India-EU Free Trade Agreement: Should India Open Up Banking

An Expert's View about Banking and Finance in India

Posted on: 25 Mar 2010

Since 2007, India and European Union (EU) are negotiating a free trade agreement (FTA). The negotiations not only cover trade in goods but also services, rules pertaining to intellectual property rights, cross-border investments, competition policy, government procurement and regulatory issues. One of the key themes under negotiation is the liberalization of cross-border trade and investment in banking services. The 70-page Special Report questions the policy framework and objectives of open

Special Report India-EU Free Trade Agreement: Should India Open Up Banking Sector? Kavaljit Singh Madhyam 2 Kavaljit Singh India-EU Free Trade Agreement: Should India Open Up Banking Sector? Kavaljit Singh Madhyam Madhyam 3 Copyright © 2009 Madhyam. Since this publication is meant for non- profit, research and educational purposes, you are welcome to reproduce it provided the source is acknowledged. We will appreciate if a copy of reproduced materials is sent to us. Madhyam is a non-profit policy research centre based in New Delhi, India. Kavaljit Singh works with Madhyam. He is also associated with Public Interest Research Centre, New Delhi. Acknowledgements: A number of individuals and organizations have provided support in the research and publication of this report. In particular, I would like to thank CIVIDEP, EED, FERN, Laura Ceresna, Myriam Vander Stichele, Public Interest Research Centre, S. L. Shetty, SOMO, Sophie Powell and The Corner House. Thanks are also due to all those whose writings and data I have drawn upon in the preparation of the report. In particular, I would like to thank Reserve Bank of India for using its data and various reports. Thanks are also due to Ranjeet Thakur for the layout and designing of the publication. Published in 2009 by: Madhyam 148, Maitri Apartments Plot No.28 Patparganj Delhi: 110092 India Phone: 91-11-22243248 Email: Website: 4 Kavaljit Singh Contents The Background 9 EU is India?s Largest Trading Partner 10 Services Take the Cake 10 Financial Services: The Modes and Models of Liberalization 12 EU?s Wish List 14 The Burgeoning Financial Services Trade 14 The Lure of Niche Banking Markets 18 Banking Services Market Access: A One-way Street? 20 India: A Bank-Based Financial System 22 Foreign Banks in India 22 The Rationale Behind Nationalization of Indian Banking Sector 24 The Positive Outcomes of Bank Nationalization Regime 25 The Introduction of Priority Sector Lending 27 Banking Sector Liberalization in India 28 Trade Agreements and Banking Sector Liberalization 29 No Reciprocity in Market Access 30 Are Foreign Banks Discriminated in India? 31 The Branch Licensing Policy Favors Foreign Banks 34 The Stark Anomalies in Banking Assets Ownership 39 The Extent of Financial Exclusion in India 41 Financial Inclusion and Foreign Banks 45 Foreign Banks: More Frills, Less Banking 47 Decline in Bank Branches in Rural India 49 The Rise in Unbanked and Underbanked Regions 50 Sharp Decline in Agricultural Credit 52 Decline in Bank Lending to SMEs 54 Steep Rise in Bank Lending to Retail and Sensitive Sectors 56 The Limitations of Microcredit Programs 61 Global Financial Crisis and India-EU FTA 62 Some Pertinent Questions 64 Madhyam 5 Rethinking Banking Sector Opening Up 65 Who Benefits? Who Loses? 67 Notes and References 68 List of Tables 1 Financial Services Trade Balance 15 2 UK Financial Sector Net Exports 15 3 UK Sector Trade Balances 16 4 FDI Net Earnings of UK Financial Services 16 5 Banking Services Trade: Accrual of Amounts to Abroad and to India 17 6 Foreign Banks in India 23 7 EU-based Banks Operating in India 23 8 Distribution of Bank Branches in India 34 9 Branches of EU-based Banks in India 35 10 Population Per Bank Branch in India 44 11 Number of ?No-Frills? Accounts Opened in India 45 12 Number of Underbanked Districts in India 50 13 The Neglect of Unbanked Areas 51 14 The Share of Agriculture Credit in Total Bank Credit 52 15 Bank Group-wise Credit to Agriculture in India 53 16 The Share of SME Credit in Total Bank Credit 55 17 The Share of SME Credit in Total Credit (Bank Group-wise) 56 18 The Share of Personal Loans in Total Bank Credit 57 19 Bank Lending to Sensitive Sectors 60 20 Operating Profits of EU-based Banks 63 List of Boxes 1 Are Foreign Banks More Efficient than Domestic Banks? 36-38 2 The Dharavi Model 46 3 Exotic Derivatives Trap Small Exporters 58-59 6 Kavaljit Singh Acronyms AIDIS All India Debt and Investment Survey ANBC Adjusted Net Bank Credit ASEAN The Association of Southeast Asian Nations ATMs Automated Teller Machines CAR Capital Adequacy Ratio CDS Credit Default Swap CECA Comprehensive Economic Cooperation Agreement CIS Commonwealth of Independent States CRR Cash Reserve Ratio DFIs Development Finance Institutions DRI Differential Rate of Interest EU European Union FDI Foreign Direct Investment FII Foreign Institutional Investor FTA Free Trade Agreement GATS General Agreement on Trade in Services GCC Gulf Cooperation Council GDP Gross Domestic Product HDFC Housing Development Finance Corporation HNWI High Net Worth Individual HSBC The Hongkong and Shanghai Banking Corporation IDBI Industrial Development Bank of India IFSL International Financial Services, London IMF International Monetary Fund IPO Initial Public Offer LABs Local Area Banks M&As Mergers and Acquisitions MFIs Micro Finance Institutions MSE Micro and Small Enterprise NABARD National Bank for Agriculture and Rural Development NAFTA North American Free Trade Agreement NBFCs Non-Banking Financial Companies NGOs Non-Governmental Organisations Madhyam 7 NIM Net Interest Margin NPAs Non-Performing Assets NPL Non-Performing Loan NREGS National Rural Employment Guarantee Scheme NRFIP National Rural Financial Inclusion Plan NRIs Non-Resident Indians OBE Off-Balance Sheet Exposures RBI Reserve Bank of India RIDF Rural Infrastructure Development Fund RoA Return on Assets RoE Return on Equity RRBs Regional Rural Banks SAFTA South Asian Free Trade Agreement SBI State Bank of India SCBs Scheduled Commercial Banks SHGs Self-Help Groups SIDBI Small Industries Development Bank of India SME Small and Medium Enterprise SSI Small Scale Industry UCBs Urban Cooperative Banks UK United Kingdom WOS Wholly Owned Subsidiary WTO World Trade Organisation Data Notes Million is 1,000,000. Billion is 1,000 million. Trillion is 1,000 billion. Dollars are US dollars unless otherwise specified. 1 US Dollar ($) = Indian Rupees (Rs.) 50 (As on February 20, 2009). Indian Financial Year: April-March. 8 Kavaljit Singh The Background The proposed trade and investment agreement between India and the European Union (EU) is an outcome of an institutionalized bilateral process initiated in June 2000. The first India-EU Summit, which took place in Lisbon in June 2000, is generally considered to be a watershed in the evolution of strong economic, political and technological ties between India and EU. Here, a decision was taken to hold annual summits. It was at The Hague Summit (2004), India and EU agreed to forge a ?Strategic Partnership.? This was a result of an earlier EU publication in December 2003 when it identified India (along with several other countries such as the US and China) as the ones with whom it should develop a long-term ?Strategic Partnership.? At the 2005 Summit, both parties adopted the India-EU Strategic Partnership Joint Action Plan and agreed to enhance bilateral trade and economic relations and remove barriers inhibiting trade and investment flows. In this regard, a High Level Trade Group was set up to study and suggest measures for strengthening bilateral trade and investment relationship. In 2006, EU launched, ?Global Europe,? a new framework under which open trade policy was given a new impetus with special focus on market access to European suppliers. At the 7th India-EU Summit held in Helsinki in 2006, both parties endorsed the recommendations of the High Level Trade Group to initiate negotiations for a bilateral trade and investment agreement. Following the agreement, negotiations for India-EU trade agreement