We need more foreign banks: Financial Express: 28th January 2011

The discussion paper on foreign banks in India is timely and appropriate as we need to look at the banking sector with the larger picture in mind and not get bogged down with ideological, operational and supervisory issues. This comes just on the back of the discussion on getting corporate houses into banking, where arguments have flowed from one end to the other on whether we should have more private banks. Alongside, there has also been the issue of MFIs, which has raised a controversy of a different sort. Curiously, for every step forward, there are arguments to push us two steps back. As RBI has brought out papers on all these subjects at about the same time, it is pragmatic to put the parts together.

The right way to address the issue is to look at banking as a strategic goal. Let us ask ourselves a question: do we need more ‘banking’ in the country? The answer is yes, from the point of view of getting a larger population involved through deposits and supporting the high growth that we are targeting by channelling funds for productive use and making it inclusive. India still follows a bank-oriented financing model, where the debt market is absent and hence relies heavily on the banking system to provide funds for growth—both short and long term. Now when we speak of growth of, say, 9-10% per annum, we require this sector’s support to come at over 20% per annum on a sustained basis for the next five years. Using March 2010 as the base, when credit was Rs 35 lakh crore, this kind of growth would mean raising the base to around Rs 85-90 lakh crore. The number is daunting, but then we need the capital for this purpose, which, using a ratio of 10% capital adequacy means getting in Rs 4-4.5 lakh crore. Where will this money come from?

Looking internally, we have all kind of issues with banking capital. The sector is dominated by public sector banks, with a share of 74% in total assets, where there is debate over disinvestment or offloading of shares to the market. While there are arguments about retaining the public nature of such banks, the fact is that garnering more capital will be a challenge. Private sector banks are aggressive in the market and can provide a solution, but the present set of banks has its own limitations. This has called for the inclusion of new banks with corporate support. Corporate houses have deep pockets and can provide the funds that are needed by the economy to move ahead. It is here that the foreign banks fit in as they too have deep pockets and the subsidiary route offers a way out as against the present branch approach with its limitations.

RBI has set the entry norms in terms of capital and suggested some very stringent conditions for screening the banks that could operate as subsidiaries and hence as specific entities. This by itself will actually end up offering opportunity to the bigger banks in the country, which hitherto have not been able to expand due to various reasons that surround the conditions placed for opening branches. Therefore, we would not really see the smaller players asking for more and it would be those with a history of operations in the country that would probably find this route attractive. The subsidiary route thus takes care of the issue of systemic risk that can emanate from banks expanding through the branch route. Foreign banks, though, are not keen on coming as subsidiaries as this exposes the parent’s balance sheet.

Will this be a panacea for our problem on capital? The answer is no. Foreign banks cannot, on their own, address this issues, but can contribute smartly to the requirement. Besides, they will evaluate the terms on dividend repatriation, listing and conversion of branches etc before taking a decision. The subsidiary route proposed makes a lot of sense from the point of view of the regulator as well as the banks and should be complemented by a more open approach to new private banks.

The important thing is that we need more banks to address the issues of capital, growth in business and inclusion. Public sector expansion—either through organic means or inorganic methods such as disinvestment or consolidation, new private banks and foreign bank subsidiaries—could work together to deliver superior results. We only need to ensure that the regulatory processes and supervisory mechanism is in place at all times. A start certainly must be made in all these areas. Given the more stringent terms imposed by Basel III, this is probably the right time.