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India gives foreign banks new door into local market

A man exits a HDFC Bank branch in Mumbai, India.
Dhiraj Singh | Bloomberg | Getty Images
A man exits a HDFC Bank branch in Mumbai, India.

India's central bank unveiled late Wednesday a far-reaching set of regulations to allow foreign banks into the country's long-protected domestic market. But it demanded that they do so through subsidiaries incorporated in India and said that eligibility would be limited to banks from countries that reciprocate by letting in Indian banks.

Despite those two conditions, the new regulations are significant in that they allow greater competition in a country with a reputation for being difficult for foreign companies.

The shift in direction is all the more notable because India has a history of opposing demands from wealthy countries for more open trade in goods and service and has even organized campaigns by developing countries against such demands during negotiations at the World Trade Organization and other multilateral organizations.

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New rules for foreign banks have been under discussion here for years. The abrupt release of the latest regulations after the close of trading on Wednesday represents the most recent in a series of moves to increase competition in financial services by Raghuram Rajan, the prominent economist who became the governor of the Reserve Bank of India, the central bank, on Sept. 4.

Mr. Rajan said in an interview at the bank's headquarters that the net effect of the new rules would be to let foreign banks, including American banks, compete on a nearly equal footing with domestic banks.

"They will have access, provided they come through the wholly owned subsidiary route and abide by the guidelines," he said.

"There will be a lot more freedom for foreign banks here," he said, sitting next to a window with a sweeping view of south Mumbai. "On net, it will be a tremendous opening to them, so I think they should be happy."

A paper released by the central bank in late August said the main goal in allowing foreign banks in was to increase competition and efficiency in the local banking sector. The central bank wants to spur Indian banks to adopt more sophisticated financial services and risk management techniques.

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But the push to attract foreign banks that form subsidiaries — and perhaps take over small Indian banks — has drawn criticism in some quarters in India. After Mr. Rajan mentioned during a visit to Washington last month that he wanted to act on the issue, a spokesman for the opposition Bharatiya Janata Party complained that such overtures should be discussed in Parliament before being adopted.

The spokesman, Prakash Javadekar, said there was no evidence that foreign banks would deliver banking services to the poor.

"The experience of foreign banks in India is that they only compete with Indian banks in creamy business segments, and their contribution as far as financial inclusion is concerned is minimal and below expectations," Mr. Javadekar told The Indian Express, a daily newspaper. "Such a major announcement should have been first debated here taking into account the global experience."

In the interview, Mr. Rajan anticipated that issue, saying the new guidelines will require foreign banks to lend to the underprivileged in India, as domestic banks are required to do. "With that will come domestic responsibilities, the same responsibilities that the Indian banks have, to lend toward the underserved areas of the economy and the underserved sectors," he said, "but they have that anyway. The large foreign banks already have those requirements."

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Some foreign banks have been lukewarm toward setting up full subsidiaries in India. Global institutions like Citibank and HSBC do business here using small branches or representative offices from their operations in other countries.

The regulatory framework issued Wednesday requires that foreign banks invest a hefty minimum of 5 billion rupees ($80 million) in equity capital in each subsidiary.

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The new rules also require separate boards for each subsidiary. Two-thirds of the directors must not be executives of the bank and at least half of the directors must be Indian citizens.

Such boards will not only require additional expense and organization for the foreign banks, compared with operating through branches, but will also force the banks to open their books to outside directors, raising the possibility that business secrets would leak.

Regulations already allow foreign banks to convert their branches in India into wholly owned subsidiaries. Foreign banks have not done so because they had little incentive. The new rules create that incentive by allowing foreign banks to open branches all over the country with few limits if they set up subsidiaries. India currently allows just 15 or so new branches a year to be opened by all foreign banks combined.

The central bank said it would impose limits if foreign banks gained too large a share of the domestic market through the subsidiaries, but did not specify the threshold for this.

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Sujan Hajra, the chief economist at AnandRathi, a financial services company based in Mumbai, said that setting up local subsidiaries in India would probably force foreign banks to lend considerably more to the country's agricultural sector under rules that apply to domestic banks.

India has just one branch of a foreign bank for every three million people and has allowed these branches to open only under pressure from the W.T.O. The branches are almost entirely in a few big cities like New Delhi and Mumbai.

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