Foreign Banks Market Entry Into India Finance Essay
This research is objectively aimed at drawing a comprehensive analysis of the Indian Banking regulatory issues which International banks have to comply with in order to have market entry in India and the hurdles posed specifically by the regulatory aspects prescribed by the Central Bank of India.
The Indian Banking system, ever since its evolution has made metamorphic commercial progress catering to a growing yet diverse economic populace. The banking system is highly developed and the economic progress of the country presents a good market for international organizations especially foreign banks that perceive India with a large potential market. However, it is also understood that the regulatory aspects of Indian Banking are stringent posing commercial and legal issues in the set up of branches of foreign banks.
I propose, through my research to employ business analytical tools and theories to present all the Indian Banking Regulations foreign banks have to accept, concede and also the hurdles which foreign banks are confronted with.
I, further propose to employ business marketing tools of primary research i.e. qualitative research and quantitative research, secondary research, P.E.S.T.L.E. analysis and Marketing Mix to ascertain the above mentioned objective of my research.
The evolution and growth of the Indian Banking System could be comprehended essentially by bifurcation of the same in three phases. The first
The primary phase constitutes the period from 1786 to 1969 of Indian Banks
The second phase presents the Nationalization of Indian Banks and up to 1991 prior to Indian banking sector Reforms.
New phase of Indian Banking System with the advent of Indian Financial & Banking Sector Reforms after 1991.
In 1786, the General Bank of India was set up and later emerged the Bank of Hindustan and the Bengal Bank. During the then pre-independence period of India, three banks were established by the East India Company i.e. Bank of Bengal in 1809, Bank of Bombay in 1840 and Bank of Madras in 1843 which were amalgamated in 1920 and the Imperial Bank of India came into existence which functioned as a shareholders bank with mostly European shareholders.
A bank exclusively for Indians was set up in 1865, the Allahabad Bank and in 1894, the Punjab National Bank Ltd. was incorporated. During 1906 and 1913, Bank of India, Central Bank of India, Bank of Baroda, Canara Bank, Indian Bank, and Bank of Mysore were set up. Reserve Bank of India came in 1935.
The Reserve Bank of India was bestowed with complete regulatory powers over all the other and was termed as the Central Banking Authority. The first phase witnessed slow growth and there were constant bank failures between 1913 and 1948. The Government of India, for legal governance came up with the Banking Companies Act, 1949 which later was amended as the Banking Regulation Act of 1949 to monitor the activities of the commercial banks with intent to safeguard the interest of the stakeholders i.e. internal and external.
The depositors did not have much faith and confidence in the banking system of the country and the most preferred mode of saving was through the saving account system of the Post Office.
This phase could be characterized as the emergence of Bank Regulation Acts with the purpose of promoting banking system in India. These acts were formulated under the Banking Reform strategies of the then Government of India. The Governing authorities realized that the banking system was flawed and in order to instill faith in the Indian populace towards banking amendments needed to be carried out.
The following regulatory Acts were passed and implemented to bring about improvisation in the banking system of India:
1949 Enactment of Banking Regulation Act.
1955: Nationalization of State Bank of India.
1959: Nationalization of SBI subsidiaries.
1961: Insurance cover extended to deposits.
1969: Nationalization of 14 major banks.
1971: Creation of credit guarantee corporation.
1975: Creation of regional rural banks.
1980: Nationalization of seven banks with deposits over 200 crore.
Bank regulations carried out by the government and nationalization of banks resulted in higher public trust and confidences about the security of their money and sustainability of the banking institutions. There was an 800% increase in deposits and loans reached a towering 11000%. Thus banking the second phase was profitable and highly commercialized.
The third phase is the current phase of the Indian Banking sector. New products and services are offered. This phase is notably characterized by the dual existence of the Indian Banks and the Foreign Banks. This has made the banking sector extremely competitive. The banking regulation of India having permitted the entry of Foreign Banks in India has resulted in many foreign banks strategizing to enter the Indian banking market as the economy is booming presents a multitude of growth opportunities.
Phone banking, net banking and ATMs are the highlights of this phase making provision for ease and comfort in banking activities.
