sickle_s.gif (30476 bytes) People's Democracy

(Weekly Organ of the Communist Party of India (Marxist)

Vol. XXVI

No. 09

March 03,2002


Banking: Opening The Floodgates

 

  • C P Chandrasekhar

  • INDIA's banking sector is set to witness a major expansion of foreign bank presence. The recent RBI clarification regarding the cap on FDI investments in private and public sector banks, set at 49 and 20 per cent respectively, finally makes clear the implications of a cabinet decision taken as far back as May last year. The foreign ceiling on FDI applies to all forms of acquisition of shares (IPOs or initial public offers, private placements, ADRS/GDRs and acquisition from existing shareholders). The clarification also states that even foreign branches having branch presence in India can undertake FDI investments in private and public sector banks, subject to approval from the Reserve Bank of India (RBI).

    This provides the basis for an expansion of the reach of existing banks through equity-enabled tie-ups with Indian entities. With the mushrooming of private banks promoted by Indians in recent years, and the more recent trend towards mergers of these entities with larger strategic partners, the new clarification sets the stage for an expansion of foreign bank presence in India.

    There remain two other hurdles. Though the regulations recently clarified ensures that the equity stake of foreign partners can rise to levels which allows for foreign control, interference by the foreign stakeholder will be tempered by the stipulation under the Banking Regulation Act that the maximum voting rights per shareholder will be 10 per cent of the total voting rights for private banks. The relevant provision, Section 12 (2) of the Banking Regulation Act, states:

    " No person holding shares in a banking company shall, in respect of any shares held by him, exercise voting rights (on poll) [in excess of 10 per cent] of the total voting rights of all the shareholders of the banking company.''

    It would not be long before this provision is diluted. In fact, foreign and private sector banks are already lobbying with the RBI to have it changed. A senior official in a foreign bank is quoted as having said: "We should be given more leeway, and majority shareholders must have a say in the management of the bank. The 10 per cent cap is interfering with our right to manage our affairs. This cap on voting rights should be increased, to be proportionate to the shareholding."

    The other hurdle is the lower cap of 20 per cent share of FDI in equity in the case of public sector banks, which clearly dominate the banking business in India. Here again, the lower ceiling has been necessitated by the fact that diluting the government’s shareholding to less than 33 per cent would require legislative changes. The lower cap appears to be a temporary measure pending such changes. Given the desperate desire of the BJP-led government to push ahead with neo-liberal reform in general, and financial sector reform in particular, it can be expected to soon make an effort at instituting the changes necessary to allow for foreign bank takeover of public sector banks as well.

    Once these changes are instituted, a fundamental restructuring of the organisational basis of India’s banking sector is inevitable. Foreign banks, which are permitted to bring in capital that can be accessed at extremely low costs abroad, have deep enough pockets to buy their way to dominance.

    MAKING THINGS EASIER

    With liberalisation there has been a significant increase in foreign bank interest in expanding operations to India. However, for a number of banks the prospect of setting up a wholly new operation, building goodwill and then establishing a permanent presence appeared too expensive relative to the prospect of developing a profitable business. The new option of testing the waters with a small acquisition in an existing private sector bank and then, as liberalisation proceeds further, garnering a controlling interest in the concerned bank if operations warranted is a far better one. Thus an increase in FDI flow to the banking sector is extremely likely.

    In fact, a number of foreign banks have already evinced an interest in acquiring a stake in Indian banks -

    Developed country governments, especially the US government, have backed this interest and have been pressurising the Reserve Bank of India to make clear the nature of the liberalised rules regarding foreign bank expansion.

    Interestingly, the RBI clarification on FDI in banks issued on February 16 came days after the US Treasury Secretary Kenneth Dam met with the Governor of the RBI and the head of Citibank’s South Asia operations. According to reports, Dam, who was ostensibly at Mumbai to discuss money-laundering rules, had taken up the issue of opening up foreign investments in local banks.

