Money & Banking

Foreign banks face Bharat challenges

Shinjini Kumar | Updated on June 28, 2012

Foreign banks are largely urban, with 302 branches in urban/metropolitan and 14 branches in rural/semi-urban India.

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Ms Shinjini Kumar

Foreign banks have been part of India’s financial landscape since late nineteenth century. For the first few decades after independence, they quietly existed as icons of global financial authority, attracting high end clients and employees.

Opening of the economy in the 1990s brought fresh attention to foreign banks for their role in facilitating trade flows, introducing new products and helping capital formation. Many foreign banks expanded and tried to ‘localise’ products, services and branding, even as new private sector banks offered competition. The latter were able to grow rapidly, aided by an active policy of branch licensing and consolidation.

Over time, the relative disadvantage in terms of branch licensing and inorganic growth opportunities became significant hurdle for foreign banks, particularly those whose business plans went beyond serving their multinational clients in one or two locations.

RBI roadmap

In this backdrop, the roadmap for foreign banks released by Reserve Bank of India in 2005 was an important pointer to the policy direction for foreign banks; moderating hopes of rapid expansion on one hand and creating long-term optimism on the other.

The roadmap termed its goals as consolidation of domestic banks and ‘synchronised’ presence of foreign banks, vaguely promising a wider play during the second phase. But before the first phase of the roadmap expired in 2009, the world as we knew it came to an end, ending with it all certainty of economic relationships.

In the wake of the financial crisis, another noteworthy demise was that of the assumption that the developed world knew all along what it was doing. Also, Indian banks fared well through the crisis. All of this damaged the foundation on which the promise of change was built; thereby delaying the second phase and denying the big opportunity that many were watching out for.

And then, RBI released a ‘Discussion paper on the presence of foreign banks in India’ in early 2011. Apart from a more assured point of view regarding local incorporation for systemically important foreign banks, the Discussion paper does little to shake up the game for existing foreign banks. It does, however, change the rules of entry for new entrants by defining categories of banks that may not be eligible for the branch mode of presence.

Interestingly, 2009 and 2010 recorded the highest number of branch licences given by the RBI in recent years. Many of these went to new entrants from hitherto under-represented geographies of South East Asia, Australia, Japan and Korea.

It is worth examining the landscape for foreign banks in India as a result of the realignment of global economies and population trends. It is also useful to contextualise this within the rise and interconnectivity of the emerging markets that seems to be here to stay and shape the future of financial services globally.

The theory of shift of economic power to emerging markets is now widely accepted. WTO data show increasing trend of interregional trade flows between countries in Asia, West Asia, Africa and South and Central America.

India’s top two trading partners are GCC and China. While Europe and the US grapple with economic and regulatory changes that make incremental capital infusion in India difficult, Indian regulations proposed in the discussion paper target these banks for local incorporation, further exacerbating capital issues. This is already playing out in the case of a few European banks in India and the overall shrinkage in the share of foreign banks.

On the other hand, banks from GCC, South East Asia, Australia, Japan or Africa may be relatively better positioned to bring capital, but in the current branch licensing regime, they cannot hope to overcome the competitive disadvantage vis-à-vis existing foreign banks. Not only is the branch expansion route like the proverbial camel passing through the needle’s eye (existing as well as new entrants compete for 12 mandatory and few discretionary branch licenses), but also the proposed WOS route promises no certain growth path, inorganic or organic.

Physical branches

A good question to ask at this stage concerns the relevance of physical branches. After all, in the age of technology and tech savvy young population, physical branches should not matter. The difficulty arises from lack of unambiguous guidance on a bank’s ability to create outreach through non-branch presence.

Regulations around deposit acceptance, doorstep banking and simple, unspecified fear of God keeps foreign banks from experimenting; and rightly so. If getting a branch licence is so difficult and getting around a branch licence so easy, it is better to be safe and follow district, municipal, state or any other boundaries!

From a business perspective also, physical presence will continue to be relevant even as economic growth leads to changes in social and economic behaviour. The projected 300 million middle class as well as the wide ‘emerging middle’ in India will not be monolithic but diverse in their language, customs and demands.

Migration patterns

Unlike the past domination of a handful of cities, the future may bring more spread wealth as States take charge of growing their economies and promote local entrepreneurship.

Migration patterns may change as Europe and America lose sheen and the corridors from India to the GCC countries and South East Asia become wider. Futuristic trends like the Marigold Hotel may actually come true, bringing in immigrants from the west for more than hip replacement. However, although physical presence may remain an essential precondition for penetration, there is a double negative response to this situation.

Firstly, foreign banks do not find small ticket retail banking in India commercially attractive and secondly, the predetermined model of financial inclusion (no frills accounts, Priority sector lending with rigid asset buckets) and branch expansion create disincentive for banks to be innovative or import ideas and best practice.

On the whole, scepticism regarding foreign banks may be justified today, given that foreign banks are largely urban, with 302 branches in urban/metropolitan and 14 branches in rural/ semi-urban India. On the other hand, the population pattern in India point to the emergence of large rural and semi-urban population that can fuel growth, given the right access to formal financial system.

For now, this difference seems irreconcilable. But given some ability to innovate, create partnerships and evolve mutually acceptable solutions, maybe the twain shall meet. After all, if foreign foods, beverages, hair colour and mobile phones can reach every village in India, why would foreign banks be such an implausible dream?

(The author is Director, PricewaterhouseCoopers. Views expressed are personal)

Published on June 28, 2012

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