Indian Banking Sector:
The banking sector of India has witness a metamorphic transition specifically in the last decade. There has been a motivated and deliberate effort on the part of the policy makers i.e. the Central Bank of India also known as the Reserve Bank of India (RBI), the Ministry of Finance, the Government of India and the regulatory entities of the sectors mainly comprising of finance. In terms of growth, degrees of profitability and non-performing assets (NPAs) the banking sector of India is now at par with any other sector of the country. Financial statistic further make the revelation that quite a few banking institutions have presented outstanding track record of value creation, growth and innovation through strategies adopted at the time of incorporation and growth in continuity. It has to be duly noted to that regulatory stipulations of the banking system in India though has been improvised upon by the policy makers yet they seem to be confined only to a part of the banking sector and not in entirety. The costing factor is relative higher of banking intermediation and bank market penetration is yet on the lower side. Hence, it becomes essential that the banking sector of the country to strengthen and consolidate itself the banking sector desire to lend support to an emerging economy which India proposes and aspires to be.
Policy makers, bank management professionals should realize the fact that the market realities and functioning undergoes changes in continuity and failure to respond in accordance has obstructed the growth of the financial sector in many countries which are in economic terms categorized as “developing”. The long term prospect and health of such economies have been led to a state of deterioration or slow growth on account of a weak banking structure. India, too as a nation, has been in global terms categorized as a developing economy.
This research in general is aimed at gaining a comprehensive insight into to the Indian Banking Scenario. The business of banking is emerging to be extremely competitive and the need to improvise on the banking regulations constantly at the commencement of every financial year is felt by the Central Bank and hence amendments for the same are made. India is a developing economy and hence is a lucrative market for many foreign banks seeking entry. This research lays focus on the issues or hurdles encountered by foreign banks seeking entry.
This research is specifically aimed at understanding the regulatory obstacles posed by the Central Bank of India to the foreign banks. To understand whether these hurdles are meant to protect the local banks from foreign competitive banks which have a large and substantial fund and overseas market base is also a specific objective aimed to be covered during research.
This dissertation is aimed at answering the following questions:
What are the regulations imposed by the Central Bank of India in context to foreign market entry?
Do these stringent regulations de-motivate foreign banks from setting up branches in India?
Why do foreign banks perceive India as a booming economy and good market for their banking activities?
To what extent is the large population of India an important consideration for foreign banks to enter the market and the reasons for the same?
To what extent to local banks feel threatened by foreign bank entry and how do they strategize to counter attack the threat?
How do foreign banks contribute to the economic development of India?
How do foreign banks overcome regulatory hurdles posed by the Central Bank of India?
What future scope lies for existing foreign banks in India in terms of profitability and commercial viability?
Purpose of Bank Regulation:
The Bank Regulation Act of 1949 was passed with the purposeful intent to improve the efficiency of the banking system, to establish trust and confidence of the consumer or stakeholder and to protect the interest of the stakeholder to bring about progress and productivity in the Indian Banking system. Prior to the enactment of this law, banking companies functioned under a general law for companies contained in Part XA of the Companies Act of 1913. Though they were amended time and again, the general law proved to be highly inadequate not sufficiently safeguarding the interest of the consumer. Thereby, it was realized a legislation which was separate for the banking business should be brought about with the purpose of protecting the clients, his interest and serve him better with the intent to develop the banking system. This finally brought about the Bank Regulation Act of 1949.
Currently the Bank Regulation Acts which are revised and amended version of the Bank Regulation Act of 1949 ensures progressive bank trading activities. Since the bank business as substantially developed over the period of years with transactions to the tune of billion carried out on a single trading day, the Bank Regulation Act protects all parties employing banking services by transparency of transaction, imposing accountability to concerned individuals and protection of consumers’ interests.
Bank Regulation Act in terms of Foreign Bank entry serves the purpose of protecting the domestic consumers from unfair banking practices on the part of foreign banks. The Act also protects the local and nationalized banks from leading to a situation of closure on account of intense competition from foreign banks. Since, India is a booming economy and is perceived as being lucrative in terms of profitability, many foreign banks desire to set up branches in India and the Bank Regulation Act ensures the entry of foreign banks with a higher degree of credibility in terms of financial standing and repute.