were launched in June 2007 in Brussels, expected to be over in two years. Already, several rounds of formal negotiations on the modalities of the agreement have taken place in New Delhi and Brussels. The signing of agreement has been delayed as differences have cropped up between India and EU over certain issues which would be kept off the agreement. However, the scope of bilateral negotiations is not merely restricted to trade in goods and services but also covers cross-border investments, non-tariff barriers and rules pertaining to intellectual property rights, competition policy, customs procedures, government procurement, regulatory transparency and state aid. Madhyam 9 EU is India?s Largest Trading Partner EU as a bloc is India?s largest trading partner. EU accounts for around one- fifth of India?s total trade (23 per cent in 2007) whereas India contributes around 1.8 per cent of the total EU trade and is its 10th largest partner. EU provides a substantial market for India?s export (mainly textiles and clothing) and has always been an important supplier (mainly machinery and chemical products) for India?s imports. Since 2001, bilateral trade between the two entities has seen 11 per cent annual growth. Services are an emerging area of EU-India trade. EU is also one of the largest sources of foreign direct investment (FDI) in India. The key EU-member states for FDI are UK, Germany, the Netherlands, France, Italy and Belgium. Much of investments from EU have come in the energy, telecommunications and transport sectors. Of late, many Indian private companies are also undertaking substantial investments in several European countries. EU initiative towards a free trade agreement (FTA) with India is a key component of its ?Global Europe? policy framework based on several long- term economic and strategic goals. India and EU have signed a number of bilateral agreements including Science and Technology Agreement (signed on 23 November 2001) and Customs Cooperation Agreement (signed on 28 April 2004). A Maritime Agreement is also under negotiation. India has already signed a free trade agreement with Singapore in 2005 and with other SAARC member-countries (SAFTA). India has also initiated several negotiations for bilateral trade agreements with Thailand, Japan, South Korea, Chile, Mercosur, Gulf Cooperation Council (GCC) and ASEAN. India currently leads the list of Asian countries with 30 FTAs, followed by Singapore with 26, China and Korea with 22 each and Japan with 19. Out of India?s 30 FTAs, eight are within the Asian region, while the remaining 22 are outside Asia. Apart from closer economic ties, India sees potential geo-political gains in forging FTAs, particularly within the Asian region. Services Take the Cake Services are important for both India and EU. Since the 1990s, the rapidly expanding services sector has been contributing more to economic growth than any other sector. The services sector contributes nearly three-quarters 10 Kavaljit Singh of gross domestic product (GDP) for EU and nearly 55 per cent of GDP for India. Over three-quarters of EU jobs are in the services sector alone. In India, services provide employment to 28 per cent of total workforce. Over the years, the share of agriculture and manufacturing in India?s GDP is declining while the share of services is rapidly increasing. Financial services, tourism, transport and communication services have been experiencing double-digit growth since 2002. It is estimated that the share of services in country?s GDP would reach 59 per cent in 2010. EU has consistently pursued the liberalization of the global trade in services both at multilateral (e.g., GATS negotiations in the WTO) and bilateral levels. Given the slow progress of Doha round negotiations at the WTO, EU is becoming increasingly focused on bilateral and regional trade agreements with an objective of gaining immediate market access. In particular, provisions pertaining to trade in services have been included in a number of bilateral and regional agreements such as the Association and Stabilization Agreements, Partnership and Cooperation Agreements with Russia and other CIS countries and agreements with Mexico and Chile. Such provisions are also included in the ongoing negotiations with India as well as Mexico, Gulf Cooperation Council, Korea and ASEAN. The rapid growth of services sector in India is not limited to domestic markets. Of late, India has emerged a major services exporter, particularly in the arena of information technology (IT) and IT-enabled services, telecommunications and construction. In 2007-08, India?s services exports were worth $86 billion, almost 40 per cent of country?s total exports of goods and services. The country?s share in the global trade of services has improved from 2 per cent in 2004 to 2.7 per cent in 2006. The main destinations of India?s services exports are developed countries, with US and the EU together accounting for over 45 per cent of services exports. The services sector has been attracting substantial amount of foreign investments. India has liberalized its cross-border trade in services with significant market access granted in sectors such as telecommunications, financial services, retail trade and courier services. India?s major interests depend on cross- border supply of services through outsourcing and movement of short-term service providers. Madhyam 11 At present, transport, travel and business services account for the bulk of services trade between India and EU. Through FTA with India, EU is seeking market access in financial services, professional services such as accounting and legal services, courier services and telecommunication services. While India is keen in IT, medical services, tourism and some components of financial services. Financial Services: The Modes and Models of Liberalization One of the major underlying themes in the ongoing negotiations on India-EU FTA is the liberalization of trade and investment in financial services. Financial services cover a wide range of services from banking to insurance to brokerage and asset management. The global trade in financial services has registered rapid growth in the past two decades on account of growing internationalization of trade and finance. Financial services firms see regulation as a biggest obstacle to their global ambitions. The main objective of liberalization of trade in financial services is to provide enhanced market access and remove regulatory barriers to foreign competition. The main barriers to financial services cross-border trade include administrative rules and regulations that restrict the supply of services by foreign suppliers. While the barriers to domestic presence of foreign services firms include limits on foreign ownership, restrictions on branches and business operations, numerical quotas, equity ceilings, differential tax treatment, etc. The liberalization of trade and investment in financial services is a part of wider financial sector liberalization which consists of domestic (e.g., interest rate deregulation) as well as external (e.g., capital account liberalization) reforms. The liberalization of financial services can occur under three ways: unilateral domestic reforms; commitments made under the auspices of the WTO and other international organizations; and commitments made under preferential trade agreements (bilateral or plurilateral). Broadly speaking, there are two models of services trade and investment liberalization under the FTAs. 12 Kavaljit Singh The first model, popularly known as ?GATS? model, differentiates various modes of cross-border supply of services. Under GATS framework, financial services could be provided through mode 1 (officially known as ?cross-border supply? such as domestic consumers taking a loan from a bank located abroad), mode 2 (officially known as ?consumption abroad? such as domestic consumers buying financial services while traveling abroad), mode 3 (officially known as ?commercial presence? such as foreign banks setting up subsidiaries or branches in host countries to provide banking services) and mode 4 (officially known as ?movement of natural