 "Subsidiarisation: a non-starter?")
The Reserve Bank of India's (RBI's) initial effort to convince foreign banks to create wholly-owned subsidiaries (WOS) in the country is turning out to be futile. The banking regulator had offered foreign lenders the option of converting their India branches into subsidiaries between March 2005 and March 2009. But none of the foreign banks came forward to set up or convert their branches into WOS in the absence of adequate incentives.
This time, after taking feedback from bankers, RBI has decided to offer foreign banks incentives to persuade them to set up subsidiaries in India. Foreign banks will not have to pay capital gains tax and stamp duty for converting their India branches into WOS. The lenders have also been promised 'near-national' treatment in branch expansion and will be permitted to acquire local private banks if they opt for the subsidiary mode of presence.
"The regulator is going a long way to meet the demands of foreign banks. Now, it is up to them to take this reform constructively and use it for a larger presence in India," Ashvin Parekh, senior expert and advisor at Ernst & Young (E&Y) in India, told Business Standard.
RBI had clarified that the government had inserted, through the Finance Act, 2012, a new chapter in the Income Tax Act, 1961 that exempted foreign lenders from paying capital gains tax while converting their branches into subsidiaries. This rule is effective from April 1, 2013.
But bankers feel that clarity is also needed in certain other areas of taxation before they decide to set up subsidiaries in India. For instance, some foreign lenders had requested the government and the central bank to consider deducting expenses incurred for creating a subsidiary from their taxable income. It is still not known if such relaxation will be permitted.
Uncertainty also remains on the stamp duty front. RBI said that a new section - '8E' - has been inserted in the Indian Stamp Act, 1899 vide Banking Laws (Amendment) Act, 2012 and notified in the Gazette of India Notification dated January 18, 2013. It exempts foreign lenders from payment of stamp duty on converting their India branches into subsidiaries.
"We understand that stamp duty is a state subject. We are not sure if the central government through a gazette notification can over-ride state laws. We need to be absolutely certain that we don't have to pay stamp duty before we decide to create a subsidiary here," a senior banker, who is part of the compliance team of a mid-sized foreign bank in India, said on condition of anonymity.
While RBI has promised 'near-national' treatment in branch expansion to foreign lenders that opt for subsidiarisation, not all of them are expected to get unfettered branch access in India even if they set up WOS here. The reciprocity clause - one of the cardinal principles in the new guidelines for foreign banks' subsidiarisation, released by RBI in November 2013 - is likely to prove a major hurdle.
As per this clause, foreign lenders creating subsidiaries will be given 'near-national' treatment only if their home countries allowed Indian banks to open branches without much restriction. Hence, banks from the US and a few other European nations may not be permitted to open as many branches as they want, even if they set up subsidiaries in India.
Also, RBI wants WOS of foreign banks to open at least one-fourth of their branches in unbanked rural markets during a financial year. Bankers said in such areas branches take at least 24-36 months to break even, and often these branches never turn profitable. Many fear that these branches will stress the overall profitability of foreign banks in India.
Foreign banks also believe that they do not have the required expertise and risk management framework to meet stiff priority sector lending targets. RBI has said the priority sector lending requirement for WOS of foreign banks will be 40 per cent, just like their Indian rivals. Out of this, 18 per cent of loans have to be offered to the farm sector.
"There is absolutely no doubt that the requirement of an 18 per cent agriculture loan target is a very significant hurdle to growth for foreign banks. Even Indian public sector banks are not able to consistently deliver those targets," Stuart Milne, chief executive officer of Hongkong and Shanghai Banking Corporation (HSBC) in India, said in Business Standard's annual banking round table event in Mumbai in November 2013.
Doubts also remain if foreign lenders will be able to expand inorganically in India. While not many Indian private banks with stable asset quality will be available for acquisition, employee unions are also expected to prevent foreign lenders from buying some of these banks.
"It will not be easy - once a subsidiary is formed, the foreign lender cannot immediately acquire domestic banks. The foreign bank has to meet all criteria, especially those pertaining to the priority sector, and prove their credentials. After that, the central bank may consider allowing them to take the M&A (merger and acquisition) route," said the chief executive of a foreign bank in India.
Current rules do not permit a foreign lender to acquire an Indian bank. Also, while foreign investors can hold up to 74 per cent in an Indian private bank, a single entity is not allowed to own more than a five per cent stake in a local lender.
Bankers admit that meeting the initial minimum capital requirement of Rs 500 crore for foreign banks' WOS may not be difficult for most lenders. But they feel that in order to compete with local banks, the investment requirement will be much higher. At a time when many global banks are focusing on capital conservation, they may not be keen to make large investments in setting up WOS in India.
At the end of March 2013 there were 43 foreign banks in India with a network of 333 branches. While RBI has not made the WOS structure mandatory for existing foreign banks (which commenced banking business in India before August 2010), it said that banks that do not provide adequate disclosure in their home jurisdiction, have complex structures or are not widely held will have to set up subsidiaries in India. It further added that foreign lenders that become systemically important on account of their balance sheet size in India will have to convert their branches into WOS.
Also, foreign banks that entered India after August 2010 will have to mandatorily convert their branches into WOS. Nine foreign banks have started banking business in India after August 2010.
To prevent domination by foreign banks, RBI said it will impose restrictions on the setting up of new WOS if the capital and reserves of the subsidiaries and branches of foreign lenders in India exceed 20 per cent of the capital and reserves of the banking system.
