The nationality question

The Reserve Bank has sent down a googly by asserting that two Indian banks (widely assumed to be ICICI Bank and HDFC Bank), which have predominantly foreign shareholding, should rightly be categorised as foreign banks. The implication is that under such an interpretation, the share of foreign banks in the banking industry crosses 15 per cent, beyond which there is no requirement that India open up its banking sector any further to foreign players. This raises two questions: What makes a bank Indian or foreign? And, what are the larger goals sought to be served through the policy on this issue?

The answer to the first question depends on whether ownership determines identity. In a fundamental sense, it of course does. But if that ownership is distributed over a large number of players, none of whom exercises control over the bank, then the question of nationality gets more complicated. Further, if the bulk of the bank's activities are in India, in that it serves mostly Indian customers on both the deposit and lending sides, and if the board of directors (as also the staff) is predominantly if not wholly Indian, then to term such a bank as foreign is a bit of a stretch because control, operations and the character of the bank are all Indian. If, despite all this, ICICI Bank is not an Indian bank, then what is it "" a German, British or American bank? Any one of them is an absurd proposition, and the Reserve Bank is being too clever by half in trying to say that such a bank is in fact foreign on account of the majority of its shares being held by foreigners. In any case, the RBI itself has so far been treating these two banks as Indian; if that is to change, and the restrictions under which other foreign banks function were to be imposed on ICICI Bank and HDFC Bank, then the future of both banks would become much less attractive "" and their share prices would tank.

What is evident is that the Reserve Bank, having bought time till 2009 before contemplating any further opening up of the banking sector to foreign entities, is now reluctant to open up even after 2009. Perhaps it sees no benefits in allowing a greater role for foreign banks in the Indian economy, although it is usually argued that foreign banks bring to the market products and practices that benefit the economy as a whole. It is also true that quite a few Indian banks could benefit from better management "" which can be inducted only if the RBI were to be more liberal in permitting mergers and acquisitions.

If one were to survey the competitive scenario, the last decade and more have been useful in that a few, new private Indian banks (among them, HDFC Bank and ICICI Bank) have emerged as strong players with enough of a footing to be able to hold their own in the face of more open competition. The banks that still need to bone up are the government-owned ones, which are handicapped by many things including salary restrictions, technology deficiencies and the inability to recapitalise in order to grow. The government and the RBI should focus on these, so that no one need be afraid of foreign competition after 2009.