persons? such as business visas or temporary entry of foreign individuals in host countries to supply financial services). Except mode 3 which directly involves investment in a host country, modes 1, 2 and 4 are related to different forms of cross-border supply of services. The ?GATS? model follows a ?positive list? approach under which countries list sectors and sub-sectors in which liberalization commitments are to be made. The EU-Chile FTA is a shining example of ?GATS? model. The EU is seeking market access and national treatment commitments under mode 3 for financial and other services under the FTA negotiations with India. The second model, popularly known as ?NAFTA? model, follows the NAFTA approach under which commitments related to ?commercial presence? (GATS mode 3) are dealt separately in the investment chapter. The ?NAFTA? model follows a ?negative list? approach under which liberalization commitments cover all sectors (and sub-sectors) unless specifically exempted by the submission of a negative list by the member-country. The US-Singapore FTA is based on ?NAFTA? model. In the case of EU-Mexico free trade agreement, a ?Hybrid? model of services trade liberalization (with a mix of both models) has been noticed. In a few trade agreements (such as Mercosur), measures related to harmonization of financial regulatory frameworks have been incorporated. It has been observed that bilateral agreements have accomplished increased financial services liberalization commitments as compared to those made under the GATS negotiations of the WTO. For instance, take the US-Singapore FTA. Signing of FTA in 2003 led to deeper opening of cross-border trade and investment in financial services in Singapore. More importantly, the FTA incorporates strong disciplines on the use of capital controls during a financial crisis. Madhyam 13 In a typical North-South bilateral trade agreement, it is the developed countries which are the main ?demandeurs? of financial services liberalization given their strong strength in financial services exports. EU?s Wish List With the help of FTA with India, EU would like to achieve significant liberalization of India?s banking sector, well beyond what has been achieved under the GATS framework. EU is seeking greater market access and export gains for its large banks through cross-border supply and direct investments. Though there are 27 member-states of the EU, only three (the UK, Germany and France) are aggressively pushing the agenda for banking services liberalization. EU?s strong demands on banking services liberalization in India are backed by influential lobbies of big banks and financial institutions. Through various foras, some of the key demands in the banking services emanating from EU include complete market access (commercial presence, cross-border supply and consumption) and national treatment commitments. It has sought removal of regulations pertaining to bank branches, numerical quotas, foreign ownership, equity ceilings, voting rights and investment by state-owned companies in foreign banks in India. Under the Doha negotiations at the WTO, the EU (along with the US) has set high benchmarks to improve access for commercial presence and cross- border supply in various financial services. It has included strong disciplines on transparency, licensing and other regulatory issues. With other countries having similar commercial interests, EU has also pushed for a plurilateral approach to seek greater liberalization of financial services in India. Many European banks have also demanded removal of priority sector lending requirements, borrowing limits and other regulatory measures. The Burgeoning Financial Services Trade Since 2000, several European economies have registered a significant growth in their financial services net exports. Banking services are a key component of their financial services exports. To illustrate, take the case of the UK, one of the most vocal proponents of banking services liberalization in India. The financial and professional services account for 11 per cent of its GDP 1. The UK is the world?s largest source of bank lending with total banking assets of £7.5 trillion in September 2008.2 14 Kavaljit Singh Table 1: Financial Services Trade Balance ($ billion) 2000 2004 2005 2006 UK 20.6 37.4 34.7 46.3 Ireland 0.4 4.8 3.9 5.1 Germany 1.1 0.0 -0.4 3.8 France 1.5 -1.6 -2.1 -3.9 of which: Bank & Other Financial Services UK 17.7 29.8 33.3 41.6 Ireland 0.6 2.5 2.7 3.1 Germany 1.5 1.7 2.2 3.0 France -0.2 -1.0 -1.0 -2.4 Source: IMF; IFSL, 2008. London is the leading financial center with over 350 banks, much ahead of New York, Paris and Frankfurt. London accounts for an estimated 41 per cent of EU?s financial services.3 Almost a half of European investment banking is conducted in London. London also accounts for over 30 per cent of world foreign exchange trade and 40 per cent of the over-the-counter derivatives market.4 The UK remains the leading exporter of financial services in the world. According to IFSL estimates, the UK?s financial sector net exports reached a record £38.8 billion in 2007, up from £29.8 billion in 20065 (Table 2). This is despite the turmoil in the credit markets which began in mid-2007. Banks were the largest contributor, with net exports of £23.2 billion in 2007. Table 2: UK Financial Sector Net Exports (£ million) 2005 2006 2007 Banks 14929 17662 23216 Fund Managers 2105 2625 4124 Insurance 1652 4132 5529 Securities Dealers 2266 2983 4785 Baltic Exchange 735 706 769 Other Financial Services 2696 1716 417 Total Net Exports 24383 29824 38840 Source: IFSL, 2008. Madhyam 15 The bulk of UK banks? net exports were generated through spread earnings (£9.5 billion), FISIM6 (£7.8 billion) and net fee income (£4.5 billion). Derivatives alone accounted for over two-thirds of total spread earnings. In terms of UK?s balance of trade in goods and services in 2007, trade surpluses generated by financial services (£36.9 billion) managed to partially offset large deficits in goods (£89 billion) and travel (£17 billion) (Table 3). Table 3: UK Sector Trade Balances (£ billion) Financial Business Transport Travel Goods Services Services 1997 13.74 8.02 -2.09 -3.64 -12.34 1999 14.47 10.87 -2.42 -8.87 -29.05 2001 18.01 12.42 -3.51 -13.27 -41.21 2003 21.52 15.01 -3.79 -15.48 -48.61 2005 20.22 16.79 -2.08 -15.91 -68.59 2007 36.98 17.87 -2.47 -16.90 -89.25 Source: Office for National Statistics, UK, 2008. In 2007, the UK recorded a trade surplus in financial services with most countries including US (£8.8 billion), Japan (£1.7 billion) and the EU (£12.2 billion) as a bloc. The FDI net earnings by the UK financial services firms jumped from £2.6 billion in 2001 to £11 billion in 2007 (Table 4). The UK?s financial services trade surplus with India was £206 million in 2007, with banks contributing £197 million. No wonder, a deeper market access to the Indian banking system would boost the services exports of the UK-based banks and financial institutions. Table 4: FDI Net Earnings of UK Financial Services (£ bn) Total Total Net Credits Debits Earnings 1997 5.55 2.79 2.77 1999 7.09 3.60 3.49 2001 8.31 5.71 2.61 2003 12.32 5.64 6.68 2005 19.02 11.99 7.22 2007 20.08 9.77 11.03 Source: Office for National Statistics, UK, 2008. 