Role of Foreign Commercial Banks in Indian Economy

Presentation BySantosh Parashar

Program Co-ordinator (Finance) Institute of Advanced Management & Research, Ghaziabad
E-mail: sk_parashar@rediffmail.com

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Topics Covered

Introduction Pre-requisites for banking business in India Licensing to Foreign Banks in India Policies adopted by RBI for Foreign banks ; Road Map Foreign Banks Operation in India; Financial Performance of Foreign Banks Conclusion References

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Introduction

For the past three decades Indias banking system has several outstanding achievements to its credit. The most striking is its extensive reach. It is no longer confined to only metropolitans or cosmopolitans in India. In fact, Indian banking system has reached even to the remote corners of the country. Thus, Growing Indian economy is the result of effective Indian banking system amongst many other responsible internal and external factors, in which the role played by foreign commercial banks in the country is also a crucial one. Foreign banks like Citibank, HSBC, Standard Chartered Bank, etc are the branches of those banks which are incorporated in foreign countries. Most of them perform essentially the same range of services as local banks, except that their focus in terms of product and customers may be different due to their limited branch network.

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They bring in new technology and facilitate in the introduction as well as assimilation of international products into the domestic markets. They help the local banking industry keep pace with developments in the financial centres abroad. They also help provide Indian corporations access to foreign capital markets. In keeping with the general trend towards liberalization, the Government has introduced several measures for widening the scope for foreign banks to enter and operate in India. On the one hand if they always brought an explanation about the prompt services to customers then on the other hand they offer biggest competition to the domestic banks in India. This paper focuses on RBI regulation (licensing requirement) for foreign banks, economic contribution and prospects of foreign Banks in Indian economy.

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A foreign bank is a bank organized under foreign law and located outside the country of its origin. A foreign bank includes offices, branches, and agencies of commercial banks or trust companies, private banks, national banks, thrift institutions, credit unions, and other organizations chartered under banking laws and supervised by banking supervisors of country of operation. A "foreign bank" does not include any foreign central bank or monetary authority that functions as a central bank, or any international financial institution or regional development bank formed by treaty or international agreement. On the basis of purpose to operate, there are two main types of foreign banks -those that come into developing countries primarily to serve their home clients, the socalled traditional or classical banks, and the opportunist, who come looking for profit (short or long-run) opportunities in developing countries. On the basis of channel to operate /mode of presence, there are three types of foreign Banks- first Branches, second -A wholly owned subsidiary (WOS) and A subsidiary with maximum foreign investment of 74% in a private bank.

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In terms of Sec 22 of the B.R. Act-1949, no company shall carry on banking business in India, unless it holds a license issued in that behalf by Reserve Bank and any such license may be issued subject to such conditions as the Reserve Bank may think fit to impose. Before granting any license, RBI may require to be satisfied that the following conditions are fulfilled:

Pre-requisites of banking business in India

that the company is or will be in a position to pay its present or future depositors in full as their claims accrue; that the affairs of the company are not being , or are not likely to be, conducted in a manner detrimental to the interests of its present or future depositors; that the general character of the proposed management of the proposed bank will not be prejudicial to the public interest or the interest of its depositors; that the company has adequate capital structure and earning prospects; that having regard to the banking facilities available in the proposed principal area of operations of the company, the potential scope for expansion of banks already in existence in the area and other relevant factors the grant of the license would not be prejudicial to the operation and consolidation of the banking system consistent with monetary stability and economic growth.

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Licensing to Foreign Banks in India

Procedurally, foreign banks are required to apply to RBI for opening their branches in India. Foreign banks application for opening their maiden branch is considered under the provisions of Sec 22 of the BR Act, 1949. Before granting any license under this section, RBI may require to be satisfied that the Government or the law of the country in which it is incorporated does not discriminate in any way against banks from India. Unlike the restrictive practices of certain foreign countries, India is liberal in respect of the licensing and operation of the foreign bank branches as illustrated by the following: India issues a single class of banking license to banks and hence does not place any undue restrictions on their operations merely on the ground that in some countries there are requirements of multiple licenses for dealing in local currency and foreign currencies with different categories of clientele. Banks in India, both Indian and foreign, enjoy full and equal access to the payments and settlement systems and are full members of the clearing houses and payments system. All banks can carry on both retail and wholesale banking. Deposit insurance cover is uniformly available to all foreign banks at a non-discriminatory rate of premium. The norms for capital adequacy, income recognition and asset classification are by and large the same. Other prudential norms such as exposure limits are the same as those applicable to Indian banks.

