Even while the issue of granting bank licences to a few private banks is gaining traction, the Reserve Bank of India (RBI) has released important guidelines for foreign banks to participate in the Indian financial sector in a bigger way than what has been possible so far.

The two developments have one common objective — they are meant to deepen the financial sector. If all goes well, a few new private sector banks will advent in early 2014. At the moment, there are 26 applicants, who have met the stiff eligibility criteria, and are being vetted by an independent committee of experts headed by former RBI Governor Bimal Jalan.

Awarding licences to corporates has been the most contentious issue in the new licensing policy, but once the decision was made, a few of the India’s biggest companies have put in their applications.

The major theme

The framework for foreign banks has one major theme — the formation of wholly-owned subsidiaries (WOS) for furthering their business in India. The RBI guidelines make it clear that the WOS model is what the regulator would prefer the foreign banks to have. Suitable incentives are being given to new as well as existing players operating through their branches in India to adopt the subsidiary route and incorporate locally.

Origin of policy

Like the new private bank licensing policy, the framework for foreign banks has passed through several stages.

The origin of the new policy is to be traced to the year 2004 when the government relaxed the foreign direct investment (FDI) limits to 74 per cent in private sector banks. Simultaneously, foreign banks were permitted to set up a 100 per cent wholly-owned subsidiary in India subject to certain conditions. A detailed roadmap for operationalising the FDI guidelines, in two stages, was issued subsequently. Then, as now, the objective was to encourage foreign banks to take the WOS route. But in the absence of any incentives, no bank came forward to set up or convert their branches into WOS.

If the latest policy is to succeed and attract new foreign banks in the WOS route, the type of incentives naturally matter. Great significance is attached to the proviso that a locally incorporated WOS will be given near-national treatment, which, for all purposes, will place them on a par with Indian banks.

For instance, they can open branches anywhere in the country (except in sensitive areas where RBI prior approval will be required). It is expected that foreign banks already operating branches in India will also see in the national treatment a big advantage and convert themselves into WOS and participate in all financial sector activities. The WOS will have a minimum paid-up capital of Rs.500 crore, which is what has been stipulated for the new private banks.

Corporate guidelines for the WOS include a proviso that not less than 50 per cent of the directors should be Indian nationals/NRIs/PIOs.

Further, not less than two-thirds of the directors should be non-executive directors and a minimum of one-third of the directors should be independent of the subsidiary.

The fear of foreign banks taking over the Indian financial sector has been there ever since the FDI rules were liberalised.

To assuage such apprehensions, restrictions would be placed on further entry of new WOS of foreign banks/capital infusion, when the capital and reserves of foreign banks and their wholly-owned subsidiaries exceed 20 per cent of the capital and reserves of the banking system,

This stipulation is unlikely to satisfy either the foreign banks or those who want the RBI to spell out a more workable system of restraining them.

On the foreign banks taking over small private banks, the guidelines are circumspect. The RBI would wait and watch before allowing mergers and acquisitions.

Evidently, how foreign banks fare in the new dispensation will matter.

That, in fact, is something everyone would be interested in. Some of the foreign banks have had a long association with India.

Yet, in terms of volume of business and balance sheet expansion, even the world’s largest banks have been laggards. While in the past they could blame restrictive policies, they probably have a more conducive environment now.

However, it is too simplistic to assume that they would rush in and make a big impact anytime soon.