General Objectives of Bank Regulation:
The Bank Regulations serve to fulfill the following purpose and objectives:
Prudential: To essentially bring about a reduction in the level of risk bank creditors have exposure to ( i.e. to make provision of protection to depositors)
Systemic Risk Reduction: Adverse trading conditions or unfair trading practices could lead to a high magnitude of bank failures. Bank Regulatory policies ensure a substantial reduction in risk of disruptive banking situations.
Aids in prevention of misuse of banks: Bank Regulation assist in reducing the risk of banks utilized for criminal activities in terms of laundering of money basically being proceeds of crime.
Confidentiality: Bank regulations ensure high degree of confidentiality which is desired by the stakeholders.
Credit Allocation: To facilitate credit channelization to favored sector of the economy facilitating growth of the economy in the process.
Comparing Bank Regulation in both Emerging and Developed Economies:
India: An Emerging Economy
Bank Regulation for Foreign Bank Entry into India:
The guidelines for licensing of new banks in the private sector were issued by the Reserve Bank of India (RBI) on January 22, 1993. Out of various applications received, RBI had granted licenses to 10 banks. After a review of the experience gained on the functioning of the new banks in the private sector, in consultation with the Government, it has now been decided to revise the licensing guidelines.
The revised guidelines for entry of new banks in private sector are given below. The guidelines are indicative and any other relevant factor or circumstances would be kept in view while considering an application. With the issue of revised guidelines, applications pending with RBI would be treated as lapsed.
Regulations prescribed by the Reserve Bank of India (RBI):
(i) The initial minimum paid-up capital for a new bank shall be Rs.200 crore. The initial capital will be raised to Rs.300 crore within three years of commencement of business. The overall capital structure of the proposed bank including the authorized capital shall be approved by the RBI.
(ii) The promoters’ contribution shall be a minimum of 40 per cent of the paid-up capital of the bank at any point of time. The initial capital, other than the promoters’ contribution, could be raised through public issue or private placement. In case the promoters’ contribution to the initial capital is in excess of the minimum proportion of 40 per cent, they shall dilute their excess stake after one year of the bank’s operations. (In case divestment after one year is proposed to be spread over a period of time, this would require specific approval of the RBI). Promoters’ contribution of 40% of the initial capital shall be locked in for a period of five years from the date of licensing of the bank.
(iii) While augmenting capital to Rs.300 crore within three years of commencement of business, the promoters will have to bring in additional capital, which would be at least 40 per cent of the fresh capital raised. The remaining portion could be raised through public issue or private placement. The promoters’ contribution of a minimum of 40% of additional capital will also be locked in for a minimum period of 5 years from the date of receipt of capital by the bank.
(iv) NRI participation in the primary equity of a new bank shall be to the maximum extent of 40 per cent. In the case of a foreign banking company or finance company (including multilateral institutions) as a technical collaborator or a co-promoter, equity participation shall be restricted to 20 per cent within the above ceiling of 40 per cent. In cases of shortfall in foreign equity contributions by NRIs, designated multilateral institutions would be allowed to contribute foreign equity to the extent of the shortfall in NRI contribution to the equity. The proposed bank shall obtain necessary approval of Foreign Investment Promotion Board of the Government of India and Exchange Control Department of RBI.
(v) The new bank should not be promoted by a large industrial house. However, individual companies, directly or indirectly connected with large industrial houses may be permitted to participate in the equity of a new private sector bank up to a maximum of 10 per cent but will not have controlling interest in the bank. The 10 per cent limit would apply to all inter- connected companies belonging to the concerned large industrial houses. In taking a view on whether the companies, either as promoters or investors, belong to a large industrial house or to a company connected to a large industrial house, the decision of the RBI will be final.
(vi)The proposed bank shall maintain an arms length relationship with business entities in the promoter group and the individual company/ices investing up to 10% of the equity as stipulated above. It shall not extend any credit facilities to the promoters and company/ies investing up to 10 per cent of the equity. The relationship between business entities in the promoter group and the proposed bank shall be of a similar nature as between two independent and unconnected entities. In taking view on whether a company belongs to a particular Promoter Group or not, the decision of RBI shall be final.
