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India Clears Way for Bigger Foreign Investment in Banks

Thomas Brown | Digital Vision | Getty Images

The Indian parliament cleared a path for more foreign investment in the banking sector by approving a bill to increase shareholders' voting rights, after dropping a controversial clause allowing banks to trade in commodity futures.

Prime Minister Manmohan Singh's government is racing against the clock to pass reforms economists say are needed to breathe life into Asia's third-largest economy, which is headed for the worst year of growth in a decade.

Progress so far has been slow.

(Read More: New Reforms — But Will India Embrace Foreign Investors?)

The banking bill is the only piece of major reform legislation to be passed in a parliament session again disrupted by protests and shouting matches. The session ends on Thursday.

Finance Minister P. Chidambaram told parliament the government was abandoning efforts to pass a bill this session to open India's cash-strapped insurance sector to foreign investment - a move eagerly watched by investors.

Another bill aimed at easing land acquisition for infrastructure and mining projects was also deferred to next year.

The banking bill will increase shareholders' voting rights to 26 percent from 10 percent in private sector banks, making investment more attractive to foreign players.

The bill will now move to the upper house of parliament for voting on Thursday, where it is also likely to be passed as it is backed by India's two biggest parties.

The legislation clears the way for more corporate houses to run banks by enabling the Reserve Bank of India (RBI) to issue new bank licences. That will boost the government's drive to expand access to financial services in a country where more than half the 1.2 billion population is without a bank account.

(Read More: What Will It Take for India to Cut Rates?)

"The raising of voting cap will have a positive impact in attracting funds as it will help foreign investors to have more say in banks," said Jagannadham Thunguntla, head of research at brokerage firm SMC Global Securities.

The main opposition party Bharatiya Janata Party (BJP) threw its weight behind the bill after the government dropped a clause allowing banks to trade commodities futures amid fears it could lead to risky, speculative trading.

"It will lead to better investor interest in the smaller private sector banks. It is also a sentiment booster, and it will pave the way for the Reserve Bank of India to issue new banking licences," said Sujan Hajra, chief economist at Anand Rathi Securities in Mumbai.

Having More Say

India has struggled for years to reform and liberalise state-dominated sectors such as banking, insurance and pensions due to political opposition, including from within the ruling Congress party.

The banking bill will give the RBI greater regulatory oversight over local banks and the ability to overrule boards when the banks are facing financial difficulties. The RBI had demanded more oversight as a precondition to issuing new banking licences.

(Read More: Indian Bourse Picks Banks for $1 Billion New Listing)

The bill also enables the government to raise voting rights in state banks such as the State Bank of India to 10 percent from just 1 percent now, acceding partially to foreign investors' demands to have more say in Indian banking.

The bank employees unions, reluctant that any control is ceded, have strongly opposed this move for years and are set to strike on Thursday in protest.

The bill will allow foreign banks to convert their Indian operations into local subsidiaries or transfer shareholding to a holding company of the bank without paying stamp duty.

Foreign banks have long sought these changes to the law which they say would encourage them to expand their operations in India. Under current laws, foreign banks such as Citibank and Standard Chartered have to pay 20-30 percent tax as capital gains and stamp duty when transferring branches to a new legal entity.

Contact Asia Economy

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