Will foreign banks make a beeline to acquire Indian private banks?

Opportunities hunt is on

Ashvin Parekh
Partner, Deloitte & Touche

Liberalisation of the banking sector plays an important role as it will ease fund flows to the concerned economies. It is in this context that ownership and shareholding will play a significant part.

Foreign players "" who are looking at jointly working with Indian banks from the point of view of trade finance, BPO or outsourcing banking processes "" are increasingly coming to India. Thus, taking stake in Indian banks is becoming more and more important.

Foreign banks and entities have always been interested in the Indian banking environment. However, they faced two key constraints in terms of the foreign shareholding having been restricted to 49 per cent, and the 10 per cent cap on voting rights. The government recently rectified the situation partially.

Today greater participation by foreign players is required in light of the changes taking place in banking. The new 90-day norm for recognition of sticky assets will require banks to make greater provisioning. This will put pressure on capital requirement and increase the need for more capital.

Further, as and when the Basle II recommendations are adopted, there will be huge demand for capital by the banking sector. If investments were to flow in from foreign players, they will give a greater boost to the total capital demand.

Since the government has enhanced the possible shareholding by foreign entities from 49 per cent to 74 per cent in private sector banks, this will afford greater control by foreign entities.

Investors will be more watchful about the financial performance of their Indian subsidiaries, and bring in hte best practices and product knowledge transfer. These practices will help in the development of the banking sector.

Trade is another area that would invite greater financial participation from foreign players. The recent liberalisation in the form of Indian residents being allowed to remit up to $25,000 every year will see flows both to and fro India.

The banking sector again would be required to provide the necessary channelling of investments in and out of the country.

Their expertise in the form of advisory services would also be in demand. These entities could then look at taking a larger stake in domestic banks in order to ensure greater vigilance and control.

With banks moving away from transaction handling and settlement to wealth management of customers, one can expect a good number of banks having these expertise looking at India.

Many are likely to increase their stake in Indian banks. A good example of this is HSBC, which recently took significant stake in UTI Bank and has expressed interest in enhancing its investment in the private sector bank.

Similarly, banks like Standard Chartered Bank and Citibank, which are looking at enhancing their presence in the country, would look at acquisition through the 74 per cent route a viable option today.

Finally, a note of caution: Considering the increasing threat of money laundering, the Indian banking sector will need to be more careful in terms of where the investment is coming from. The regulator will need to be more vigilant in this regard.

Some glitches to take care of

R Maheshwari
Head-Financial Sector Ratings, Crisil

The recent government notification on the subject eliminates one of the most important hurdles in consolidation of the sector. Now a foreign bank can operate either through a 'branch model' or a 'subsidiary model'. This opens up the prospect for inorganic growth for a foreign bank by acquisition of an existing private bank.

However, the restriction of potential takeover targets to private sector banks limits the choices. Additionally, the voting rights limitation, which pose a significant impediment in the exercise of effective management control by an acquirer, continues to dampen the interest of foreign investors in Indian banks. Until these issues are resolved, the Indian banking system is unlikely to see major acquisition activity by foreign banks.

So far, a foreign bank could only have conducted banking business in India by opening branches as an extension of its international operations (known as 'the branch model'). Organic growth in this model - by opening new branches - was possible at a pace that was much slower than that possible for a domestic bank.

Even now, the speed of availability of new branch licenses may not be sufficient for a foreign bank establishing itself as a 'mass bank' as quickly as a domestic bank can.

The branch model also ruled out equity-oriented alliances, mergers and acquisitions. In effect, there is virtually no way for inorganic growth of a foreign bank in India. Moreover, in the branch model unless specifically 'ring-fenced', the Indian liabilities are honourable by the international balance sheet.

Now that a foreign bank has the option of operating either through 'branch model' or 'subsidiary model', it can overcome some of the historical limitations. The only major limitation remains that of the ceiling on voting rights, at 10 per cent of the total voting rights of all shareholders of the bank. An amendment to the Banking Regulation Act, which includes provision for removal of this ceiling, is yet to be passed by Parliament.

This ceiling is, however, not relevant in case of a 100 per cent subsidiary of a foreign bank. The ceiling can be a significant impediment in exercise of effective management control by an acquirer. However, this does not seem to be a totally insurmountable problem for foreign strategic investors in a few existing private banks.

The organic growth for a foreign bank that chooses the subsidiary model can now be much faster. Additionally, inorganic growth is possible as acquisition of an existing private bank would also be an option available to such a bank.

However, such acquisition activity would be possible subject to availability of attractive, or at least suitable, takeover targets.

The public sector banks, which account for about three-fourths of the commercial banking system, are out of the reckoning as foreign holding in these is still restricted to 20 per cent.

Hence, the 30 private sector banks comprise the super set available for potential acquisitions. Collectively, their assets account for Rs 2,97,000 crore"" about 17.5 per cent of the banking assets. The top three banks constitute more than half of this asset base.

Hence, there are a large number of private banks with small asset bases (of an average Rs 5,000 crore). These have only a regional presence, primarily in the south. Hence, the availability of attractive acquisition targets is limited.