Recently the Reserve Bank of India (RBI) released the framework for the setting up wholly-owned subsidiaries (WOS) by foreign banks in India. The policy is guided by the two cardinal principles of reciprocity and single mode of presence. As a locally incorporated bank, the WOS will get near national treatment that will enable them to open branches anywhere in the country on a par with Indian banks, with some exceptions.
Although the principle of a single mode of presence poses no difficulty, the criterion of reciprocity could make the implementation of the policy a non-starter. As we have seen in many other instances, few countries like the reciprocal treatment clause. Their main interest is in protecting their domestic turf. A good example is civil aviation. Despite all the high-sounding talk about the "freedoms of the air" and open skies, the US does not allow foreign airlines to operate purely domestic services within the country. Foreign banks will wait for the reciprocity agreements between their home countries and India before they decide whether to set up subsidiaries. Since August 2005, India has signed a comprehensive economic co-operation agreement with Singapore that provides, inter alia, for reciprocity. It is the only one of its kind.
The undercurrent of the policy is to favour setting up subsidiaries over branch banking of the traditional type. That is why the policy talks about "incentivising" banks to convert branches into subsidiaries. This conversion process can be considered from two points of view - one, of the regulatory authorities and, two, of the banking entities.
The guidelines come against the backdrop of the 2008 global financial crisis, which has shown that growing complexity and inter-connectedness of financial institutions have compromised the ability of home and host authorities to cope with the failure of big banks. The RBI feels that the lessons learnt during the crisis lean in favour of domestic incorporation of foreign banks. Explaining its reasoning, the central bank has said this proposal will create separate legal entities with their own capital base and local board of directors, which will help in better regulatory control. Also, subsidiaries would ensure that there is a clear delineation between the assets and liabilities of the domestic bank and those of its foreign parent and provide for ring-fenced capital and assets within the host country.
But does the subsidiary route necessarily help the monetary authority? When one refers to regulatory control, one should also consider the resolution mechanism for subsidiaries in distress. It is like the Western practice of incorporating provisions for dissolution even when the marriage contract is drawn up! In fact, the root cause of the international financial crisis is to be traced to the process of subsidiarisation. According to Anat Admati and Martin Hellwig in their book The Bankers' New Clothes: What's Wrong With Banking and What to do About it, complex financial institutions such as J P Morgan Chase, Bank of America, or Citigroup have thousands of subsidiaries or other related entities, many of them in different countries. Under international banking law, there would be separate resolution procedures for different subsidiaries in all the different countries. Resolution would require coordination among the authorities and procedures that may well be incompatible with the prevailing laws.
For instance, Lehman Brothers had used its London subsidiary for many investment banking and brokerage activities. In the UK, the authorities were shocked to discover there was hardly any cash in the London subsidiary. Although the different units of Lehman Brothers in different countries were legally independent, their cash management had been integrated so that, at the close of the business day in London, all cash would be sent to New York. It was facilitated by the absence of any prescription for cash reserve ratio by the Bank of England. Lehman's bankruptcy involved about 8,000 subsidiaries in more than 40 countries. The RBI could, of course, ring-fence the Indian subsidiary from others but it means that regulatory control is not as simple as it is assumed now and carries a cost of supervision.
What are the merits and demerits from the point of view of banks? The advantage is near-national treatment on a par with other banks of local origin in the matter of opening branches without RBI approval, subject to certain restrictions. Even as it is, under a World Trade Organisation agreement, RBI is required to give foreign banks 12 new permits to open branches every year, including those given to new entrants and existing lenders. Would national treatment also imply all the other features such as inclusive banking, no-frill accounts and so on? The RBI needs to clarify the point.
As of now, foreign banks with 20 or more branches have to observe the priority sector target of 40 per cent of adjusted net bank credit (ANBC) or credit equivalent amount of off-balance sheet exposure (OBSE), whichever is higher. In the case of banks with less than 20 branches, the target is 32 per cent of ANBC or credit equivalent amount of OBSE, whichever is higher. In both cases, the sub-targets for individual sectors do not apply. Would these rules be the same for subsidiaries too?
Recent developments suggest that international banks are switching to wholesale and corporate banking and increasingly leaving the field of retail banking. In recent years, Barclays has exited retail banking and the Royal Bank of Scotland has sold its Indian credit cards, mortgage and commercial banking portfolios. So, there are likely to be few takers for subsidiarisation in any case.
The author is an economic consultant and a former officer-in-charge in the department of economic analysis and policy at the Reserve Bank of India
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
