How do you define a tier-VI city in India?" The global CEO of a foreign bank asked recently at a meeting with his top management. Flipping through the Reserve Bank of India's 20-page discussion paper on a new regulatory framework for foreign banks in India, he quizzed his officials on the fine print. Among the raft of proposals, RBI has suggested the local incorporation of foreign banks as subsidiaries. Foreign banks in India currently operate only as branches of the parent banks.
What made this CEO apprehensive was the priority sector lending stipulations - particularly agricultural lending. His bank at present has no exposure to agriculture and the bulk of his branches are located in the Indian metros. The mood at the boardrooms of other foreign banks is no different.
|What the RBI has proposed|
- Local incorporation of foreign banks as subsidiaries. They will then be treated at par with Indian banks for branch expansion
- Local listing as well as permission to raise rupee resources as part of tier-II capital
- Minimum capital requirement will be in line with the policy for new private sector banking licences
- Minimum capital adequacy ratio of 10%
- Independent board members on the Indian board Priority sector lending target at 40%
Many global CEOs of foreign banks, from Deutsche Bank's Josef Ackermann to Citi's Vikram Pandit, have been discussing the merits and demerits of converting their branch operations into a subsidiary during recent India visits. Most of them are lukewarm to the idea. The hurdles: high agricultural lending targets, compulsory local listing, and ambiguity on taxation and stamp dutyrelated issues.
The option to convert into subsidiaries was given to foreign banks in 2005 as well but none of the three dozen odd banks then operating in India took the plunge.
They had the same concerns then and saw little to gain in changing the legal structure. The renewed review, however, does dangle some carrots as well, but come with riders attached. (see What the RBI Has Proposed...) Credit Crisis Aftermath The immediate trigger for RBI's fresh proposals seems to be the global financial crisis of 2008/09. In its annual report 2009/10 released in July 2010, RBI had observed: "Lessons from the global crisis have supported the subsidiary route or domestic incorporation of foreign banks as it would provide better regulatory control over foreign banks and would also facilitate a simpler resolution in the event of bankruptcy, in relation to a branch structure." The move would allow the central bank to impose minimum capital requirements for the entry-level whollyowned subsidiaries of foreign banks in line with new private sector banks.
For instance, the unit will be required to maintain a minimum capital adequacy ratio of 10 per cent of the risk weighted assets. Today, foreign banks in India run the bulk of their operations in tier-I and tier-II cities with a focus on highend customers, both in the retail as well as in the corporate segment. If they accept RBI's new road map, it would be a whole new ball game for them. Says Douglas Flint, Chairman of HSBC Holdings Plc.: "It's a challenge for foreign banks in India. Agricultural lending is not something we have done."
There are no agricultural lending targets for foreign banks operating through branches. The new draft guidelines place a 10 per cent agricultural lending target for foreign banks. Meeting the target, most bankers concede, would be a mountain to climb. Most Indian banks have struggled to meet their agricultural lending targets of 18 per cent.
According to the latest RBI figures, Indian private banks such as HDFC Bank, ING Vysya Bank, Karnataka Bank and Corporation Bank have disbursed agricultural loans in the range of 10 to 12 per cent of their net advances in 2009/10. Stateowned banks do better at 16 to 18 per cent - not surprising given their vast network of branches in India's interiors.
| ...And its likely impact|
- More headroom for foreign banks to expand in India, though there is a limit on foreign banks assets at 15% of the total banking assets
- Deeper penetration into tier-III to tier-VI towns
- Greater flow of credit to agriculture and other priority sectors
- Local incorporation for foreign banks may pave the way for M&As in the sector
- More competition in the domestic market
- Only state-owned banks have rural expertise
- Most banks fail to meet their agricultural lending targets
- Defaulters aplenty in the agricultural sector
- No credit bureau to keep a credit history of borrowers or defaulters in rural markets
- Indian listing doesn't enthuse foreign banks
- No clarity on whether parent's credit rating is allowed for raising capital
- Tax issues, especially incidence of Capital Gains Tax and stamp duty on transfer of assets
Most global banks have no domain expertise of direct lending to agriculture. They have not done it in other emerging Asian economies. Piyush Gupta, CEO of Singaporebased DBS Bank, says: "Agricultural lending is something we only do bits of. The challenge is to transfer global commodity financing knowledge into the farm sector in India. It might not be easy." Adds Ulrich Korner, Group Chief Operating Officer at Switzerland-based UBS, a relatively new bank in India: "It is possible that we service certain clients with specific needs in the agricultural sector or related sectors."
But at present, outside Switzerland, UBS focuses on investment banking and wealth management and does not offer commercial banking services on a global scale. Going Rural? Not Yet In the new road map, RBI has suggested the branch policy for foreign subsidiaries will be similar to that of domestic banks, meaning expansion into towns in tier-III (population between 20,000 and 49,999) to tier-VI (population of less than 5,000) categories. In future, the foreign bank's expansion into top tier cities will be linked to branches in tier-IV to tier-VI towns. It will be yet another big challenge for foreign bankers as their branch network is highly concentrated in the top metros and cities.
"Stepping out into rural areas will take time," says DBS Bank's Gupta. That is not going to happen soon, say foreign bankers. "We have a long way to go in terms of branches," says Richard Waugh, President and CEO of Scotiabank, whose Indian unit has only half a dozen branches in big cities. In December 2009, the apex bank allowed commercial banks to open branches in tier-III and tier-VI cities without its prior permission.
For foreign banks, the permission to set up branches in tier-I and tier-II is on a case by case basis. Many foreign banks say they require greater clarity on the ratio of tier-I and tier-II to tier-III to tier-VI branches. "Such clarity will enable banks to take a faster decision on adoption of subsidiary model," a banker said.Banks wary
There are other proposals that are making the foreign banks wary, too. RBI wants listing of the local subsidiary at a later date, which many foreigners are not very enthused about. "The liquidity in our stock market is largely in Hong Kong and London," says HSBC's Flint, who feels the Indian capital market doesn't offer high liquidity and depth. There is already a listing route open for global corporations, including banks, through Indian depository receipts, or IDRs. So far, though, only one bank has exercised that option - Standard Chartered Plc, which was listed in India through the IDR route in May 2010. Foreign bankers are demanding that the dilution of parent shareholding in Indian subsidiary should be voluntary and not compulsory.
We have a long way to go in terms of branches
Richard Waugh, President and CEO, Scotiaba
They also want to be exempted from paying capital gains tax while converting into subsidiaries. If a foreign bank chooses to incorporate locally, it will have to buy the business of the branches, requiring the parent to pay capital gains tax for the transaction. "We must be given tax breaks," says a CEO.
The central bank has tried to overcome the resistance from the foreign banks to become subsidiaries with some incentives. For the first time, it plans to permit them to raise preference capital and subordinate debt. The current regulations allow foreign banks to raise resources only from their parent body or head office through Innovative Perpetual Debt Instruments. "Banks will use that route," says Sanjiv Bhasin, CEO India, DBS Bank.
Many foreign bankers also want freedom to achieve scale in India. Here, too, this time, the central bank has given them enough headroom for growth. The fresh proposals limit capital and reserves of foreign players at 25 per cent of the banking system capital. Today, it is around 15 per cent.
RBI also proposes that foreign banks should be allowed to acquire any domestic private sector bank if they set up a subsidiary, which gets a chorus of approval from the players. "In 2005, too, RBI had promised to permit M&As (mergers and acquisitions) but did not deliver," says a foreign banker.
Overall, despite RBI's best efforts, foreign banks remain wary of the proposals. Expect some hectic parleys to evolve a consensus in the coming months.