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Policies adopted by RBI for Foreign banks

The policy for approving foreign banks applications to open maiden branch and further expand their branch presence has been incorporated by RBI in the Roadmap for presence of Foreign banks in India indicated in the Press Release dated February 28, 2005 as well as in the liberalized branch authorization policy issued on September 8, 2005. The branch authorization policy for Indian banks has been made applicable to foreign banks subject to the following steps specified in the roadmap:

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Road MAP: Phase I: March 2005 to March 2009

Foreign banks are required to bring an assigned capital of US $25 million up front at the time of opening the first branch in India. Existing foreign banks having only one branch have to comply with the above requirement before their request for opening of second branch are considered. Foreign banks may submit their branch expansion plan on an annual basis. Foreign banks and its groups track record of compliance and functioning in the global markets is considered. Reports from home country supervisors are sought, wherever necessary. Weightage is given to even distribution of home countries of foreign banks having presence in India. The treatment extended to Indian banks in the home country of the applicant foreign bank is considered . Due consideration is given to the bilateral and diplomatic relations between India and the home country. The branch expansion of foreign banks is considered keeping in view Indias commitments at World Trade Organization (WTO). As a part of market access, India is committed to permit opening of 12 branches of foreign banks every year. As against these commitments, Reserve Bank of India has permitted up to 17- 18 branches in the past . Licenses issued for off-site ATMs installed by foreign banks are not included in the ceiling of 12.

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The Reserve Bank follows a liberal policy where the branches are sought to be opened in unbanked/under-banked areas. Permission for conversion of existing branches of a foreign bank into a WOS will be guided by the manner in which the affairs of the branches of the bank are conducted, compliance with the statutory requirements and the overall supervisory comfort of RBI. Also, for reckoning the minimum net worth the local available capital including the remittable surplus retained in India will qualify. In order to allow Indian banks sufficient time to prepare themselves for global competition, initially entry of foreign banks will be permitted only in the private sector banks that are identified by the RBI for restructuring. In such banks, foreign banks would be allowed to acquire a controlling stake in a phased manner. RBI will consider the application for acquisition of 5% or more stakes in a foreign bank depending upon the reputation of the foreign bank, its desired level of presence in the country and the interest of the shareholders of the investee bank. RBI may also specify, if necessary, that the investor bank shall make a minimum acquisition of 15% or more and the period of time for such acquisition. The overall limit of 74% will continue to be applicable.

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Phase II: April 2009 onwards

In the second phase, the removal of limitations on the operations of the WOS and treating them on par with domestic banks to the extent appropriate will be designed and implemented after reviewing the success of Phase I. The WOS of foreign banks on completion of a minimum prescribed period of operation will be allowed to list and dilute their stake (by way of IPO or offer for sale) so that at least 26% of the paid up capital of the subsidiary is held by resident Indians. After a review is made with regard to the extent of penetration of foreign banks in India and their functioning, foreign banks may be permitted, to enter into merger and acquisition transactions with any private sector bank in India subject to the overall investment limit of 74%.

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Foreign Banks Operation in India

As at June 2009, 32 foreign banks were operating in India with 295 branches as compared with 30 foreign banks with 279 branches as at end June 2008. These banks originated from 23 different countries. In addition, 43 foreign banks operated in India through representative offices. During the period from July 2008 to June 2009 , permission has been granted to the four existing foreign banks to open 12 branches and to three new banks, (viz., CIMB Bank Berhad, Malaysia, Commonwealth Bank of Australia and FirstRand Bank Ltd. of south Africa) to open one maiden branch each in India. During the same period, permission was granted to three foreign banks (viz., Kfw-IPEX Bank GmbH, Toronto Dominion Bank and Duncan Lawrie Ltd.) to open a representative office each in India. Three foreign banks viz., DBS Bank ltd., Deutsche Bank AG and FirstRand Bank Ltd. together set up 12 branches during July 2008 to June 2009. Besides, two foreign viz., DnB NOR Bank and KfW IPEX Bank GmbH opened a representative office each in India during the same period.

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Offices of Commercial Banks in India-2005-09

Bank Group 2005 (1) State Bank of India and its Associates Nationalized Banks$ 14006 35096 2006 (2) 14294 35848 As on March 31 2007 (3) 14651 37413 2008 (4) 15814 39204 2009 (5) 16731 40766

Foreign Banks
Regional Rural Banks Other Scheduled commercial Banks Non-Scheduled Commercial Banks Total

242
14763 6462 37 70606

259
14776 6828 41 72046

272
14812 7415 46 74609

279
15029 8294 46 78666

295
15384 9186 46 82408

Notes : No. of offices includes administrative offices. $ Includes IDBI Bank Ltd. Data for 2005 to 2008 have been revised and data for 2009 are provisional. Source: Master Office File (latest updated version) on commercial banks, Department of Statistics and Information Management, RBI. SANTOSH PARASHAR

Offices of C ommercial B anks in India 2009

Non-Sch e dule d Co m m e r cial Ban k s , 46 SBI & its As s ociate s , 16731 SBI & its As s ociate s Nationaliz e d Ban k s For e ig n Ban k s Re gio nal Rur al Bank s Othe r Sche du le d Co m m e r cial Bank s No n-Sche dule d Com m e r cial Ban k s

Othe r Sche d ule d Com m e r cial Bank s , 9186

Re g ional Ru r al Bank s , 15384

For e ig n Bank s , 295 Natio naliz e d Bank s , 40766

Source: Master Office File (latest updated version) on commercial banks, Department of Statistics and Information Management, RBI