    DANGEROUS IMPLICATIONS

    There are a number of implications of such an expansion of foreign presence. To start with, even with the diluted regulation that is currently in place, it is clear that private banks in general, and foreign banks in particular, have been lax in meeting regulatory norms. The takeover trend would result in a sharp reduction in the extent of regulation of banking sector operations by the RBI. The implications of this for the priority sectors, especially agriculture can be quite damaging.

    Thus, during 2001, one of the observed effects of financial sector reform was a shortfall in private sector banks’ advances to the priority sectors, which stood at 38.7 per cent of the total, as compared to the required 40 per cent. On the other hand, despite a marginal fall in public sector bank advances to these areas, its overall tally in terms of share of advances stood at 43 per cent. The sector most affected was agriculture, in whose case private bank lending amounted to just 9.6 per cent of net credit, which was far short of the stipulated 18 per cent.

    Within the private sector, the foreign banks were the major defaulters. According to the annual report of RBI, the advances of foreign banks to the priority sectors came down from 35 per cent as of March 2000, to 31 per cent during 2001. Here again, agriculture was the prime area of neglect.

    Foreign banks' performance on credit to the small scale industries and export sectors was much better, with lending to these sectors accounting for 10 and 19 per cent, respectively, of the net bank credit, against the sub-sectoral targets of 10 per cent and 12 per cent.

    Clearly, even to the extent that priority-sector lending targets had been met, the choice was in favour of the more cost effective and profitable sectors. Overall, 60.8 per cent of the priority sector lending by foreign banks was directed towards export credit.

    ADVERSE INFLUENCE ON PSBs

    Second, the expansion in foreign bank presence, by subjecting public sector banks to unfair comparisons of "profitability" and "efficiency", would force these banks to change their lending practices as well. Thus, though the overall performance of the public sector banks in terms of priority-sector lending was satisfactory during 2001, total agricultural advances of these banks as a share of net bank advances fell by 2.3 per cent to 15.7 per cent, as compared with the norm of 18 per cent. Yet, it must be said that their advances to agriculture and small-scale sector units accounted for the bulk of the public sector banks’ advances to the private sector.

    The RBI reports that the aggregate outstanding priority sector advances of the public sector banks increased by Rs 18,739 crore (14 per cent) to Rs 1,46,546 crore during 2001. This would have affected public sector bank income, relative to the private sector in general, and the foreign banks in particular.

    In the net, public sector banks are less profitable than the private banks -

    RISKY MEASURES

    Among the factors that account for this differential in profitability, there are two that are important. One is that the operating expenses for a given volume of business tends to be higher with public sector banks. The other is that income generated out of a given volume of business tends to be lower in the case of the public sector banks. These are the two areas in which changes are being made as part of the effort of the public sector banks to "match up" to the performance of private domestic and foreign banks. The expansion of foreign presence would only accelerate this tendency.

    The effort of the public sector banks to trim operating expenses has taken many forms. They are seeking to reduce the wage bill by reducing employment through the twin mechanisms of retrenchment under the VRS scheme and simultaneous computerisation. They are also seeking to reduce costs by limiting branch expansion and even reducing the number of bank branches. The full implications of the former for organised sector employment are yet to be gauged. The latter, which affects the rural areas first, reduces access to credit in rural areas that were well-served by the post-nationalisation branch expansion drive, and worsens the tendency towards reduced provision of credit to the agricultural sector.

    While this is occurring, public sector banks are working to increase income generated from a given volume of business. This not only leads to reduced interest in priority sector lending. It also encourages diversification to more risky high profit lending as well as to investments that yield incomes other than interest income.

    One form of high-profit lending is lending to stock market players, in the form of credit for share purchases and guarantees to brokers. And the principal form of investments that yield non-interest income is investment in shares. Recent experience, such as the stock-market collapse in the wake of the Ketan Parekh affair, point to the dangers implicit in such diversification, which increases bank fragility substantially. This increase in fragility is all the more disturbing since it occurs in a context where mergers and acquisitions involving foreign and Indian banks are resulting in consolidation and increasing the size of entities that could be adversely affected.

    Thus, the RBI’s eagerness to rush through with reform of a kind that reduces its own regulatory authority and power can find India’s banking sector displaying weaknesses of a kind that, in the face of any economic shock, can destabilise the system.

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