16 Kavaljit Singh In 2008, the Reserve Bank of India (RBI) carried out an Annual Survey on International Trade in Banking Services (2006-07) to find out the quantum of cross-border trade in banking services in the context of India.7 The Survey covered banking services provided by 12 Indian banks operating abroad and 25 foreign banks operating in India. The RBI Survey found that the fee income of the Indian banks operating abroad was Rs.18,900 million in 2006-07. Whereas the total fee income generated by foreign banks operating in India was much higher at Rs.60,830 million. Thus, Indian banks were no match to foreign banks in generating income through trade in banking services. The RBI Survey found that the amount accrued to India by Indian banks? operations in foreign countries was Rs.14,250 million during 2006-07 whereas the amount accrued to abroad by foreign origin banks? operations in India was Rs.60,830 million during the same period. The amount accrued to India by Indian banks? operating in the UK, Germany, the Netherlands and France was much lower than the amount accrued abroad by banks from these countries operating in India (Table 5). For instance, the fee income generated by 84 branches of UK-based banks was Rs.8,553 million in 2006-07 compared to the fee income of Rs.1,893 million generated by 22 branches of Indian banks operating in the UK. The amount accrued to India was greater than the accrued to Belgium and Singapore. The RBI Survey noticed that Indian banks generated major share of fee income by rendering credit related services, trade finance related services Table 5: Banking Services Trade: Accrual of Amounts to Abroad and to India (2006-07) (Rs. million) Foreign Banks Indian Banks Operating in India Operating Abroad Accruals to Abroad Accruals to India Belgium 69.4 339.6 France 929.1 406.5 Germany 3403.5 353.4 Netherlands 1595.8 NA UK 8553.3 1893.3 All Countries 60831.2 14253.5 NA: Branch is not available. Source: Reserve Bank of India, 2009. Madhyam 17 and money transfer services. On the other hand, foreign banks in India generated major share of fee income by rendering derivatives, stock, securities and foreign exchange trading service activities. The Survey observed that Indian banks generated major share of fee income (69.4 per cent) by rendering banking services to non-residents while foreign banks generated major share of fee income (91 per cent) from residents. The Lure of Niche Banking Markets The commercial motives behind entering banking markets in India are obvious as they provide immense profit opportunities to foreign banks. For London-headquartered Standard Chartered, India is the second largest contributor to the bank?s global operating profits after Hong Kong. The bank?s Indian operations posted 71 per cent increase in operating profit to $690 million in 2008 from $403 million in 2006.8 In 2008, its operating profits touched an all time high of $943 million.9 In wholesale banking business, India is now Standard Chartered?s largest contributor in global revenues. For UK-based HSBC Holdings, Europe?s largest bank by market capitalization, India was the seventh largest contributor to its global profits in 2008. Its Indian operations witnessed a 25.9 per cent jump in profit before tax to $666 million in 2008 against $529 million in 2007 10. However, the big European banks are particularly interested in serving three niche market segments in India: up-market consumer retail finance, wealth management services and investment banking. The growth potential for consumer finance products in India is enormous. Consider the following statistics. India has only 22 million credit cardholders as against 200 million mobile phone subscribers. The domestic credit card market is growing by 35 per cent annually. The share of housing mortgage to the GDP is a mere 6 per cent as compared to China?s 11 per cent. India?s household savings invested in financial products is just 18 per cent of the GDP. The country?s favorable demographics (60 per cent of India?s population is below 30 years) also offer the prospect of greater spending power in the hands of working youngsters. 18 Kavaljit Singh For Deutsche Bank and Barclays, India has become a launch pad for retail banking services. Both banks have started off with India in the Asia-Pacific region. Other European banks such as Societe Generale and Royal Bank of Scotland are also keen to enter niche markets such as private banking. For the past few years, India is creating millionaires at the fastest pace in the world. According to World Wealth Report 2008, India led the world in the high-net-worth-individual (HNWI) population growth at 22.7 per cent, driven largely by market capitalization growth of 118 per cent and real GDP growth of 7.9 per cent.11 India added another 23,000 more millionaires in 2007 to its 2006 tally of 100,000 millionaires holding at least $1 million in financial assets excluding their primary residence and consumables. According to Barclays Wealth Insights Report, India will be the eight largest nation of wealthy individuals in the world by 2017, with 411,000 millionaires having an aggregate wealth of $1.7 trillion. As the newly wealthy grapple with their riches, wealth management and advisory services have become a booming business in India. The HNWI community is a key market segment for wealth management services. In 2009, the Royal Bank of Scotland launched Royal Wealth Management which exclusively offers services to wealthy Indians. Several international banks have created specific products and launched specialized branches to serve the HNWI segment. The demand for specialized financial products and services (such as structured products, tax and real estate planning, etc.) is rising at an unprecedented pace. Market estimates suggest that the contribution of financial products and services to India?s GDP would be close to 19 per cent by 2012. During 2003-08, the investment banking business experienced a boom under the buoyant market conditions in India. In terms of market capitalization, India?s two stock exchanges, the Bombay Stock Exchange and the National Stock Exchange of India, were ranked among the world?s top 12 exchanges in 2007. Much of market capitalization growth in the stock markets was contributed by financial services, real estate and infrastructure sectors. The buoyancy in the Indian stock markets has helped foreign banks to consolidate their underwriting and advisory businesses. In 2007, 103 companies raised $9.3 billion through initial public offerings (IPOs) in the Indian stock markets. Six out of ten top underwriters were foreign banks. Madhyam 19 Big European banks are the leading issue managers and underwriters in India. For instance, take the case of Deutsche Bank. Apart from retail banking services launched in 2005, Deutsche Bank provides a complete range of products and services in the areas of investment banking and asset management in India. Its Indian operations had a balance sheet size of over $4.2 billion in 2007 12. The Deutsche Bank has been a leader in mergers and acquisitions, with the bank involved in Tata Steel's acquisition of Corus.13 During 2006-07, Deutsche Bank was the leading manager of bonds and equities offerings in India. In sales and trading, Deutsche Bank is among India?s leading foreign exchange dealers. The bank ranks among the top three in derivatives sales. In 2008, Deutsche Bank was the top holder of Indian stocks among foreign institutional investors in the country 14. The surge in demand for corporate financial products has attracted the attention of international banks. Indian companies are increasing the scale of their operations for which they require capital and advisory services. The big-ticket mergers and acquisitions (particularly in cross-border segment) taking place in corporate India require investment banking, underwriting and other advisory services where big European banks have a competitive edge over domestic banks. The large-scale infrastructure projects in power, roads and ports also need financial intermediation which opens up new business opportunities for foreign banks. In addition, the share of foreign banks in foreign exchange market in India is also growing at a tremendous speed. During January-June 2007, the share of foreign banks in the total foreign exchange turnover stood at 52 per cent.15 The private equity (PE) business has witnessed rapid growth in recent years. The total PE investments in India hit a record $17 billion in 2007. European banks play an important role in the financing of leveraged buyouts. Banking Services Market Access: A One-way Street? Despite wide-ranging asymmetries between India and EU, the negotiations in the banking services cannot be simply construed as one-way process. Apart from big European banks seeking greater market access to the Indian markets, a number of big Indian banks (both state-owned and private) are also seeking increased presence in the European countries (particularly in 20 Kavaljit Singh the UK and Germany) as they aim to serve the