Eager to take advantage of India's economic strength and increase their presence in the region, foreign banks are coming up against strict branch-licensing laws as India seeks to protect its banking sector from the vagaries of the global market. Writer Rekha Mehon

With India's economy galloping ahead, boasting an 8.9% growth in gross domestic product (GDP) in the second quarter of this financial year, it is not surprising the country is on the radar of banks across the world. There are 34 foreign banks from 24 countries currently operating in India, along with 45 foreign banks with representative offices. While banks such as Standard Chartered, HSBC and Citi have been present in the country for more than a century, several new ones are keen to explore opportunities in one of the fastest-growing economies in the world.

Commonwealth Bank of Australia and FirstRand Bank from South Africa are among those that have established commercial banking operations in India in the past two years, while Spain's second largest bank, BBVA, which set up a representative office in India in 2006, recently took its first step in India's retail banking market with a credit card joint venture with India's state-backed Bank of Baroda.

Between July 2009 and September 2010, the Reserve Bank of India (RBI), the country's central bank and the banking industry regulator, granted permission to three banks, Russia's Sberbank, ANZ from Australia and Credit Suisse, to start commercial banking operations with one branch each in the country. It also granted permission to both CIMB Bank of Malaysia and Spain's La Caixa to open a representative office in India. Banks such as Goldman Sachs and Bank of New York Mellon are also rumoured to have applied for banking licences. At the last count, 14 banking applications were pending with the RBI.

"For any international bank, India is a very important market," says Mark Robinson, CEO for south and south-east Asia at ANZ, which is in the process of re-entering the Indian market after a 10-year hiatus. ANZ, which was the second largest foreign bank in India with more than 50 branches when it sold its assets to Standard Chartered, aims to generate nearly 20% of its business from Asia by 2012. To achieve that, being in India is vital, says Mr Robinson. "India is developing very fast and is fast-growing and diversified. It has a very large domestic market. In fact, there are only three or four other markets where the domestic sector is growing as quickly. Over the past couple of decades, there has been an increase in its connectivity to the external world in terms of trade-flows, investments and people, and an international bank can support these opportunities," he says.

Neeraj Swaroop, CEO of Standard Chartered Bank, India, says: "There is a change happening globally. The balance is shifting from West to East, and any international player needs to have India on the agenda. The banks' boards are pushing them to get India licences."

Foreign banks in India, he says, can be divided into three groups: the representative offices or one-branch outposts that facilitate trade between India and the home country; the specialised players with six to 10 branches that focus on specific niche offerings; and the committed players who have been in the country for a long time and compete with the domestic private-sector players on an almost equal footing. Standard Chartered, which along with Citi and HSBC offers a diversified set of services in India, features in the last group.

Licence limits

With almost 9% GDP growth, India could be growing faster than China within the next five to 10 years, says Naina Lal Kidwai, group general manager and country head of HSBC Group Companies in India. "As foreign companies come in and Indian companies go out, foreign banks have huge opportunities in assisting with fundraising in offshore markets and cross-border-related work," she says. However, she points out that the Indian banking industry is facing a talent-crunch in areas such as investment banking, and has to also deal with stratospheric real-estate prices, which are "out of synch with business opportunities".

The biggest challenge for foreign banks remains that of branch licences. "Due to the current branch-licensing norms, we have a problem of sub-optimal scale," says Ms Kidwai. Although the RBI awards about 20 branch licences a year to foreign banks -more than the 12 licences mandated by the World Trade Organisation (WTO) - it is far less than what foreign banks desire and what the RBI gives to domestic banks.

The 34 foreign banks currently operating in India have 315 branches between them, as compared to the more than 65,000 branches owned by the domestic banks. HSBC, which can trace its presence in India as far back as 1853 through Mercantile Bank in Mumbai, has only 50 branches. Citi, which has the largest asset base among foreign banks and established its first branch in India in 1908, has 45 branches, while Standard Chartered Bank, present in India since 1858, has the largest branch network among foreign banks of about 100 branches - a result of its acquisition of Grindlay's retail operations.

Standard Chartered Bank's Mr Swaroop believes that the licensing norms place constraints on their retail banking operations because of a limited number of branches. "We cannot reach out to a larger geography or smaller towns," he says. He adds that fewer branches means there is a limitation in the amount of rupee deposits Standard Chartered can take and, as a consequence, the amount of lending it can do. "This is the main reason why even after so many years of operation, the share of foreign banks remains at only about 7% of the assets of the banking system," says Mr Swaroop. "While the overall economic growth is attractive enough, and in some segments our share is as high as 20% to 25%, foreign banks' share of overall balance-sheet assets will remain at this level unless there is a policy change with regards to branch licensing."

Restricted ambitions
Due to constraints around branch scalability, several foreign banks have limited their efforts to wholesale and investment banking, while those that looked at retail banking have focused primarily on offering wealth management services to high net-worth individuals (HNWIs). A few banks, including Citi, tried to overcome the branch issue by providing consumer finance through non-banking financial institutions, which have fewer restrictions on branch expansion, but had their fingers burnt in the unsecured lending area.
"Consumer and retail banking will always remain the bastion of domestic banks," says Gunit Chadha, country head and CEO of Deutsche Bank Group in India, which has 13 branches in the country. Deutsche Bank started its retail banking initiative targeting HNWIs in 2005, and Mr Chadha says the bank is expecting to break even in this segment and see growth once the market opens up and HNWIs start investing in global products.

However, some recent market reports suggest the bank is looking to exit its credit card portfolio. What Mr Chadha is extremely bullish about is Deutsche's corporate and investment banking franchise, where the bank holds a leadership position having been involved in 13 out of 15 international debt issuances out of India, and two out of the three largest equity issuances in 2010. As a result, Deutsche Bank's India business, according to Mr Chadha, has been growing at 25% year on year.

