Reserve Bank of India

Sound Technical Capacity Building Workshop on Afganistan’s Accession to WTO

Deepak SinghalRegional Director, New Delhi

Reserve Bank of India

Experience from India in opening and regulating the banking sector - An Introduction

Reserve Bank of India

Why Regulate Financial Sector n To Preserve Systemic Stability and preventing

Contagion effect

n To ensure public confidence and orderly development ofmarket

n Regulation of banking important to ensure depositor’sinterests.q Banks are “special” as they accept and deploy large amount of public money in

fiduciary capacity. q Leverage funds through credit creationq Because of their role in the payment and settlement systems

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Role of RBI as Regulator & Supervisorn RBI as regulator and supervisor of banking system overseas:

n Commercial Banksn All India Financial Institutionsn Urban Cooperative Banks n Regional Rural Banks, District Central Coop Banks and State

Coop Banks n NBFCs

n Range of activities as regulator : n Licensingn Prescribing capital requirementsn Monitoring governancen Setting prudential regulation to ensure solvency & liquidity of anks n Prescribing lending to certain priority sectorsn Initiating new regulation

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Other regulators in financial Sector n Security Exchange Board of India

n Insurance Regulatory and Development Authority

n Pension Fund Regulatory and Development Authority

n Financial Stability & Development Council (FSDC) -Apex Council headed by FM, with explicit intention ofstrengthening and institutionalising the mechanism formaintaining financial stability. Financial sector regulatorslike SEBI, RBI, PFRDA and IRDA are the members ofFSDC.

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Overview of banking sector as on March 31, 2012

Parameter Public Sector banks

Private Sector banks

Foreign banks

All SCBs

Number of banks 26 20 40 86Number of branches

69498 13408 323 83229

Share in total capital

58.43% 26.18% 15.39% 100%

Share in total deposits

77.51% 18.20% 4.29% 100%

Share in total advances

76.43% 19.04% 4.53% 100%

ROA 0.88 1.53 1.76 1.08CRAR 13.23 16.21 16.76 14.25Net NPAs 1.53 0.46 0.61 1.28

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Foreign banks

n As on March 31, 2012, there were 40 foreign banks with 323 offices operating in India.

n The balance sheet assets accounted for 7% of the total assets of SCBs as on March 31, 2012 as against 8.5% as on March 31, 2009.

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Year Share of assets of foreign banks in total SCB assets

End-Mar 1991 4.7

End-Mar 1995 6.5

End-Mar 2000 7.2

End-Mar 2001 7.6

End-Mar 2002 7.0

End-Mar 2003 6.9

End-Mar 2004 6.9

End-Mar 2005 6.5

End-Mar 2006 7.2

End-Mar 2007 7.9

End-Mar 2008 8.4

End-Mar 2009 8.5

End-Mar 2010 7.2

End-Mar 2011 6.8

End-Mar 2012 7.0

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Year Share of Financial Sector in Services

Share of Banking in Services

Share of Insurance in Services

Share of Services* Sector in GDP

1950-51 2.8 2.1 0.7 34.6

1960-61 3.6 2.7 0.9 36.6

1970-71 4.2 3.2 1.1 40.9

1980-81 5.3 4.0 1.3 45.3

1990-91 7.8 6.4 1.4 49.6

2000-01 9.6 8.5 1.2 57.0

2010-11 12.6 10.2 2.4 65.2

Share of financial sector in Services Sector and GDP

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Current permissible FDI Sector Sectoral Cap Asset Reconstruction Companies 74% of paid up capital of ARC (FDI + FII) under Govt rule.

Banking – Private Sector 74% including investment by FIIs (Automatic upto 49%Govt route beyond 49% and upto 74%)

Banking – Public Sector 20% (FDI and Portfolio Investment) under Govt route

Commodity Exchanges 49% (FDI and FII) [Investment by Registered FII underPIS limited to 23% and Investment under FDI Schemelimited to 26% under Govt. route]

Credit Information Companies 49% (FDI and FII) under Govt. rule.

Infrastructure company in the Securities Market

49% (FDI and FII) [FDI Limit of 26% under Govt’sroute and an FII limit of 23% of the paid up capital)

Insurance 26% under automatic route

NBFCs (18 activities furthercategorised into fund basedand non-fund based)

100% under automatic route subject to compliance with minimum capitalisation norms.

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Case for opening up of domestic sectorto foreign participation

n Encourages competition and efficiencyn Better quality/modern methods of bankingn Better accounting and disclosure standardsn Expected to strengthen corporate governance, risk

management and technological competencen New Productsn Improved and more modern methods of

regulations/better quality supervision.n Better facilitated international trade

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Case against opening up of domesticsector

n Concerns for financial stability if foreign banks come todominate the domestic financial system.

n Competitive threat to domestic banks.

n Creaming/cherry picking may lead to deterioration inportfolio of domestic banks.

n Dependence on foreign capital.

