RBI releases policy framework for foreign banks

RBI has released its policy framework for foreign banks in India, that offers near national treatment to foreign banks In India, if they opt for presence via a wholly owned subsidiary (WOS). In our view, with this framework in place, there is now much greater likelihood of foreign banks looking to seriously expand their

operations in India.

Reciprocity may not be a stumbling block: Though some clarity is awaited as regards what reciprocity would entail, however the main policy objective appears to be increasing competition, increasing availability of capital and accelerating financial penetration, rather than clearing hurdles for Indian banks to majorly increase presence abroad (which does not appear to be a major strategic priority for them at present in any case). Hence, the condition of reciprocity may not be a stumbling deterrent.

Nor, PSL requirements: Priority sector lending requirements may be seen as another deterrent (notwithstanding five-year transition period for existing foreign banks). However, we note that new private banks which have started from scratch have managed superior profitability (20% plus RoEs), while managing the compliance with the PSL norms utilizing various modes like securitization, RIDF investments etc.

Current position of foreign banks in India: Major foreign banks like Citi Bank, Standard Chartered, HSBC India, Deutsche Bank and few others have credit market share exceeding 0.25% of total Indian Banking sector (1.1% each for the largest - Citi & Standard Chartered).

As a sub-group, foreign banks have about 6% market share of investments & credit put together (likely higher share including off-balance sheet items), which has declined by about 100bp since the Lehman crisis. This share is well below the 20% and even 15% thresholds that would trigger RBI restrictions on expansion of foreign banks’ business in India. Hence, this policy framework is likely to lead to further increased competition in the sector (apart from new domestic entrants) and reinforces our medium to long-term view of accelerated market share loss for PSU banks.

Makes M&A transactions more likely: The framework specifies that the RBI may allow foreign banks to merge/acquire domestic private banks, subject to its satisfactory review of functioning of foreign banks in India, overall 20% threshold and also within the overall FDI limit of 74% in any private bank. It opens the possibility for the foreign banks to dilute stake to 74% in their WOS and list on Indian exchanges. Promoters of domestic banks need to bring down their stake over time, and it’s not clear if this would apply to foreign bank WOS once it lists in India and/or acquires an Indian bank.

Salient highlights of policy framework are as follows

 Conditions which necessitate WOS form of presence: Foreign banks which endure any of the following criteria would be mandatorily required to operate in India through the WOS mode only. Foreign banks, which do not fall under below conditions, can opt for a branch or WOS form of Indian presence.

i) has complex structures,

ii) which do not provide adequate disclosure in their home jurisdiction,

iii) which are not widely held,

iv) which belong to a jurisdictions where preferential claim to depositors of home country is given in a winding up proceedings,

v) for a bank setup after August 2010, if that bank becomes systematically important by having assets more than 0.25% of Indian banking system asset’s,

 No restrictions on branch expansion: WOSs would be able to open branches anywhere in the country at par with Indian banks, except in certain sensitive areas where RBI’s prior approval would be required.

 Safeguards to prevent domination by foreign banks: To provide safeguards against the possibility of the Indian banking system being dominated by foreign banks, the framework specifies that in case the capital and reserves of the foreign banks (ie WOSs and foreign bank branches) in India exceed 20% of the capital and reserves of the banking system, restrictions would be placed on further entry of new WOSs of foreign banks and capital infusion into the existing WOSs of foreign banks. As regards foreign banks in branch mode of

presence, as per the WTO commitments, licences for new foreign banks may be denied when the assets in India (both on and off balance sheet) of foreign banks’ branches exceed 15% of total assets of Indian banking system

 Minimum paid up capital to be `500cr: The initial minimum paid-up voting equity capital for a WOS shall be `500cr for new entrants. Existing branches of foreign banks converting into a WOS shall have a minimum net worth of Rs.500cr.

 Corporate Governance requirements: WOSs shall have (i) not less than twothird of the directors as non-executive; (ii) a minimum of one-third of the directors as independent and (iii) a minimum 50% of the directors should be Indian nationals /NRIs/PIOs subject to the condition that not less than onethird of the directors are Indian nationals resident in India.

 PSL requirement would be 40%: Just like any other domestic scheduled bank,PSL requirement for WOSs would be 40%, with 5 year transition period (which would end on March 31, 2018) for existing foreign bank branches converting into WOS.

 Option for diluting stake exists, but in that case listing required: WOSs may, at their option, dilute their stake to 74% or less in accordance with the existing FDI policy. In the event of dilution, they will have to list themselves.

 M&A permitted subject to RBI’s review of functioning of foreign banks and foreign investment in Indian banks: In its policy framework, the RBI says it may allow foreign banks to buy Pvt. banks after it makes a review of functioning of foreign banks and foreign investment in Indian banks, but it should not exceed

overall FDI limit of 74% in any private bank.

DISCLAIMER -

Nothing in this post should be construed as investment or financial advice. Each reader of this post should make such investigations as they deem necessary to arrive at an independent evaluation of an investment in the securities of the companies referred to in this document (including the merits and risks involved), and should consult their own advisors to determine the merits and risks of such an investment.