Sharing insights. News Alert 24 January, Discussion paper on presence of foreign banks in India Regulatory Alert. Overview.

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1 Sharing insights News Alert 24 January, 2011 Discussion paper on presence of foreign banks in India Regulatory Alert Overview Setting the ball rolling for the foreign banks presence in India, the Reserve Bank of India ( RBI ) has released the much awaited discussion paper for feedback from all stakeholders and public at large. In early 2005, the RBI had released the Road map for presence of foreign banks in India which aimed at increasing the efficiency and stability of the banking sector in India. The current discussion paper has been prepared taking into account the lessons learnt from the global crisis and practices followed in other countries. Based on the feedback received, the RBI will frame detailed guidelines on the presence of foreign banks in India. In summary, the RBI has considered the pros and cons of the branch and subsidiary form of presence. In light of its multiple objectives including financial stability, meeting World Trade Organisation ( WTO ) commitments, financial inclusion, control over dominance of foreign banks, appropriate supervision, the RBI has indicated that the advantages in the wholly owned subsidiary ( WOS ) form outweigh the downside risks and hence, the subsidiary form of presence appears to be a preferred mode for foreign banks presence under certain conditions and thresholds. The 1

2 branch expansion of both the existing foreign banks and the new entrants present in the branch mode would be subject to the WTO commitments. Branch v. Subsidiary - Key advantages and disadvantages The key advantages and disadvantages considered by the RBI in the discussion paper are as under: Branch Subsidiary Key advantages Key advantages Greater operational flexibility. Clear delineation between the assets Increased lending capacity (loan and liabilities between parent and size limits based on the parent itself. bank s capital). Easier to define laws of which Reduced corporate governance jurisdiction applies on account of requirements. local incorporation. Own board of directors who would act in the best interests of the bank Effective Control of host country authorities in a banking crisis. Key disadvantages Key disadvantages Difficulty in asset identification The insolvency of parent may lead to in the event of failure of bank to immediate failure of their subsidiary. satisfy local liabilities. Substantial curtailment of operations Management of branch does not of withdrawal from the host country, have a fiduciary responsibility in the event of financial turmoil. to local clients. Proposed framework The RBI will continue to follow the principles of reciprocity and single mode of presence while allowing foreign banks to establish a presence in India. The RBI considers the subsidiary form as having clear advantages over the branch form of presence, despite downside risks. Accordingly, the discussion paper mandates a WOS form of presence for new entrants meeting specified criteria. Further, the existing branches may not be mandated to convert into WOSs but the expectation of the RBI would be that the existing branches of foreign banks that meet the parameters would voluntarily convert themselves into WOS. The norms with respect to new entrants and existing branches have been discussed in detail as under: New foreign banks seeking entry in India The following category of banks would be allowed to enter India only by way of setting up a WOS: Banks incorporated in a jurisdiction that has legislation which gives deposits made/credit conferred, in that jurisdiction a preferential claim in a winding up; or Banks which do not provide adequate disclosure in the home jurisdiction; or Banks with complex structures or banks that are not widely held; or If the RBI is not satisfied with the supervisory arrangements (including disclosure arrangements) and market discipline in the country of their incorporation. 2

3 Foreign banks that do not satisfy any of the above conditions can opt for a branch or WOS on entry in accordance with the single mode of presence requirement. However, it would be mandatory for foreign banks that opt for a branch form to convert themselves into a WOS in case any of the parameters mentioned above are triggered or the bank s presence in India becomes systemically important 1 by virtue of their balance sheet size. Further, for new entrants, the RBI has laid down eligibility criteria for having a presence in India. The conditions prescribed are as under: Foreign parent banks are subject to adequate prudential supervision in their home country; The setting up of WOS/branches in India should have the approval of the home country regulator; Other indicative factors including the economic and political relations between India and the country of incorporation of the foreign bank, financial soundness, ownership pattern, international presence and ranking of the parent. Existing foreign banks in India The discussion paper states that, considering India s commitments to the WTO, it would not be possible to mandate the conversion of existing foreign banks branches. However, the discussion paper also states that it would be an expectation of the RBI that a foreign bank branch would 1 Foreign bank branches would be considered to be systemically important once their assets (on balance sheet and credit equivalent of off-balance sheet items) become 0.25% of the total assets (inclusive of the credit equivalent of off-balance sheet items) of all scheduled commercial banks in India as on March 31 of the preceding year. voluntarily convert into a WOS, considering the incentives proposed to a WOS form of presence, if: it triggers any of the conditions which mandate an initial WOS form of presence for new entrants; or if the respective foreign bank s presence in India is / becomes systemically important. WOS form of presence incentives, obligations and limitations Considering the experience that no foreign bank has earlier adopted a WOS form of presence in India, the RBI has provided certain incentives including a liberal branch expansion policy, allowing the WOSs to classify export finance towards priority sector lending. Full national treatment has not been granted, but the WOSs of foreign banks would be placed in a relatively better position than branches. Further, to achieve its objectives of, inter alia, corporate governance, controlling dominance of the foreign banks, the RBI has cast some obligations and limitations on the WOSs of foreign banks. The key incentives, obligations and limitations are as under: Branch expansion A less restrictive branch expansion policy would be followed in case of WOS and it is proposed that the branch expansion policy as applicable to domestic banks as on 1 January, 2010 may be extended to WOSs of foreign banks. This would mean, inter alia, that the WOS would be able to open branches in Tier 3 to 6 centers except at a few locations considered sensitive on security considerations. Further, currently the RBI has been allowing more branches than its current WTO commitments. In order to urge the foreign banking entities 3