(i) The bank shall be required to maintain a minimum capital adequacy ratio of 10 per cent on a continuous basis from the commencement of its operations.
(ii) In order to ensure level playing field,
a) the new bank will have to observe priority sector lending target of 40 per cent of net bank credit as applicable to other domestic banks, and
b) the new bank will be required to open 25 per cent of its branches in rural and semi-urban areas to avoid over concentration of their branches in metropolitan areas and cities on the same lines as new private sector banks established under guidelines laid down by RBI in January 1993,
(iii) The promoters, their group companies and the proposed bank shall accept the system of consolidated supervision by the Reserve Bank of India.
(iv) The new bank shall not be allowed to set up a subsidiary or mutual fund for at least three years from the date of commencement of business.
(v) The headquarters of the proposed new bank could be in any location in India as decided by the promoters.
(vi) The new bank shall make full use of modern infrastructural facilities in office equipments, computer, telecommunications etc. in order to provide cost-effective customer service. It should have a high powered Customer Grievances Cell to handle customer complaints.
(vii) The new bank will be governed by the provisions of the Banking Regulation Act, 1949, Reserve Bank of India Act, 1934, other relevant Statutes and the Directives, Prudential regulations and other Guidelines/Instructions issued by RBI and the regulations of SEBI regarding public issues and other guidelines applicable to listed banking companies.
Russia: Developed Economy
Banking Regulations for foreign bank entry into Russia:
Licensing is a first step in the supervisory process. Application conditions consist of:
(1) Being a financial institution;
(2) Holding minimum amount of total assets;
(3) Consent of home country supervisors.
The only option for foreign banks wishing to carry on a banking business in Russia is to establish a Russian-incorporated subsidiary or to acquire share in the existing Russia’s bank.
The special rules governing the state registration of credit organization with foreign investments and branches of foreign bank are settled in the Law on Banks (Articles 17 and 18) and the Central Bank acts.
In addition to the documents specified in Article 14 of the Law On Banks, required for domestic banks’ registration69, the duly formalized documents enumerated below shall be submitted by the foreign juridical person for the state registration of credit organization with foreign investment or a foreign bank branch:
(1) The decision concerning the participation thereof in the creation a credit organization on the territory of the Russian Federation or opening of the branch of the bank;
(2) The document confirming the registration of the juridical person and balance sheet for the three preceding years confirmed by the auditor’s opinion;
(3) The written consent of the respective control agency of the country of its whereabouts to participation in the creation of a credit organization in Russia or opening of the branch of the bank in those instances when such authorization is required according to the legislation of the country of its whereabouts.
A foreign natural person shall submit confirmation of a first-class (according to international practice) foreign bank of the ability of this person to pay. Article 18 of the Law On Banks established additional requirements for creation and activity of credit organizations with foreign investments and branches of foreign banks:
(1) The amount (or quota) of participation of foreign capital in the banking system shall be established by a federal law upon the proposal of the Government agreed with the Bank of Russia. The said quota shall be calculated as the relationship of the total capital belonging to non-residents in the charter capital of credit organizations with foreign investments and the capital of branches of foreign banks to the aggregate
Charter capital of credit organizations registered in Russia. The Bank of Russia shall terminate the issuance of licenses for the effectuation of
Banking operations to banks with foreign investments and branches of foreign banks when the established quota is reached. The Bank of Russia shall have the right to impose a prohibition on an increase of the charter capital of a credit organization at the expense of the means of nonresidents and the alienation of stocks (or participatory shares) to the benefit of nonresidents if the result of the said action is exceeding the quota of participation of foreign capital in the banking system of Russia.
(2) The Bank of Russia shall have the right by agreement with the Government to establish limitations for credit organizations with foreign investments and branches of the foreign banks on the effectuation of banking operations if limitations are applied in the respective foreign States with respect to banks with Russian investments and branches of Russian banks on their creation and activity.
