Open question

RBI's incentives for foreign banks are well-intentioned, but they may not be effective.

The RBI, on Wednesday, unveiled its roadmap for foreign banks operating in India. In an attempt to incentivise existing branches of foreign banks to convert into wholly-owned subsidiaries (WOS) of their parent banks, it announced that the ones that do so will get "near-national treatment". By being treated at par with domestic scheduled commercial banks, WOS will be able to take advantage of the RBI's liberalised branch expansion guidelines, which are not applicable to branches of foreign banks. Importantly, WOS will also be allowed, subject to regulatory approval, to acquire up to 74 per cent of a private domestic bank.

When the going is good the regulatory benefit of WOS may not be apparent. But in times of crisis, moving away from the branch model has several benefits. Branches of foreign banks are not separate legal entities. Local incorporation makes their asset and liability base easier to assess and gives them their own board of directors. This model brings foreign banks under the firm regulatory control of the RBI and leaves no doubt as to the legal jurisdiction appropriate to them. Especially after the financial crisis, which witnessed unprecedented bank failures, this clarity is welcome as it helps to protect local creditors' and depositors' interests by ring-fencing a bank's assets.

How effective the incentives for subsidiarisation are going to be is an open question. WOS will be treated like domestic banks as far as the RBI's branch guidelines are concerned. However, this will only prove to be tempting if foreign banks aim to expand in the retail segment. Currently, foreign banks like HSBC and Citibank seem more invested in trade and corporate finance. It is unlikely that liberal branch expansion rules will be a game changer for them. Additionally, WOS will have to comply with the RBI's priority sector lending norms ó 40 per cent of the bank's adjusted net bank credit will have to be allocated to certain underserved sectors of the economy ó which will mean a significant rejig of their portfolios. While the M&A rules applicable to subsidiaries are certainly a sweetener, foreign banks will likely wait for clarity on the capital tax implications of subsidiarisation before taking a call on changing their Indian business models.

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