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India may find few takers for new foreign bank rules

Adam Jeffery | CNBC

India's move to encourage foreign banks such as Citigroup and HSBC to reposition as wholly-owned subsidiaries may find just a handful of takers, given the regulatory trade-off.

Under the Reserve Bank of India (RBI) rules announced late on Wednesday, foreign banks which convert their local operations from a branch structure to being subsidiaries will be treated on nearly equal terms with local lenders.

(Read more: India gives foreign banks new door into local market)

This could open the way to them opening more outlets across India and could also allow them to buy local private sector banks - potentially a major lure as banks seek to tap into the fast-growing Indian economy.

The rules are aimed at giving India greater regulatory power over foreign banks in the wake of the global financial crisis.

Yet foreign banks would also face a bigger regulatory burden in the subsidiary setup, including having to earmark 40 percent of their lending to the "priority sector," which includes undeserved parts of the economy and agriculture.

That's a requirement that domestic banks must already meet and is being phased in for foreign banks with 20 or more branches. As a subsidiary, a foreign bank would also need approval to tap its parent's balance sheet, something it doesn't need under existing rules.

The new rules come as global financial firms have been paring back their investment in non-core markets.

(Read more: The 'sexy' central banker who's causing a stir)

"The environment has changed, both in India and overseas. Only a handful of banks who have retail banking ambitions will consider it," said a senior banker with a large U.S. bank, declining to be named given the sensitivity of the matter.

The 43 foreign banks in India account for less than half a percent of the country's 92,114 banking outlets. Under exiting rules, foreign banks can open up to just 12 branches between them per year in India.

Citigroup, HSBC and Standard Chartered are the biggest and operate as branches, not subsidiaries. They along with Singapore-based DBS Group, which has 12 branches, are widely seen as the likeliest to consider switching to subsidiaries.

"If you look at Citi, StanC or HSBC, they have an embedded India strategy, so it makes a lot of sense for them to convert because they are getting near-national treatment," said Abizer Diwaji, national leader for financial services at EY India.

(Read more: Raghuram Rajan: India's deficit is under control)

"The flip side is that they will have to commit (more) capital in India."

Achievable target

DBS India CEO Sanjiv Bhasin said the bank was evaluating the RBI guidelines. "If you read it, it looks intimidating, but the fact is you have been given five years," Bhasin said, referring to the priority sector lending target. "It's difficult but it's certainly achievable".

Citigroup and HSBC declined comment. StanChart welcomed the guidelines but said it was too early to comment in detail.

In recent years, Barclays has exited retail banking in India and Royal Bank of Scotland has sold its Indian credit cards, mortgage and commercial banking portfolios, part of a broader trend by global banks looking to shore up their capital base to meet regulatory requirements.

(Read more: Is India's economy finally getting its groove back?)

"Most of the foreign banks in India have moved away from retail banking and are now focusing on corporate banking," said the India operations head of a European bank who declined to be named.

Under the new rules for wholly-owned subsidiaries, foreign banks can buy a local private-sector lender after a central bank review of overall foreign bank penetration.

To prevent foreign domination of the banking sector, the central bank will restrict further entry of new wholly owned subsidiaries of foreign banks if the assets of institutions owned abroad exceed 20 percent of the country's total.

Currently, foreign banks' capital, reserves and surplus account for 15 percent of the overall banking sector, even though foreign banks have less than 5 percent of industry deposits, leaving little room for big acquisitions.

(Read more: Soaring India stocks have strategists on edge)

India's banking system is dominated by state banks, which accounted for more than two-thirds of industry assets at the end of March 2012, the latest RBI data showed.

Foreign banks operating in India before August 2010 have the option of continuing as branches. "However, they will be incentivized to convert into WOS (wholly owned subsidiaries) because of the attractiveness of the near-national treatment afforded to WOS," the central bank said.

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