non-resident Indians (NRIs) based in these countries. It has been estimated that there are over 150,000 millionaire NRIs in the world and a substantial number of them reside in Europe. The Indian banks are increasingly focusing on servicing this niche market of NRI millionaires. As India is the largest remittance recipient country in the world with inflows of US$ 24 billion annually, Indian banks want to increase their market share in this segment by increasing their presence abroad. In addition, Indian banks are facilitating acquisition of European and other foreign companies by big Indian corporations. The domestic banks have been allowed to extend financial support to Indian companies for acquisition of equity or strategic investments overseas. Due to increasing number of Indian corporations accessing the international equity and debt markets, a larger presence of Indian banks in the overseas markets is being planned. To illustrate, take the case of ICICI Bank, the second largest bank and largest private sector bank in India. The ICICI Bank operates in 19 countries (including the UK and Belgium) in the form of full-fledged branches, wholly owned subsidiaries, offshore banking units and representative offices. The ICICI Bank has over 25 per cent share in the Indian remittance market. The bank?s global assets account for about 25 per cent of its total assets. The ICICI Bank has expanded into corporate and advisory services in foreign markets. The bank co-financed United Spirits? takeover of Scotch whisky distillers, Whyte & Mackay, in 2007 and Tata Motors? $2.3 billion takeover of Jaguar and Land Rover in 2008. The ICICI bank suffered a loss of $264 million on account of its exposure to credit derivatives and investments made by its subsidiaries in the UK and Canada in 2008. ICICI Bank is not the only Indian bank seeking greater international presence. Several large state-owned banks (such as State Bank of India, Bank of India and Bank of Baroda) are also interested in having a strong overseas presence. Many of them have recently begun operations in the UK, China, Singapore and South Africa. Despite the severe banking crisis in the Western countries, Indian banks plan to expand their operations there. In 2008, 18 Indian banks (13 state-owned and 5 private) were operating a network of 203 offices abroad. The network included 131 branches, 22 subsidiaries, 7 joint ventures and 43 representative offices in 51 countries. Madhyam 21 India: A Bank-Based Financial System India follows a bank-based financial system with a multilayered network consisting of large state-owned banks, old private banks, new private banks (established in the post-1991 period), foreign banks, regional rural banks, cooperative banks, non-banking finance companies (NBFCs) and development financial institutions. The share of banking assets in India?s financial sector assets is around 75 per cent. Therefore, the contribution of banking sector is very vital for economic growth and poverty reduction strategies. Of late, niche players such as microfinance institutions have become active in the Indian banking sector. However, India?s banking landscape is still dominated by commercial banks which control a majority of the banking assets in the country. As of March 2008, there were 79 commercial banks with diverse ownership. The government-owned ? State Bank of India (SBI) and its associated banks ? along with other state-owned and regional rural banks were established by the enactments of the Indian Parliament. Under the Banking Regulation Act of 1949, the Reserve Bank of India, country?s central bank, has the power and responsibility to regulate and supervise all banks. No bank can carry out business in India without a license issued by the RBI. Foreign Banks in India In India, the presence of foreign banks dates back to the pre-independence period. Established in 1858, Standard Chartered Bank is the oldest foreign bank in India. BNP Paribas and HSBC began their operations in 1860s. Since 1991, the entry of foreign banks has been liberalized. The number of foreign banks in India increased from 24 in 1990 to 41 in 2000 but their number declined to 29 in 2005 largely due to mergers and acquisitions in the global banking industry. The number of branches of foreign banks increased from 138 in 1990 to 207 in 2003 and further to 277 in 2008. The foreign banks? share in total banking assets also increased from 5.6 per cent in 1990 to 8 per cent in 2008. In 2008, 30 foreign banks were operating in India with a network of 22 Kavaljit Singh Table 6: Foreign Banks in India Year Foreign Number Share in Total Share in Total Banks of of Commercial Assets of (No.) Branches Banks Operating Commercial in India Banks (Per cent) (Per cent) 1980 14 129 9.5 3.9 1990 24 138 8.8 5.6 1995 29 156 10.2 7.3 2000 41 186 13.9 7.5 2003 36 207 12.9 6.9 2005 29 251 13.6 6.5 2006 29 262 16.5 7.2 2007 29 272 16.5 8.0 Source: Reserve Bank of India, 2008. 277 branches and 765 off-site ATMs. These banks originated from 21 countries. Besides, 41 foreign banks have also opened representative offices in India. The 9 EU-based banks operating in India are ABN-AMRO Bank (acquired by a consortium led by Royal Bank of Scotland in 2007), Antwerp Diamond Bank, Barclays Bank, BNP Paribas, Caylon Bank, Deutsche Bank, HSBC, Societe Generale and Standard Chartered. Table 7 provides the list of EU-based banks with their branch network in India. By asset size, out of top 10 foreign Table 7: EU-based Banks Operating in India Name of Bank Country of No. of Branches Incorporation in India ABN-AMRO Bank Netherlands 28 Antwerp Diamond Bank Belgium 1 Barclays Bank United Kingdom 5 BNP Paribas France 9 Calyon Bank France 6 Deutsche Bank Germany 10 HSBC Holdings United Kingdom 47 Societe Generale France 2 Standard Chartered Bank United Kingdom 90 As at end-March 2008. Source: Reserve Bank of India, 2008. Madhyam 23 banks in India, 6 are EU-based. The 9 EU-based banks together controlled 65 per cent of total assets of foreign banks in India in 2008. The Rationale Behind Nationalization of Indian Banking Sector The nationalization of privately-owned banks was a major development in the banking sector in the post-Independent India. India nationalized its banking sector with the promulgation of the Banking Companies Ordinance on July 19, 1969. Under the Act, 14 of the largest privately-owned banks were nationalized. In 1980, 7 more private-sector banks were nationalized under the same Act. Prior to nationalization, the entire banking system was in the hands of private sector. Most of privately-owned banks were in the form of joint stock companies controlled by big industrial houses. For instance, Tatas were the major shareholders of Central Bank of India which was established in 1911. The Birla family, one of the leading corporate houses of India, controlled United Commercial Bank. More importantly, there were several bank failures due to imprudent bank lending in the absence of regulatory safeguards. During 1947-58, for instance, as many as 361 banks of varying sizes failed in India. The failed banks were either amalgamated or ceased to exist. In those times, the limited outreach of banks coupled with weak regulatory framework represented a classic case of market failure in the Indian banking sector. Before nationalization, privately-owned banks were located in metropolitan and urban areas. The population covered per branch was 1,36,000 in 1951. Much of bank lending was concentrated in a few organized sectors of economy and limited to big business houses and large industries. Whereas farmers, small entrepreneurs, laborers, artisans and self-employed were totally dependent on informal sources (mainly traditional moneylenders and relatives) to meet their credit requirements. The share of agriculture in total bank lending was a meager 2.2 per cent during 1951-67. To reverse this trend, the Indian government introduced the policy of social control over banks in 1967. The objective of this policy framework was to bring structural changes in the management of banks by delinking the nexus between big business houses and big commercial banks. Under this policy, new