The scheduled review in 2009 of “Road Map for presence of foreign banks” laid down in 2005 was put on hold primarily on account of uncertainties caused by the financial crisis in late 2008. Further, many foreign banks applied to RBI for setting up a branch presence in India during the last couple of years. There were representations to consider differentiated banking licenses regime in line with other developed nations. During this time, RBI has had the occasion to study and analyse, the impact on the Indian banking system, of the financial crisis and also the practices followed in other countries.

With the above background, RBI has released a discussion paper on the presence of foreign banks in India. The discussion paper seems to make a compelling case for Wholly Owned Subsidiary form of presence for foreign banks. Presently, Foreign banks can undertake banking operations only through a branch form of presence in India.

RBI has invited suggestions and comments on the discussion paper by 7 March 2011. The final guidelines would be issued after considering the feedback received.

Comparative Summary – RBI view-point

Branch form of Presence

Pros Cons
(i) Greater operational flexibility. (i) In the event of failure of the bank, it is difficult to determine assets available for local creditors.
(ii) Increased lending capacity (loan size limits based on the parent bank’s capital). (ii) Management of a branch does not have a fiduciary responsibility to the branch’s local clients.
(iii) Reduced Corporate Governance requirements. (iii) Assets attributable to a branch can be transferred by it to the foreign head office. In times of distress, this would be a negative from the branch country perspective.
(iv) Strong support from parent in situations of local adversity (iv) Insolvency procedures may differ in different countries with some following separate entity doctrine while others follow one-entity doctrine.

Subsidiary form of presence

Pros Cons
(i) Clear delineation between the assets and liabilities of the domestic bank and those of its foreign parent. (i)         Parent support may not be there in all weathers
(ii) Ring-fenced capital within the host country. (ii) Where the liquidity is managed centrally by the parent and the local subsidiary is funded on a short-term basis, the failure of the parent may result in the failure of the subsidiary too.
(iii) Own set of directors who are required to act in the best interest of the bank. (iii) Possible downside risk to financial stability if the subsidiaries dominate the domestic financial system.
(iv) The host country authorities are able to exercise greater control in times of distress.

Considering the above and in particular the experience during the recent financial crisis, RBI sees merit in the subsidiary form of presence for the foreign banks.

Proposed Framework

The prevailing principles of (i) Reciprocity and (ii) Single form of Presence should continue to guide the framework of future policy on presence of foreign banks in India.

Entry Norms for new players

Following category of banks can undertake banking operations only by way of setting up a Wholly Owned Subsidiary (WOS):

(i)         Banks coming from jurisdictions where deposits enjoy a preferential claim in a winding up scenario

(ii)        Banks which do not provide adequate disclosure in the home country

(iii)       Banks with complex structures

(iv)       Banks which are not widely held, and

(v) RBI may require banks to incorporate locally, if the former is not satisfied with the degree of supervision in the home country. RBI at its discretion, may require banks to incorporate locally, it has any reason to do so.

Other foreign banks can decided whether to opt for a branch or WOS form of presence. However it would be mandatory for them to convert themselves into a WOS if:

(a)        Any of the conditions mentioned above materialize

(b)        They become systematically important in India by virtue of their balance sheet size.

A bank would be deemed to be systematically important if its assets (on balance sheet and credit equivalent of off-balance sheet items) become 0.25 percent of all total assets (inclusive of credit equivalent of off-balance sheet items) of all scheduled commercial banks in India as on 31 March of the preceding year.

Expectation from existing foreign bank branches

As regards existing foreign banks that already have a branch form of presence, RBI’s expectation is that where the parameters laid down in I) above are triggered, such banks should voluntarily convert themselves into WOS. It needs to be mentioned that considering WTO commitments, it would not be possible for RBI to mandate conversion of existing branches into subsidiaries.

Key policy considerations for a WOS

RBI is apprehensive about according full national treatment (as regards branch expansion, raising of capital etc.) to a WOS since it may result in foreign banks dominating the Indian banking system. Further the WOSs of foreign banks would be treated as “foreign banks” under the Foreign Direct Investment policy. In view of these considerations, RBI does not intend to give the WOSs of foreign banks a level playing field with Indian bank corporates on all parameters.

However, RBI intends to lay down a more favorable policy framework for a WOS of foreign banks vis-à-vis a branch of a foreign bank. Such an olive branch, RBI hopes, would result in significant incentives for the WOS mode of presence of foreign banks in India.

