Banking on reform

The new Act could nudge the sector towards the goals of financial inclusion and growth

When it comes to economic policy, it is better to be safe than sorry because decisions once taken cannot be reversed easily. This is true of the Banking Laws (Amendment) Bill, 2012, which was passed by Parliament on December 20. The amendments to the existing laws will be followed up by the RBI through suitable policies. The reforms will not transform the landscape of banking in India, or fully open up the sector to foreigners and industrial houses, though it will admit a few of the serious ones from among them.

But there seems to be a grudging acceptance that the current structure of Indian banking is not helping the expansion of banking services, thereby putting the government's financial inclusion and growth objectives at risk. It is widely believed that, in comparison with the rest of the world, banking penetration in India is low and profits are high. Therefore, more competition would help. Enter private and foreign banks.

Foreign banks in India currently operate as branches of their foreign parent. But it makes sense for many of them to become Indian subsidiaries of the foreign parent, which would give them access to cheaper funds and more freedom to expand. The RBI would also like that, as the subsidiary will then appoint its own CEO and board of directors, making it more accountable to Indian depositors than in the current system, where the branch reports to the foreign headquarters. Moreover, the RBI will get greater supervisory control over the bank, especially in times of crisis. The reforms have paved the way for all this by removing the stamp duty that would have previously been imposed on foreign bank branches during their conversion to subsidiaries. However, there is still a lack of clarity on whether tax will be imposed on capital gains arising from the conversion. The government has not exactly covered itself in glory when it comes to tax on foreign entities, which may make foreign banks wary.

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