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Foreign Banks Regulation in Indian Entry of foreign bank allowed under GATT under Mode 3 viz. commercial

presence.

n Policy on presence of foreign banks in India has followed two cardinal principlesof Reciprocity and Single Mode of Presence

n India gives a single class of banking licence to conduct both wholesale and retailbanking

n Full members of the clearing houses and payments system.

n Maiden branch is considered under the provisions of Sec 22 of the BR Act, 1949

n Host country regulations should not discriminate in any way against banks fromIndia.

n Deposit insurance cover available to all foreign banks at uniform rate of premium

n Broadly same Income Recognition and Asset Classification & exposure limits asapplicable to Indian banks.

n All SCBs allowed to set up offsite ATMs without prior approval of RBI

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Opening of branches by Foreign banks n Required to bring an assigned capital of US $25

million at the time of first branch in India.

n Submit their branch expansion plan on an annualbasis.

n Nature of banking facilities provided by banks inunder banked areas, actual credit flow to the prioritysector, pricing of products and overall efforts forpromoting financial inclusion, record of opening no-frills account & quality of customer service providedby the banks

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Opening of branches by Foreign banksn Track record of compliance - Reports from home country

supervisors soughtn Weightage given to even distribution of home countries of foreign

banksn Treatment extended to Indian banks in the home country of the

applicantn Bilateral and diplomatic relations between India and the home

countryn India’s commitments of 12 branches at WTOn Licences for new foreign banks may be denied when the

maximum share of assets in India both on and off balance sheetof foreign banks to total assets both on and off balance sheet ofthe banking system in India exceeds 15%.

n Subject to existing prudential norms like protection of investors,depositors & integrity of the financial system as permitted underGATS.

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Branches vs Subsidiaries-Regulatory perspective

Branch Form

Advantages Disadvantages

Greater operational flexibility Difficult to determine available assets to satisfy local creditor’s claim

Reduced corporate governance Assets easily transferred by the branch to foreign Head Office

Stronger support from parent No fiduciary responsibility to local clients

Subsidiary Form

Ring fencing of capital Comfort letter provided by parent not enforceable in times of stress

Easier to define laws Insolvency of parent has some effect

Own board of directors Failure of parent sometime results in failure of subsidiary due to central management of liquidity.

Enables host country authorities to act more independently

Subsidiaries tend to curtail their operations during crisis.

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Issues

n Branch Vs Subsidiary route?n Should subsidiaries be given full national treatment by

virtue of their local incorporation? If not what should bethe nature and extent of restrictions?

n Should the subsidiary form of presence be mandated forall new entrants or should it be selectively applied basedon certain parameters? and

n What approach should be adopted towards the existingbranches of foreign banks – whether incentives shouldbe provided to them to convert into subsidiaries?

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Measures to contain dominance of foreign banks

Possible measures As mandated by RBI

Restrictions on number of branches WTO commitment of 12 branches.Discretion to prescribe market accessand national treatment limitationconsistent with WTO/Internationalpractices and country’s requirement

Share of total banking assets Licenses may be denied if share ofassets exceeds 15% of total assets

Minimum capital Min cap req of `3 bn

Eligibility of parent bank Parent bank to be subjected toadequate prudential supervision,approval of home country regulatorand other factors viz. Intl presence,rating, ownership pattern, financialsoundness, etc considered

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Possible measures As mandated by RBI

Mandated presence in certain form if certain conditions are met

Certain category of banks mandatedto have entry only through subsidiaryroute viz. banks incorporated injurisdictions providing preferentialclaim in winding up, inadequatedisclosures, complex structures,closely held, etc.

Share of capital in banking system Restrictions on further entry andbranch expansion when capital andreserves of foreign banks exceed 25%of capital of banking system

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Lessons from the Global Crisis n Crisis has shown that in countries where foreign banks

had large presence and share had tended tosubstantially curtail their operations/withdraw from thehost country when the home countries were afflicted.

n Indian experience in this regard has been no exception.

n Foreign banks had withdrawn substantially from thecredit markets in India to the extent that year-on-yeargrowth of credit was -7.1% (as on July 3, 2009) and -15.9% (as on October 9, 2009).

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n In India, foreign banks not only withdrew from the creditmarket, they also hoarded liquidity with their HeadOffices.

n Thus, a gradual/calibrated approach to opening up ofdomestic banking sector is the preferred approach.

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Thank you