The extent of national treatment and limitations thereon on important parameters are given below:

Capital Requirement

The Capital requirement for WOS on entry would generally be in line with those that would be prescribed for new private sector banks (RBI had issued a discussion paper on Entry of New Banks in Private Sector in August 2010.) . The WOS shall be required to maintain a minimum adequacy ratio of 10 percent of the risk weighted assets or as may be prescribed from time to time.

The minimum net worth of the WOS on conversion from branches should not be less than the minimum capital requirement for new private sector banks. They would be required to maintain a minimum capital adequacy ratio of 10 percent of the risk weighted assets or as may be prescribed from time to time.

Corporate Governance

To ensure that the board of directors of the WOS of foreign bank set up in India acts in the best interest of the local institution, RBI may, mandate that

•           not less than 50 percent of the directors should be Indian nationals resident in India

•           not less than 50 percent of the directors should be non-executive directors

•           a minimum of one-third of the directors should be totally independent of the management of the subsidiary in India, its parent or associates and

•           the directors shall confirm to the “Fit and Proper” criteria as laid down in the extant RBI guidelines

Raising of Non-equity capital

RBI may consider allowing WOS of foreign banks to raise rupee resources through issue of non-equity capital instruments (in the form of Innovative Perpetual Debt Instrument, Tier I and Tier II Preference Shares and subordinate debt) as allowed to domestic private sector banks.

Branch Expansion Norms

While processing applications for new branches of foreign banks, RBI generally has permitted more branches than the 12 mandatory (per year) under the WTO commitments. With a view to incentive WOS form of presence, RBI intends to strictly restrict branch expansion to 12 branches (per year) for all existing foreign banks

It is proposed that the applicable branch expansion policy to domestic banks would be extended to WOS of foreign banks too. This would mean that the WOS would be enabled to open branches in Tier 3 to 6 centres. As regards Tier I and Tier II, centres would also be dealt in a manner and on criteria similar to those applied to domestic banks.

Priority Sector Norms

It is proposed that priority sector obligations on WOS have to be more onerous than for branches of foreign banks but less than those for domestic banks since they would not get full national treatment.

Recognizing the major role played by foreign banks in trade finance, RBI may allow WOS of foreign banks to classify export finance as a part of their priority sector lending. However, WOS of foreign banks should also be required to lend to agriculture in India.

Newly set up WOS may be required to comply with the Priority Sector Norms of 40 percent of Adjusted Net Bank Credit (ANBC) or credit equivalent amount of off-balance sheet exposure whichever is higher. Out of the above, the sub-target for Export, Agricultural and Small Enterprise advances is 12 percent, 10 percent and 10 percent respectively.

WOS set up by conversion of existing branches may be allowed a transition period of five years from the year in which they incorporate in India for meeting priority sector lending norms. RBI has laid down a yearly roadmap for the same.

Use of Credit Rating and Parent / Head Office Support

It is proposed to treat WOS of foreign banks at par with domestic banks in this regard. Hence the parent company would not be allowed to give explicit guarantees to the creditors for the liabilities of the subsidiary. Else the WOSs would have an unfair advantage over domestic banks in terms of lending, raising resources etc.

Others

•           Contrary to industry demand for exemption from tax, RBI has directed foreign banks to approach the appropriate authority for suitable clarifications on the tax implications of the conversion of branch to WOS.

•           For the purpose of declaration of dividends, WOSs of foreign banks will be allowed to declare dividends subject to fulfillment of criteria laid down by RBI under the prevailing guidelines for domestic banks.

•           As regards setting up of Non-Banking Financial Companies (NBFCs) by foreign groups, RBI does not view favorably setting up of subsidiaries by the WOS or significant investment in associates for activities that can be undertaken within the bank.

•           Currently, limits are imposed on an Indian bank for downstream investments that can be made by it in a subsidiary company, financial services company etc. RBI may impose the same limitations to WOS of foreign banks too.

•           The issue of listing by a WOS or allowing mergers between Indian private sector banks and foreign banks may be considered only after review of experience gained on the functioning of WOS of foreign banks in India.

Comments

With a view to restrict the systemic risk in times of distress, WOS is being advocated and encouraged by RBI. At the same time, RBI is trying to ensure that the local banking system is not dominated by foreign banks.

The fact that full national treatment has not been accorded to such WOS and also the absence of one-time tax exemption on conversion of branch to a subsidiary model may prove to be a dampener. Ultimately the final shape and form of the final guidelines would determine the course of action that foreign banks may choose.

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