Liberalization Regime Of The Indian Banking Sector

19 Aug 2011

Banks have since ages been one of the vital props of any economy. They enable the streamlining of financial resources in a profitable way, and bridge the gap between their demand and supply. They also act as an intermediary in financial transaction besides providing an array of other services.

Regulating the banks is important because banks are a keystone in the edifice of financial stability of the economy. The banking regulative regime in India underwent various changes and crystallized in 1949 with Banking Regulation Act, 1949 (passed initially as Banking Companies Act, 1949 and changed subsequently to Banking Regulation Act, 1949.). Banking Regulation Act, 1949 in conjunction with Reserve Bank of India Act, 1934 empower the Reserve Bank of India (RBI) to superintendent the banking system of the country and to act its guardian.

Foreign investment in the banking sector, in keeping with the increased cap of March 2004, from all sources including FDI, FII, NRI is increased from 49% to 74%. However, voting right of the foreign investor is capped at 10%, thereby ensuring that local banks are not taken over by foreign banks.

To begin with foreign banks wishing to establish presence in India for the first time can either choose to operate through branch presence or set up a 100% wholly owned subsidiary(WOS). Foreign banks already operating in India are also allowed to convert their existing branches to WOS while following the one mode presence criterion. The WOS is to be treated on par with the existing branch of foreign banks for branch expansion in India.

Before granting licence to foreign branch under the provisions of Section 22 of the Banking Regulation Act, 1949, RBI may satisfy itself that the government or the law of the country in which it is incorporated does not in any way discriminate against banks from India. Foreign banks’ track record of compliance and functioning in the global market may also be considered. Further, bilateral and diplomatic relations between India and the country in which the bank is incorporated may also be taken into consideration.

 RBI issues a single class of banking licence to all banks and thereby does not place any limitation in the operation of foreign banks. In other words, foreign banks can conduct both retail and wholesale banking. In addition, the norms for foreign banks’ capital adequacy, in come recognition and asset classification vis-à-vis Indian banks are by and large same.

However, in recent times, the RBI has been giving dubious signals as regard its intention about the prospects of the proliferation of foreign banks and the admissibility of foreign capital in the banking sector. RBI’s Annual Policy Statement of April 2009 indicated the intention to continue with the current policy and procedure governing the presence of foreign banks in India and to review its roadmap after due consultation with the stakeholders, once there was greater clarity regarding the stability and recovery of the global financial system. Accordingly the Annual Monetary Policy 2010 directed to prepare a discussion paper on the mode of presence of foreign banks through branch or WOS by September 2010.

During the first phase of their operation, foreign banks have been given the option by the RBI to convert their branch operation into wholly owned subsidiaries without the branch licensing available to their domestic counterpart. No bank, however, came forward to avail this option and according to reports, the discussion paper to be released this month again favours the subsidiary route for fresh entry of foreign banks into the country. Unless they are given national treatment, branch expansion in India would remain circumscribed, regardless of whether the branch – only or the WOS route is employed. A compulsory listing in Indian stock exchange in case of the adoption of the subsidiary route also worries the foreign banks.

India’s public banking sector and the regulatory regime with which the RBI guardians it, is hailed as one of the best in the world. During the recession of last few years Indian public sector banks’ sturdy fundamentals have come in for hefty praise from the international circles. Thus it is a little absurd to expect that the public sector banks will crumble in the face o stiff competition from the foreign banks. On the other hand, often what few of these banks crave for in order to compete with the foreign banks is a liberty to adopt the foreign banks’ modus operandi. What these government owned banks privately desire for is to transform themselves into a commercial institution in the real sense of the term and not just be an instrument of social policy.