guidelines on the management of banks were issued to ensure that persons with specialized knowledge and experience could join the board of 24 Kavaljit Singh directors of a bank. The RBI also got new powers to appoint or sack senior management in a bank. Another policy objective of social control was to improve the distribution of credit towards agricultural and developmental sectors. Despite such laudable policy measures implemented under the social control framework, a large segment of the population (particularly in rural areas) had not access to the institutionalized credit. Based on this experience, it was realized that the nationalization was the only option to channelize banking resources to the neglected sectors of economy and rural areas. In 1969, the Government nationalized 14 banks with deposits of over Rs.500 million. There were several policy objectives behind the bank nationalization strategy including the transformation of ?class banking? into ?mass banking,? expanding geographical and functional spread of institutionalized credit, mobilizing savings from rural and remote areas and reaching out to neglected sectors such as agriculture and small scale industries. Another policy objective was to ensure that no viable productive business should suffer for lack of credit support, irrespective of its size. In sum, the bank nationalization drive was inspired by a larger social objective so as to subserve national development priorities. The Positive Outcomes of Bank Nationalization Regime Before nationalization, banks were reluctant to open small accounts as these were not considered profitable. Between December 1972 and June 1983, as many as 212 million new bank loan accounts were opened up, out of which nearly 93 per cent were small loan accounts (Rs.10,000 or less). At the time of nationalization, scheduled commercial banks had 8,187 branches throughout the country. But in 1990, the branch network increased to 59,752. With such a rapid increase in bank branches across regions, the population covered per branch, which was 65,000 in 1969, also decreased to 13,756 in 1990 (Table 10). In 1990, out of 59,752 bank branches in the country, 34,791 (58.2 per cent) were located in the rural areas. In contrast, the share of rural branches was 17.6 per cent in 1969. Such a massive expansion of bank branches in the rural and unbanked areas was the result of 1:4 licensing policy of 1977 under the nationalization regime. Madhyam 25 Prior to nationalization, branch licenses were issued on the financial strength of the banks. The 1:4 licensing policy changed the focus to providing banking services throughout the country, particularly in remote and unbanked areas. Under the 1:4 licensing policy, banks were given incentive to open one branch in metropolitan and one branch in urban areas, provided they open four branches in the rural areas. This policy led to rapid growth of bank branches in the rural and remote regions of the country and thereby helped in correcting the urban bias of the banking industry. Between 1977 and 1990, more than three-fourths of bank branches were opened in the unbanked areas. Even the supporters of banking sector liberalization cannot deny that such a rapid expansion of bank branches, after nationalization, was unparalleled among developing countries. The rapid expansion of the branch network led to large deposit mobilization by banks, which in turn, contributed to higher saving rate. The household financial savings increased manifold as nationalized banks enhanced public confidence in the banking system. For instance, household sector financial savings increased from Rs7950 million in 1969 to Rs.60810 million in 1980. Similar trends were witnessed in bank credit too. The bank credit-GDP ratio witnessed a sharp rise, from 10 per cent in 1990 to 24 per cent in 1991. Apart from licensing policy, the establishment of regional rural banks (RRBs) in 1976 also widened the reach of banking services. The mandate of RRBs was to serve small and marginal farmers, agricultural laborers, artisans and small entrepreneurs in the rural and remote areas. In rural areas, there was significant rise in bank deposits and credit. According to official data, the share of rural deposits in total deposits increased more than five times, from 3 per cent in 1969 to 16 per cent in 1990. The share of credit to rural India in total credit jumped from 3.3 per cent to 14.2 per cent during the same period. In addition, banks were directed to maintain a credit-deposit ratio16 of 60 per cent in the rural and semi-urban branches in order to ensure that rural deposits are not used to increase urban credit. The credit-deposit ratio in rural areas increased from 37.6 per cent in 1969 to over 60 per cent in the 1980s and 1990s. 26 Kavaljit Singh To a large extent, these policy measures helped in reducing the dependence on rural population on non-institutional sources such as traditional moneylenders and landlords. The Introduction of Priority Sector Lending The bank lending to priority sectors and weaker sections of society received a major boost under the nationalized regime. In the early 1970s, the concept of priority sector lending (also known as directed lending) was evolved to ensure that adequate credit flows to the vital sectors of the economy and according to social and developmental priorities. Under this policy, specific targets were imposed on the banks to meet the priority sector credit requirements. Slowly, the definition of priority sector has acquired new meaning but broadly it includes bank lending to agriculture, small and medium-sized enterprises (SMEs), weaker sections of society and exports. Under priority sector lending, bank loans to students, retail traders, farmers, small businesses, food and agro-industries, exports and other activities were made available often at concessional rates. The Differential Rate of Interest (DRI) Scheme was also launched in 1972 to provide bank loans at concessional rates of interest to low income groups (such as landless laborers, handicapped persons, scheduled castes and scheduled tribes who did not have tangible assets) for productive purposes. The nationalization regime witnessed substantial flow of credit to all sectors, including the neglected sectors of the economy such as agriculture and small- and medium-enterprises (SMEs). The share of agriculture credit in the total bank credit increased from 2.2 per cent in 1968 to 13 per cent in 1980 and further to 15.8 per cent in 1989. The share of small-scale industry in the total bank credit which was negligible before nationalization reached 15.3 per cent in 1989, a significant achievement by international standards. There is no denying that the banking system under the nationalization regime was not perfect as it could not reach out to each and every household but at least a serious effort was made to spread banking services: geographically, socially and functionally. No one can deny that there were cumbersome lending procedures, inadequate supervision, corruption and political interference which affected functional efficiency and profitability of the Madhyam 27 banking system. Nevertheless, nationalization regime made the entire banking system subservient to the needs of the real economy. Besides, the unholy nexus between the banks and big corporate houses was dismantled to an extent. In sum total, nationalization changed the orientation of commercial banking in India from ?class banking? to ?mass banking.? The state ownership was used as a tool to exert social and democratic control over the banking system. There are very few parallels in the history of banking in the world where such large-scale geographical expansion and functional diversification of the banking system (with social and developmental orientations) took place. Banking Sector Liberalization in India Banking sector liberalization is a process in which allocation of bank resources is determined by market forces rather than the state and public institutions. It minimizes the role of the state in the financial sector by encouraging market forces to decide who gets and gives credit and at what price. Implemented in conjunction with other macroeconomic policy reforms, banking sector liberalization has remained one of the most controversial policy issues in India. Since the launching of liberalization and globalization policies in 1991, a series of important developments have taken place in the Indian banking sector, ranging from a liberalized regime for the entry of foreign banks to divest in state-owned banks to interest rate deregulation to dismantling of developmental financial institutions to the mushrooming of microcredit programs and non-banking financial institutions. The stated objective of banking liberalization has been to make banks more competitive, efficient and profitable. The processes involved in the banking sector liberalization in India are very dynamic and complex. The pressure to open up the banking sector in India has come from various sources (domestic and foreign). Since 1991, the entry of foreign banks has been liberalized. Several official committees have recommended opening up of India?s banking sector on the grounds that the entry of foreign banks would enhance competitive efficiency of the banking sector and would encourage domestic banks to adopt ?best practices? and new technology. 