(3) The Bank of Russia shall have the right to establish in accordance with the procedure established by the Law On the Central Bank additional requirements for credit organizations with foreign investments and branches of foreign banks relative to the procedure for the submission of reports, confirmation of the members of management and list of banking operations to be effectuated.
In comparative analysis of the regulatory aspects of the foreign entry in India and Russia bring forth the fact that the policies for Russia are far more liberalized than that of India. There is a regulation stating a minimum 300 cr investment of a foreign bank desiring entry in India whereas Russian Central Bank does not pose such figurative regulations. The initial amount of foreign investment in Russia would fluctuate as per understanding and agreement with the Russian Government. In India a further 40% of the initial investment needs to be brought in by the foreign bank whereas the Russian Bank presents no such stipulation.
Another important aspect which presents a difference in Regulatory policy is the fact that foreign banks can operate independently in India whereas foreign banks desiring entry in Russia need to merge or tie-up with an existing local Russia bank.
The regulatory process of set up of foreign banks in India is lengthy and time consuming and a lot of bureaucratic procedural aspects need to be followed besides fulfilling the prescribed procedures whereas in Russia the process is simplified and less time consuming.
General Overview of Bank Regulation in India-Mainly Central Bank regulation on local banks:
India’s Central Bank is known as the Reserve Bank of India. The Reserve Bank of India is the apex banking body which formulates implements and monitors the monetary policy of the country. The RBI was established in 1935 and was nationalized in the year 1949. The bank is fully owned by the Government of India and has 22 regional offices in various state capitals of India. The headquarters of RBI is located at Mumbai. The State Bank of India is where the RBI has a major stake.
The Central Bank primarily controls and supervises the entire banking system of the country. The Central banks define guidelines under which the local banks operate. By supervision of local banking activities, the depositor is indemnified of protection and provision of cost-effective services is made to the general populace. The Banking Ombudsman Scheme enables a customer with a grievance to seek solution for the problematic issue encountered. The foreign exchange inflow and outflow with local banks is regulated by Central Bank as per the Foreign Exchange Management Act of 1999. The Central Banks also decide the limits of fund transfer out of India by local banks. The transfer could be for personal or trade purposes.
The Central Bank is the issuing authority of currency notes and coins. The Central Bank employs measures to prevent the circulation of counterfeit notes by making periodic modifications in the currency notes. The trade of Gold by local banks is regulated by the Central Bank of India. Currently 17 banks are actively participating in Gold trading. The Central Bank promotes local banks to deal in Gold to prevent illegal trade of Gold and bring about a higher degree of competition in the Gold market. As per regulatory issues, it is mandatory for all local banks to maintain their financial accounting with the Central Bank.
Complying in accordance with its regulatory policies over the local banks, the Central Banks makes decisions regarding the increase or decrease interest rates provided to customers on bank deposits, changes in lending rates etc. The Cash Reserve Ratio which is the percentage of deposits required by all Indian banks to keep with the Central Bank is decided by it. Current the Cash Reserve Ratio is at 5%. RBI provides insurance for deposits over 1 lac rupees with local banks. The Repo Reserve Rate is the rate at which the Central Bank absorbs funds from the local banks.
KYC or Know Your Customer guidelines have been issues to local bank instructing them to called further personal data about their consumer to serve them better with provision of a multitude of banking products and services. The Central Bank regulates the parameter set for local banks to access their consumers on the basis of low risk, medium risk and high risk.
The installations of ATMs (Automated Teller Machines) by local banks take place with the prior regulatory approval of the Central Bank. The Central Bank makes provision for fresh supply of notes for ATMs.
The Central Bank makes announcements annually in the month of April about the monetary policies which are to be followed by local banks.
The opening of new branches of existing local banks is also regulated by the Central Bank.
Conclusively, the Central Bank of India is the governing bank of India which constantly monitors the financial activities of the local banks through regulatory policies with intent to safeguard the customer, prevent unfair trade practices by local bank and help them grow in the financial market. Importantly, retain customer confidence in the banking system of the country through local banks.
Need help with your literature review?
Our qualified researchers are here to help. Click on the button below to find out more:
In addition to the example literature review above we also have a range of free study materials to help you with your own dissertation: