A clearer route for foreing banks: 21st October Financial Express

The choice is really between operating as a branch of an entity that is incorporated overseas or functioning as a subsidiary of the same. The former means that they operate in the current manner where there are apparent barriers to expansion. They pay higher corporate tax rates but have it easy when meeting the preemption norms in the form of priority sector lending. The subsidiary route would imply that they would work like any domestic bank, except that the equity holding would be different.

The issue has come up for two reasons. RBI, for its part, would like to be better able to regulate foreign banks in the country considering the role they could play, given their financial strength. But the financial crisis showed that there is a major risk in the current model wherein the branch would be jeopardised in case the overseas parent had severe problems. This could be destabilising at the limit for the domestic banking system. Therefore, from the point of view of risk management, RBI would prefer to have better oversight over their operations.

As far as foreign banks are concerned, they would like to expand their operations in the country but are constrained in terms of the number of branches that they could set up as the rules are clear—not more than 12 branches a year as per the WTO agreements. There are 31 foreign banks operating in the country with 310 branches as of March 2010—with 75% being held by 5 banks. The market is vast and they do have the skill sets to reach out and expand their business in rural India, provided they are allowed to do so. The current regulatory environment may be considered to be inhibiting.

From the point of view of the banks, the subsidiary route would help them expand their business, which would probably apply to these 5 banks. They would get more operational flexibility and can push forth their business plans. Further, they would be able to grow inorganically through M&A activity, which is not available currently. Therefore, there would be certain gains for them in operating as a subsidiary as their market share increases. Also, given the financial strength of the parent company, they would be able to bring in the requisite capital to support their enhanced operations. In fact, given that there would be more new private banks operating in the interiors, the foreign banks would get left out from this business and would, hence, find the subsidiary route a convenience.

However, what is not clear is whether or not there would be the encumbrance of priority sector lending the way it is defined for Indian banks. There will probably be no concession here, which means that they would perforce have to go into the rural interiors and cater to the agriculture, small scale industry sector, weaker sections, etc. Currently, they get away with 32% ratio, which also includes export finance. Also, the tax rules governing capital gains or stamp duty are not quite clear when they convert from a branch to subsidiary, which will have to be examined before taking a decision. The DTC, however, has addressed the issue of corporate taxation, which used to be at a higher level for foreign companies, which will be restored to that for domestic companies.

RBI would also have to provide clarity on the listing requirements for such subsidiaries as there would be stipulations for new private banks. A public offering would be good for the country as domestic shareholders could get a slice of the benefits of the operations of these banks. This would be a major consideration for banks, which would want to convert to a subsidiary. Management issues would probably not be a major issue as the branches too operate with an Indian management and changes would only be at the fringe.

Setting the stage for the expansion of foreign banks is pragmatic but given that they are heterogeneous, all may not prefer the subsidiary route. Ideally, they should have the right to choose the route. They would have, to use the cliché, to decide to be or not to be a subsidiary.