28 Kavaljit Singh To enlarge the presence of foreign banks in the Indian banking markets, RBI announced a roadmap entailing sequencing of banking reform measures in 2005. The roadmap consists of two phases. In the first phase, between March 2005 and March 2009, foreign banks will be allowed to establish a 100 per cent wholly owned subsidiary (WOS) or conversion of the existing branches into a WOS. Besides, the WOS will be treated on a par with the existing branches of foreign banks for branch expansion. To date, surprisingly, no foreign bank has opted for a WOS route. During this phase, foreign banks will also be allowed to take over ailing private sector banks identified by the central bank. In the second phase, starting from April 2009, foreign banks will be given the ?National Treatment? under which they would be treated on par with domestic banks and the remaining restrictions on foreign ownership and investments will be removed. As a part of financial sector reforms, the successive political regimes have undertaken partial privatization of state-owned banks, reducing the government stake to 51 per cent. In 2008, the Planning Commission?s High Level Group on the Services Sector recommended that the government stake in public sector banks should be further reduced to 33 per cent. For many years, foreign investors have been demanding the removal of 10 per cent ceiling on voting rights in the Indian banks. They are seeking voting rights in commensurate with their ownership in the private Indian banks. To remove this ceiling, the government introduced a bill in the Indian Parliament in 2008. A further boost for global integration could come if India undertakes capital account liberalization which, in turn, would further expand cross-border trade and investment in the banking and other financial services. Trade Agreements and Banking Sector Liberalization Under the WTO agreement, India has given commitments to offer 12 new licenses every year to foreign banks. The trade agreement such as India-Singapore Comprehensive Economic Cooperation Agreement (CECA), which came into effect in 2005, is an example of opening up banking sector on a bilateral basis. Under the CECA, Madhyam 29 three Singapore banks are allowed to open 15 branches in India and three Indian banks would be given the Qualifying Full Banking (QFB) status in Singapore. The QFB status allows banks to undertake all banking activities, including retail and wholesale banking, in Singapore. Besides, banks with QFB status can also transact business in Singapore dollars. The CECA provides special privileges to three Singapore banks (DBS Bank, United Overseas Bank and Overseas-Chinese Banking Corporation) as they are allowed to set up a wholly-owned subsidiary (WOS) in India to enjoy treatment on a par with domestic banks in terms of branch licenses, places of operations and prudential requirements. In case these three banks choose to set up as branches in India, CECA provides a separate quota of 15 branches (for all three banks) over four years, over and above the quota for all foreign banks. Despite the much-touted roadmap for banking sector liberalization, the Indian authorities are violating it to accommodate commitments made under the CECA. In principle, the commitments made by India under the CECA are in conflict with domestic regulations related to foreign ownership. For instance, two sovereign wealth funds owned by the Government of Singapore (Temasek Holdings and Government of Singapore Investment Corporation) have been allowed to acquire 10 per cent stake each in ICICI Bank. As per existing rules, no single foreign institutional investor can own more than 10 per cent equity in a listed company in India. The different foreign institutional investors owned by a common entity are classified as a group and are subject to the 10 per cent limit. Instead of treating both Singapore funds as a single entity because of their common state ownership, the Indian authorities have allowed them to hold up to 20 per cent of shares in ICICI Bank. No Reciprocity in Market Access Contrary to popular perception, Indian authorities are opening up its banking markets, far exceeding the international commitments. The RBI has gone beyond the existing international commitments to give greater market access to foreign banks. The number of branches permitted each year to foreign banks has been higher than the WTO commitments of 12 branches in a year. During July 2006-June 2007, India allowed seven established foreign banks (including 30 Kavaljit Singh ABN AMRO Bank, Barclays Bank and Deutsche Bank) to open 20 new branches and additional seven foreign banks to set up representative offices. During July 2007-June 2008, 3 existing foreign banks were allowed to open 18 branches. Besides, 5 new foreign banks (including Dresdner Bank) were given permission to open one branch each. One of the key policy issues determining the market access is reciprocity. How much market access Indian banks are getting in return? The recent experience shows that market access to Indian banks is far from satisfactory. During 2003-07, India allowed US-based banks to open 19 branches (excluding the off-site ATMs). But, in the same period, the US did not allow a single Indian bank to open a branch or subsidiary or representative office in its territory despite many requests made by Indian banks. In the case of India-Singapore CECA, the principle of reciprocity has not been followed. Though the RBI has allowed market access to Singapore banks as per the agreement but the Monetary Authority of Singapore (MAS) has failed to fulfill its commitments for providing full bank license (QFB status) to three Indian banks. Currently, the DBS Bank is operating 10 branches in India along with other Singapore banks whereas only State Bank of India has been given QFB status in Singapore. The other Indian banks (such as ICICI Bank and Bank of India) have been denied the QFB status. Are Foreign Banks Discriminated in India? There is a popular perception that the entry of foreign banks in the Indian market is very restricted and the regulatory framework discriminates against the foreign banks. A closer examination of current banking regulatory framework reveals that it is no longer discriminatory and in many important ways put foreign banks in the same footing as Indian banks. As pointed out by V. Leeladhar, former Deputy Governor of RBI, India issues a single class of banking license to foreign banks which means that there are no restrictions on the scope of their activities.17 In many countries including the US, Singapore and China, strict restrictions have been imposed on the kind of businesses (e.g., foreign-country related business) that could be carried out by foreign banks. But in India, foreign banks are free to undertake any banking activity (e.g., wholesale, retail, private banking, investment banking, foreign exchange, etc.) which is allowed to