4 to have a WOS, the RBI would allow branches in India strictly in line with the WTO commitments ie 12 branches each year. Raising of non-equity capital in India As an incentive to foreign banks to set up a WOS in India or convert their branches into WOS, it is proposed to allow WOSs to raise rupee resources through issue of non-equity capital instruments in the form of Innovative Perpetual Debt Instruments, Tier I and Tier II Preference shares and subordinate debt as allowed to domestic private sector banks. Capital requirement WOSs of foreign banks would be treated at par with new private sector banks with regard to the minimum capital requirement. The WOSs shall be required to maintain a minimum capital adequacy ratio of 10 per cent 2 of the risk weighted assets on a continuous basis from the commencement of operations. Corporate governance To ensure that the board of directors of the WOS act in interest of the WOS, the RBI may mandate that: At least 50 per cent of the directors should be Indian resident nationals; At least 50 per cent of the directors should be non-executive directors; At least one-third of the directors should be totally independent of the management of the WOS, its parent or associates; and The directors should be compliant with Fit and Proper criteria as specified by the RBI. Priority Sector lending requirements As per the discussion paper, the new entrants would have priority sector lending requirements similar to Indian private sector banks including the sub-target for agricultural advances. For WOSs set-up by conversion of existing branches, a transition period of 5 years from the year of conversion would be allowed to meet the more onerous priority sector lending norms prescribed for WOSs. Setting up of Non-banking financial companies ( NBFCs ) The RBI has prescribed guidelines restricting investments by a bank (other than investments made for treasury operations). Further, the RBI does not favourably view setting up of subsidiaries or significant investment in associates for activities that can be undertaken within the bank. The discussion paper indicates that WOSs of foreign banks would be subject to restrictions as applicable to Indian banks. Further, in case of granting approval for downstream investments by the WOS, the RBI will consider if the parent banking group has an NBFC in India for undertaking same or similar activities. Mergers / Acquisitions and Dilution of WOS to 74% The issue of dilution or listing of WOS of foreign banks in India and allowing mergers and acquisitions of Indian private sector banks by foreign banks or their WOS may be considered by RBI after a review is 2 Subject to amendment from time to time, by the RBI 4

5 made of experience gained on the functioning of WOS of foreign banks in India. Measures to control dominance of foreign banks Under the WTO commitments, when the assets of the foreign bank branches in India exceed 15% of the assets of the banking system, the RBI may deny licences new foreign banks. In the discussion paper, it is proposed that when the capital and reserves of the foreign banks in India (including WOS and branches) exceed 25% of the capital of the banking system, restrictions would be placed on further entry of new foreign banks and branch expansion in Tier I and Tier II centres of WOS and capital infusion into the WOS would require a prior RBI approval. Further, the RBI has also indicated that it would not favour granting differential banking licences to foreign banks seeking entry in niche markets, since it would not support the objective of financial inclusion of the RBI. Next Steps Foreign banks aspiring to have Indian presence as well as foreign banks having existing bank branches in India can do an impact assessment of the proposed policy framework in context of their respective business plans and strategy. Based on the impact assessment, the feedback can be given to the RBI. The last date to provide feedback to the RBI is 7 March, Separately, the impact of change in the business model of existing banks, if they decide to convert into a WOS, would need to be analysed from an Indian tax perspective and foreign banks may approach the appropriate authority for clarification. 5

6 Gautam Mehra Executive Director Tax and Regulatory Services Tel Board Shinjini Kumar Director Tax & Regulatory Services Tel: Board Our Offices For private circulation only Ahmedabad President Plaza, 1st Floor Plot No 36 Opp Muktidham Derasar Thaltej Cross Road, SG Highway Ahmedabad, Gujarat Phone Bangalore 6th Floor, Millenia Tower 'D' 1 & 2, Murphy Road, Ulsoor, Bangalore Phone Bhubaneswar IDCOL House, Sardar Patel Bhawan Block III, Ground Floor, Unit 2 Bhubaneswar Phone / 2296 Chennai PwC Center, 2nd Floor 32, Khader Nawaz Khan Road Nungambakkam Chennai Phone Hyderabad # /82/A/113A Road no. 36, Jubilee Hills, Hyderabad , Andhra Pradesh Phone Kolkata South City Pinnacle, 4th Floor, Plot XI/1, Block EP, Sector V Salt Lake Electronic Complex Bidhan Nagar Kolkata Phone / Mumbai PwC House, Plot No. 18A, Guru Nanak Road - (Station Road), Bandra (West), Mumbai Phone Gurgaon Building No. 10, Tower - C 17th & 18th Floor, DLF Cyber City, Gurgaon Haryana Phone : Pune GF-02, Tower C, Panchshil Tech Park, Don Bosco School Road, Yerwada, Pune Phone For more information contact us at, pwctrs.knowledgemanagement@in.pwc.com The above information is a summary of recent developments and is not intended to be advice on any particular matter. PricewaterhouseCoopers expressly disclaims liability to any person in respect of anything done in reliance of the contents of these publications. Professional advice should be sought before taking action on any of the information contained in it. Without prior permission of PricewaterhouseCoopers, this Alert may not be quoted in whole or in part or otherwise referred to in any documents 2011 PricewaterhouseCoopers. All rights reserved. "PricewaterhouseCoopers", a registered trademark, refers to PricewaterhouseCoopers Private Limited (a limited company in India) or, as the context requires, other member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity. 6