Neeraj Swaroop, CEO, Standard Chartered Bank, India

Neeraj Swaroop, CEO, Standard Chartered Bank, India

A niche market

"Foreign banks in India will always be highly profitable but small in size. But then from a return-on-equity perspective, they don't really need a huge presence. Many of them have found their own niches and are servicing them extremely well," says Abizer Diwanji, executive director of KPMG in Mumbai. Foreign banks have strength in their ability to leverage technology and be instrumental in bringing new products to the market, such as home loans and credit cards, he says. The first ATM in India, for instance, was set up by HSBC. "Foreign banks will not feature in the mass consumer banking area. Fees and structured products will be their core areas of focus."

Foreign banks' primary role in India is to bring new innovations and processes to the sector, says Dr KC Chakrabarty, deputy governor at RBI. "Foreign banks play several important roles. They bring new products to the market, new technology and play a key role in strengthening the relationship between India and their home country," he says. However, he is categorical about the fact that "foreign banks will never be major players in India in terms of market share". This is the guiding philosophy that drives the RBI's strict rationing of branches to foreign banks.

"In the off-balance-sheet segment, foreign banks do lead the market - they have about 60% market share - and that is okay. But in other areas we see the domestic banks dominating. For example, we do not expect the foreign banks to play a role in financial inclusion. It requires a huge branch network and it is essentially the responsibility of domestic banks," says Mr Chakrabarty.

One of the main concerns the regulator has regarding foreign banks, according to Mr Chakrabarty, is that they retreat to their home markets in times of crisis, as has happened in various countries in recent years, including India. He points out that during the financial crisis, the share of foreign banks in the banking industry's assets contracted by 2.7% in 2009-10. This was a break in the trend observed since 2006, as assets of foreign banks posted annual growth consistently exceeding 20%.

"A bank's tendency to withdraw to their home market is understandable, since it is the home country's regulator that is going to bail them out, but this can adversely impact the host country's economy and the regulator needs to guard against such a situation," says Mr Chakrabarty.

HSBC's Ms Kidwai agrees there are merits to the regulator's argument and cautious stance. "Their fear is valid that dominance by foreign banks will leave the banking system open to the vagaries of the global environment." However, she points out that foreign banks currently account for only about 7% of the country's banking system. Given the strength and maturity of India's banking sector, and the ability of domestic players, dominance by foreign banks will not happen any time soon, she says.

Naina Lal Kidwai, group general manager and country head of HSBC Group Companies in India

Ongoing debate
Nonetheless, India's regulator is treading carefully. The RBI is due to issue an eagerly anticipated 'position paper' that will outline its stance on foreign banks' mode of presence in the country - through a branch, as is the norm now, or as a wholly owned subsidiary, which requires a significantly higher capital commitment. This discussion paper is long overdue. The initial discussion began in 2004-05, when the RBI had released its 'Roadmap for presence of foreign banks in India' paper. As a first step, it had given foreign banks the option to choose between operating through a branch or as a wholly owned subsidiary, and stated that the rules and procedures would be reviewed and revised in April 2009. In light of the recent global financial markets turmoil and the uncertainties surrounding the strength of banks across the world, the April 2009 review was put on hold.

None of the foreign banks had opted for subsidiarisation between 2005 and 2009, but there are strong indications to suggest the regulator favours this route. Speaking at a banking conference organised by the banking industry body, the Indian Bank's Association, Duvvuri Subbarao, governor of the RBI, said that the subsidiary form of presence provides several comforts to regulators. "First, managerial decisions in subsidiaries are mainly driven by local economic conditions. Second, there is a clear delineation of the capital of the domestic bank from its parent bank, which protects the interests of domestic depositors. Third, independent directors on the boards of the subsidiaries provide sufficient separation between the bank and its owners to ensure the board does not have unfettered ability to lean in favour of the owners and against the interest of domestic depositors, especially in times of stress. Finally, local incorporation affords greater leverage to host-country authorities than does a branch operation to ringfence the operations of the bank."

He adds that the discussion paper will highlight in detail all the issues related to the branch and subsidiary mode, such as what approach should be mandated for existing branches of foreign banks, and whether the subsidiary form of presence should be mandated for all new entrants or selectively applied based on certain parameters.

Mr Chakrabarty says: "While the subsidiary route is preferable, we are well aware it is not a panacea for all problems. Also, we understand that for some banks the subsidiary route will not work, and we cannot close the branch option completely."
One of the key points foreign banks will be looking for in the discussion paper is whether the branch licensing policy for wholly owned subsidiaries will be relaxed.

"The trend is evident across the world that regulators want foreign banks to set up wholly owned subsidiaries. If the branch restriction goes, no bank would think twice about converting to a wholly owned subsidiary," says Ms Kidwai.

Mr Chadha of Deutsche Bank adds: "We can understand from the regulator's perspective why local incorporation is more comforting but there are inherent issues that need to be debated, such as tax implications and relaxation in branch licensing norms."

Sanjiv Bhasin, CEO of Singapore's DBS Bank's Indian operations, says: "Becoming a wholly owned subsidiary requires capital commitment. If subsidiarisation becomes mandatory, hopefully we will get the benefits of a larger branch network."

Standard Chartered's Mr Swaroop is positive about the new discussion paper. "It has taken time but... we are very optimistic," he says. What works in favour of the RBI is the fact that the dialogue is consultative and inclusive, so a lot of debate precedes action. But no one is complaining, especially because it is this cautious approach that stood RBI in such good stead during the financial crisis.


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