domestic banks.18 Madhyam 31 Owing to single class license policy, foreign banks are having a field day. They are handling bulk of their home-country trade and investment businesses. A substantial portion of foreign institutional investments and foreign exchange business is also handled by the foreign banks thanks to this liberal policy. Foreign banks also enjoy comparative advantage in undertaking off-balance sheet activities, such as forward exchange contracts and guarantees owing to their foreign exchange positions and relevant expertise. In India, there are also no restrictions on the establishment of non-banking financial subsidiaries by foreign banks. Unlike many other developed and developing countries, deposit insurance cover is uniformly available to both foreign and domestic banks in India. If any bank (domestic or foreign) fails, a payment of up to Rs.1,00,000 to each depositor is guaranteed under the Indian regulations. Further, the prudential norms applicable to foreign banks for capital adequacy, reserve requirements and asset classification are the same as for the Indian banks.19 Foreign banks also pursue independent staff recruitment policies. Foreign banks often complain that they are not allowed to manage state- owned company term deposits. According to rules, state-owned companies can only park their funds with any scheduled commercial bank (irrespective of ownership) incorporated in India. Since foreign banks are incorporated in their home countries, they are not eligible for accessing these funds. However, this curb will not be valid if the foreign banks incorporate subsidiaries in India. As pointed out by Mathew Joseph and Rupa Rege Nitsure, this restriction will not longer be valid if the foreign banks incorporate subsidiaries in India.20 Similarly, foreign banks can get equal tax treatment by incorporating subsidiaries in India.21 Despite the RBI permission, no foreign bank has converted their existing branches into WOS, till date. The possible reason could be once they opt for a WOS route, they would have to follow priority sector lending guidelines, which are applicable to domestic banks. Domestic banks complain that foreign banks are given undue favor when it comes to priority sector lending. The Indian authorities have imposed lower priority sector lending requirement at 32 per cent (of their adjusted net bank credit or credit equivalent amount of off-balance sheet exposures, whichever is higher) for foreign banks as against 40 per cent for Indian banks. 32 Kavaljit Singh Within the overall target of 32 per cent, foreign banks are required to lend 10 per cent to micro and small enterprises and 12 per cent to export credit. But no target has been prescribed for foreign banks to lend money to agricultural sector and weaker sections of society. In addition, foreign banks are also exempted from Differential Rate of Interest (DRI) scheme under which loans are offered to people below the poverty line, particularly to scheduled caste and tribal people, at a much lower rate of interests with easy repayment rates and no margins. In contrast, within the overall target of 40 per cent, it is mandatory for domestic banks (both state and private) to lend 18 per cent to agricultural sector and 10 per cent to the weaker sections of the society besides meeting the requirements under the DRI scheme. Moreover, state-owned banks are required to lend at least 5 per cent of their net bank credit to women. In other words, this lopsided policy framework has ensured that foreign banks can remain insensitive to the requirements of the agricultural sector and the weaker sections of society. The RBI statistics reveals that since 2000, state-owned banks, as a group, have been meeting the overall priority sector lending targets, despite steep shortfall in agricultural lending. The priority sector lending by state owned banks was 39.6 per cent during 2006-07, marginally short of mandatory 40 per cent.22 At end-March 2008, aggregate credit to women by state-owned banks was 6.12 per cent of their net bank credit with 24 banks reaching the target.23 Eight state-owned banks have also opened 19 specialized women branches.24 The private sector banks, as a group, are failing to meet the priority sector targets. For instance, no private bank has achieved the 10 per cent sub- target lending to weaker sections during 2006-07. In order to avoid penalties, often private banks buy such loan assets from their state-owned counterparts. While foreign banks, as a group, have been achieving the overall lending target of 32 per cent, but largely only on the account of export credit, in tune with their priorities. In fact, the share of export credit in total net bank credit of foreign banks was 18 per cent in 2006-07, much higher than the prescribed target of 12 per cent. Madhyam 33 At the individual bank level, some foreign banks have been unable to meet the priority sector lending targets and sub-targets. But there are glaring loopholes leading to some foreign banks missing the lending targets. Those foreign banks which are unable to meet the priority sector lending targets are required to deposit amounts equivalent to the shortfall with the Small Industries Development Bank of India (SIDBI) for three years. In return, foreign banks earn interest on such deposits. Aggregate amounts of Rs.10,580 million and Rs.10,310 million were deposited by the foreign banks with SIDBI for 2006 and 2007 respectively as they could not meet the stipulated targets.25 The Branch Licensing Policy Favors Foreign Banks In the case of branch licensing policy, there is no regulatory prescription for foreign banks to open branches in rural and semi-urban areas. Foreign banks have the freedom to decide the location of their branches. While for new private banks, the licensing policy stipulates that while these banks need not necessarily open up branches in rural or semi-urban areas during the first three years of their operations. But once the moratorium is over, one out of four new branches would have to be opened in such centers. This lopsided policy works in favor of foreign banks because rural branches generate less profit due to low value transactions. Most of the bank branches in the rural areas are operated by state-owned banks. On the other hand, foreign and private sector banks operate largely in urban and metropolitan Table 8: Distribution of Bank Branches in India (in Per cent) Bank Groups Rural Semi-Urban Urban Metropolition State-owned Banks* 35.0 25.9 20.5 18.6 Old Private Banks 18.2 33.5 28.6 19.4 New Private Banks 6.3 25.4 32.3 36.0 Regional Rural Banks 77.9 17.6 4.0 0.4 Foreign Banks 0 0.7 17.9 81.4 As at end-March 2008. * Includes nationalized banks, SBI Group and IDBI Ltd. Note: Population group wise classification of branches is based on 2001 Census. The ?Rural? group includes all centers with population of less than 10,000. The ?Semi- Urban? group includes centers with population of 10,000 and above but less than 100,000. The ?Urban? group includes centers with population of 100,000 and above but less than 1 million. The ?Metropolitan? group includes centers with population of 10 lakhs and above. Source: Reserve Bank of India, 2008. 34 Kavaljit Singh areas and manage accounts of high-net-worth-individuals and large corporations. To date, most of bank branches of foreign banks are located in metropolitan areas and major cities where bulk of premium banking business is concentrated. As on June 2008, there were 30 foreign banks operating in India with a network of 279 branches and 765 off-site ATMs. Out of 279 branches, 227 (81.4 per cent) were located in metropolitan areas, 50 (17.9 per cent) in urban areas and just 2 (0.7 per cent) in semi-urban areas (Table 8). Not a single foreign bank has opened a branch in rural areas. Since foreign banks have no branches in the rural areas, they are also not obliged to fulfill the agricultural loans commitments under the priority sector lending policy. In the case of EU-based banks operating in India, they have yet to open a branch in the rural areas. This is despite t
Posted: 25 March 2010

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