prevent its misuse,
direct a larger volume of credit flow to priority sectors and to make it an effective instrument
of economic development. The definition of priority sector has evolved over a period of time.
Priority sector includes those sectors of the economy which in the absence of inclusion in the
priority sector categories would not get timely and adequate finance, such as, small loans to
small and marginal farmers for agriculture and allied activities, loans to micro and small
enterprises, loans for small housing projects, education loans and other small loans to
people with low income levels. Currently, the definition is under a review.
Foreign banks' operations in India - Issues flagged often and RBI's take
Priority sector lending
19. Presently, the domestic scheduled commercial banks are required to achieve priority
sector lending target of 40 per cent of the aggregate bank advances. The same would be
applicable for new WOS of foreign banks. Foreign banks with 20 or more branches in the
country are being brought on par with domestic banks for priority sector targets in a phased
manner over a five year period starting from April 1, 2013. For foreign banks with less than
20 branches the overall target is fixed at 32 per cent.
20. Foreign banks have from time to time raised the issue of fully or partially exempting
them from the need to undertake priority sector lending on account of their limited
geographical presence and expertise in areas like agro / small scale lending. These are the
sectors where formal flow of credit is necessary to create equitable development. Reserve
Bank has tried to facilitate bank lending to these sectors by ensuring that the pricing of credit
is made free. Foreign banks on their part are expected to bring in innovation and develop
new models through their global experience to deliver credit to needy sectors of the economy
in a cost effective manner. Foreign banks had to a large extent pioneered in the areas of
technology banking, ATMs in India which was followed by the domestic players and has
today changed the landscape of banking in India. As regards foreign banks with 20 and more
branches required to undertake priority sector lending at par with domestic scheduled
commercial banks, it may be noted that many of these banks are present in India for more
than 100 years and are present even before some of the public sector banks were born.
These foreign banks, therefore, not only know the Indian economy well but are also well
versed with the culture and psyche of the local populace. Therefore, it should not be an
insurmountable problem for them to comply with the priority sector requirements.
21. It is to be appreciated that different jurisdictions, including advanced countries, have
been requiring the concept of mandated lending for identified sectors, communities and
programmes.
Opening of branches in unbanked and underbanked centres
22. WOS of foreign banks are freely allowed to open branches in any centre with a
stipulation that at least 25 percent of the total number of branches opened during the
financial year must be in unbanked rural (Tier 5 and Tier 6) centres, i.e. centres which do not
have a brick and mortar structure of any scheduled commercial bank for customer based
banking transactions. Tier 1 comprises metropolitan and urban centres, Tiers 2, 3, and 4
comprise semi-urban centres and Tiers 5 and 6 comprise rural centres.
23. Incidentally, foreign banks operating as branches are not governed by these
stipulations, although, for opening a branch they need to seek prior approval from Reserve
Bank on case to case basis. However, keeping in view the concentration of foreign bank
branches in urban and metropolitan areas, it is expected that foreign banks when desiring to
expand presence may also like to open branches in underbanked centres, measured in
terms of average population per branch office in a district / state. I understand that there are
similar stipulations in other jurisdictions which have been laid down after factoring the
specific needs of their economy and the extent of banking penetration.
24. Currently, foreign banks have around 99% of their branches in urban and
metropolitan centres of the country. For increasing banking penetration and financial
inclusion, there is a need to open branches in centres that are unbanked. With a liberal
branch expansion policy, WOS would have access to the hinterland, which hitherto remained
unexplored by foreign banks in India. Thus, there is ample growth opportunity for foreign
banks under the WOS set up. In the case of foreign bank branches, there are again plenty of
prospects by way of opening branches in underbanked centres. Incidentally, underbanked
centres do not necessarily constitute rural areas and many of the centres are located in the
fringes of metropolitan and urban areas. Further, with the Government of India's plans to
develop hundred smart cities across India, there is ample opportunity to open branches in
these centres and in fact I believe many existing foreign banks in India would by now have
started to strategize to foray into such centres so as to have the first mover advantage.
Niche banking vs. universal banking
25. Foreign banks have often sought to do niche banking like corporate / wholesale
banking, investment banking rather than undertaking a bouquet of activities as would be
required of a commercial bank. The rationale for such request stems from the limited
geographical reach, stymied business model for foreign branch operations, lack of expertise
in local market, etc.
26. Reserve Bank of India issues universal banking licence to foreign banks for
conducting all type of banking business. There is no restriction as to the type of business to
be conducted through branches unlike in some other countries where restrictions are placed
on foreign bank branches on acceptance of retail deposits, conducting business in local
currency, types of clientele, availability of deposit insurance, access to clearing and
settlement systems etc. Once established, the regulation is non-discriminatory in India, as
foreign banks enjoy near national treatment in the matter of conduct of business. As
indicated earlier, on account of the typical requirements of the economy, it is our desire and
expectation that the foreign banks offer commercial banking with a view to ensure further
penetration of banking activities. Needless to indicate that in the process foreign banks could
diversify their risks and also it helps to tap the available latent opportunities.
Growing the inorganic way
27. There have been requests on whether Reserve Bank would allow foreign banks to
expand inorganically to explore possibilities for acquisition of banks operating in India. In this
regard, the stance of Reserve Bank has already been conveyed in the framework of WOS of
foreign banks in India. To repeat, it has been stated that once WOS are in operation for a
while and after a review is made with regard to the extent of penetration of foreign
investment in Indian banks and functioning of foreign banks, WOSs may be permitted to
enter into mergers and acquisitions with private sector banks in India, subject to the overall
foreign investment limit of 74 per cent. Since mergers and inorganic growth are natural
phenomena, it is likely that over a period of time a number of small institutions may look in for
such possibilities to reap benefits of economies of scale and the attendant gains. At the
same time, as the population needing basic financial services increases and more
opportunities unfold, more entities would like to establish presence within the gamut of policy
on entry of new banks and the existing foreign banks would be making exploratory inroads
into hinterland to seize the opportunities. However, depending upon the developments in the
banking system and the needs of the economy, Reserve Bank would review the policy on the
presence of foreign banks in India at an appropriate point of time.
Conclusion
28. To conclude, India has a long history of welcoming foreign banks, while cautiously
allowing its expansion, keeping the country's needs in perspective. India offers ample scope
for growth for the foreign banks in universal banking, more specifically in the highly
sophisticated and profitable markets of trade finance, investment banking, treasury banking
and personal banking. The permitted and desired structure of foreign banks is in effect as per
the current international ethos. The regulatory and supervisory approaches are, by and large,
common and non-discriminatory. Welcome to India.
29. Thank you all for patient listening.