With not many foreign lenders keen in creating subsidiaries, such restrictions are unlikely to be enforced soon.
This time, after taking feedback from bankers, RBI has decided to offer foreign banks incentives to persuade them to set up subsidiaries in India. Foreign banks will not have to pay capital gains tax and stamp duty for converting their India branches into WOS. The lenders have also been promised 'near-national' treatment in branch expansion and will be permitted to acquire local private banks if they opt for the subsidiary mode of presence.
"The regulator is going a long way to meet the demands of foreign banks. Now, it is up to them to take this reform constructively and use it for a larger presence in India," Ashvin Parekh, senior expert and advisor at Ernst & Young (E&Y) in India, told Business Standard.
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Most foreign banks, however, appear unimpressed and are reluctant to create subsidiaries in India.
RBI had clarified that the government had inserted, through the Finance Act, 2012, a new chapter in the Income Tax Act, 1961 that exempted foreign lenders from paying capital gains tax while converting their branches into subsidiaries. This rule is effective from April 1, 2013.
But bankers feel that clarity is also needed in certain other areas of taxation before they decide to set up subsidiaries in India. For instance, some foreign lenders had requested the government and the central bank to consider deducting expenses incurred for creating a subsidiary from their taxable income. It is still not known if such relaxation will be permitted.
Uncertainty also remains on the stamp duty front. RBI said that a new section - '8E' - has been inserted in the Indian Stamp Act, 1899 vide Banking Laws (Amendment) Act, 2012 and notified in the Gazette of India Notification dated January 18, 2013. It exempts foreign lenders from payment of stamp duty on converting their India branches into subsidiaries.
"We understand that stamp duty is a state subject. We are not sure if the central government through a gazette notification can over-ride state laws. We need to be absolutely certain that we don't have to pay stamp duty before we decide to create a subsidiary here," a senior banker, who is part of the compliance team of a mid-sized foreign bank in India, said on condition of anonymity.
While RBI has promised 'near-national' treatment in branch expansion to foreign lenders that opt for subsidiarisation, not all of them are expected to get unfettered branch access in India even if they set up WOS here. The reciprocity clause - one of the cardinal principles in the new guidelines for foreign banks' subsidiarisation, released by RBI in November 2013 - is likely to prove a major hurdle.
As per this clause, foreign lenders creating subsidiaries will be given 'near-national' treatment only if their home countries allowed Indian banks to open branches without much restriction. Hence, banks from the US and a few other European nations may not be permitted to open as many branches as they want, even if they set up subsidiaries in India.
| SUBSIDIARIES: THE PROS AND CONS |
Incentives
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Also, RBI wants WOS of foreign banks to open at least one-fourth of their branches in unbanked rural markets during a financial year. Bankers said in such areas branches take at least 24-36 months to break even, and often these branches never turn profitable. Many fear that these branches will stress the overall profitability of foreign banks in India.
Foreign banks also believe that they do not have the required expertise and risk management framework to meet stiff priority sector lending targets. RBI has said the priority sector lending requirement for WOS of foreign banks will be 40 per cent, just like their Indian rivals. Out of this, 18 per cent of loans have to be offered to the farm sector.
"There is absolutely no doubt that the requirement of an 18 per cent agriculture loan target is a very significant hurdle to growth for foreign banks. Even Indian public sector banks are not able to consistently deliver those targets," Stuart Milne, chief executive officer of Hongkong and Shanghai Banking Corporation (HSBC) in India, said in Business Standard's annual banking round table event in Mumbai in November 2013.
Doubts also remain if foreign lenders will be able to expand inorganically in India. While not many Indian private banks with stable asset quality will be available for acquisition, employee unions are also expected to prevent foreign lenders from buying some of these banks.
"It will not be easy - once a subsidiary is formed, the foreign lender cannot immediately acquire domestic banks. The foreign bank has to meet all criteria, especially those pertaining to the priority sector, and prove their credentials. After that, the central bank may consider allowing them to take the M&A (merger and acquisition) route," said the chief executive of a foreign bank in India.
Current rules do not permit a foreign lender to acquire an Indian bank. Also, while foreign investors can hold up to 74 per cent in an Indian private bank, a single entity is not allowed to own more than a five per cent stake in a local lender.
Bankers admit that meeting the initial minimum capital requirement of Rs 500 crore for foreign banks' WOS may not be difficult for most lenders. But they feel that in order to compete with local banks, the investment requirement will be much higher. At a time when many global banks are focusing on capital conservation, they may not be keen to make large investments in setting up WOS in India.
At the end of March 2013 there were 43 foreign banks in India with a network of 333 branches. While RBI has not made the WOS structure mandatory for existing foreign banks (which commenced banking business in India before August 2010), it said that banks that do not provide adequate disclosure in their home jurisdiction, have complex structures or are not widely held will have to set up subsidiaries in India. It further added that foreign lenders that become systemically important on account of their balance sheet size in India will have to convert their branches into WOS.
Also, foreign banks that entered India after August 2010 will have to mandatorily convert their branches into WOS. Nine foreign banks have started banking business in India after August 2010.
To prevent domination by foreign banks, RBI said it will impose restrictions on the setting up of new WOS if the capital and reserves of the subsidiaries and branches of foreign lenders in India exceed 20 per cent of the capital and reserves of the banking system.
With not many foreign lenders keen in creating subsidiaries, such restrictions are unlikely to be enforced soon.