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Fig- OCCUPATION WISE DISTRIBUTION OF CREDIT BY FOREIGN BANKS-2008 (AS ON 31ST MARCH)

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Financial Performance of Foreign Banks in India (As on 31st March)

Statement I: Foreign Banks in India: Deposits/Investments/Advances (Rs. Crore) Deposit 2007 150,750 2008 2009 2007 71,471 191,443 214,077 Investment 2008 99,092 2009 130,353 2007 126,339 Advances 2008 161,959 2009 165,415

Statement II: Foreign Banks in India: Total Assets/Gross NPAs/Net NPAs (Rs. Crore) Total Assets 2007 274,392 2008 365,255 2009 447,070 2007 2,263 Gross NPA 2008 2,872 2009 6,807 2007 927 Net NPA 2008 1,254 2009 2,973

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Financial Performance of Foreign Banks in India (As on 31st March)

Statement III: Foreign Banks in India: Income (Rs. Crore) Interest Income 2007 17,924 2008 24,422 2009 30,322 2007 7,044 Other Income 2008 10,616 2009 14,890 2007 24,968 Total Income 2008 35,037 2009 45,211

Statement IV: Foreign Banks in India: Expenditure (Rs. Crore) Interest Expended 2007 7,603 2008 10,609 2009 12,817 Operating Expenses 2007 7,745 2008 10,374 2009 12,298 2007 15,348 Total Expenditure# 2008 20,983 2009 25,114

# excludes provisions and contingencies

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Financial Performance of Foreign Banks in India (As on 31st March)

Statement V: Foreign Banks in India: Profit (Rs. Crore)

Operating Profits 2007 2008 2009

Provisions &Contingencies 2007 2008 2009 2007

Net Profit

2008 6,613

2009 7,509

9,619 14,054 20,097 5,034 7,441 12,588 4,585

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Net Profit Trend of Foreign Banks (as on 31st March 2007 to 2009 )
(Rs, in Crores)
Net Profit Trend of Foreign Banks
(As on 31st March) 8000 7000 6000 5000 4000 3000 2000 1000 0 1 7509 6613 4585
44.23% Growth 13.54% Growth

Net profit

years net profit

2 years

By

having look on performance of foreign banks in India mentioned in statement I to V it is very clear that their Deposits/Investments/Advances have increased altogether from year 2007 to 2009 But with the increase in net NPAs (Proportionately more in year 2009) over the years their net profits has declined in year 2009, as the percentage increase in net profits in year 2008 was 44.23% whereas in year 2009 it was only 13.54%.
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Rising non-performing assets, or NPAs, and constraints on capital flows following the global financial turmoil have taken their toll on foreign banks operations in India. Banks need capital to expand loan assets, but in many cases, parents of foreign banks operating in India are not in a position to infuse capital. Rising NPAs are also discouraging foreign banks from the aggressive asset creation they pursued in the past few years when the Indian economy was growing at an average pace of 8.5% and consumers were buying homes and cars and spending more on their credit cards. Banks have to set aside money to cover NPAs, for which they require more capital.

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However, by the year 2010, the list of foreign banks in India may become more quantitative as numbers of foreign banks are still waiting with baggage to start business in India despite of liquidation decision discouraging foreign players- like, RBS which has 31 branches in India and employs about 10,000 people has already approached the Indian central bank for approval of liquidation deal and The Reserve Bank of India has confirmed that it will require foreign banks to undergo a full audit of their Indian operations prior to be allowed to establish new branches. The requirement to audit foreign banks before further expansion is to preserve risk management capabilities over concerns that any failure could create risks for Indian financial markets.

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Conclusion The move to audit foreign banks expansion in India is seen as a sensible precaution in light of the current global crisis. Foreign banks committed to making a play in India will need to adopt alternative approaches to win the race for the customer and build a value-creating customer franchise in advance of regulations potentially in 2010. At the same time, they should stay in the game for potential acquisition opportunities as and when they appear in the near term. Maintaining a fundamentally long-term value-creation mindset will be their greatest challenge. The extent to which Indian policy makers and bank managements develop and execute such a clear and complementary agenda to tackle emerging discontinuities will lay the foundations for a highperforming sector in 2010.

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References:
1. 2. 3. 4. 5. 6. 7. 8.

Report on Trend and Progress of Banking in India (2008-09),RBI Bulletin; Nov.09. Principles and practices of Banking; IIBF, McMillan reprinted, 2009 http://www.rbi.org.in/scripts/statistics.aspx www.legalhelpindia.com/bareACTS/BANKING%20REGULATION %20ACT%201949.doc http://www.idlo.int/microfinance/DOCUMENTS/REGULATIONS/INDIA2. pdf http://www.mckinsey.com/locations/india/mckinseyonindia/pdf/india_ban king_2010.pdf http://www.rupeetimes.com/news/personal_loan/foreign_banks_to_reco nsider_growth_plans_for_india_2390.html http://www.livemint.com/2009/08/02205613/Capital-constraints-risingba.html?d=1

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THANK YOU

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