A seminar report on

Foreign Banks in India

Submitted to: Dr G.V Joshi

Submitted by: Prasanna Bhat Prithviraj

Submitted on: 25th Sep 2010

Justice K.S Hegde Institute of Management, Nitte.

INTRODUCTION: Foreign Banks operating in India are banks of other countries having their branches in India. At present, there are about 31 foreign banks having a total of more than 250 branches in most of the big cities of the country. These foreign banks have a flourishing business and earn large profits. Foreign Banks were established in India quite early during the British rule and have been around for over a century now. As a result of globalisation of Indian economy, the number of foreign banks is likely to increase in the coming years. The foreign banks are also called foreign exchange banks, as they also finance the foreign trade of India. Of late, a sort of competition has developed between various foreign banks and Indian commercial banks because the foreign banks, which previously dealt only in big money, have now also started performing the day-to-day banking functions, which were previously performed only by the Indian commercial banks. These day-to-day banking functions include acceptance of deposits, creation of credit by fixing lending rate in accordance with the RBI policies, etc. ANZ Grindlay Bank has its presence in a number of Indian cities with as many as 56 branches in the country. The Standard and Chartered Banks has 24 branches while Hong Kong Bank has 21 branches in various Indian cities. One peculiar feature of these foreign banks is that they concentrate on the corporate clientele and have specialised in areas of international banking.

Roles of foreign bank in India Foreign banks play a relatively minor role in the Indian economy, as reiterated in Global Development Finance 2008, an annual publication from the World Bank that was released last week. This fact is relevant right now for two reasons. First, the Reserve Bank of India is likely to open up the Indian banking market further in April, or around 300 days from now. Two, the global credit crisis has shown how problems in Western banks can reverberate through financial systems in emerging markets. The advantages of greater foreign bank participation are clear: They tend to increase the efficiency of the local banking system, bring in more sophisticated financial services and have the ability to nurse weak banks back to health. That underlies the case for greater freedom for foreign banks. The credit crisis has brought the dark underside into focus. Global banks that boast of the best practices in the way they allocate capital and manage risks are also prone to make elementary mistakes, partly because of the imperfect nature of regulations and partly because bankers have perverse incentives to be loose with other peoples money. So, which way should policy swing? It is tempting to conclude that India is better off with its current policy of caution about the entry of foreign banks. But that would be a mistake. While we agree that banking markets tend to be prone to crises and, hence, need tighter regulation than markets in goods and services, India needs more foreign bank participation. The main contentionthat foreign banks account for just 5% of Indias loan marketis misleading. Local banks have been on a borrowing spree abroad. They raised more than $12 billion between 2003 and 2006, which is one reason that India could support credit growth of 28.1% despite the fact that deposits grew at only 18.5%.A lot of this overseas borrowing must have come from foreign banks operating in global financial centers. The question is: If regulators are comfortable getting resources from foreign banks indirectly through the global credit markets, what is the objection to more direct participation?

Foreign banks in India account for roughl y 6.5% of the banking industrys assets and there has not been any change in their market share over the years. RBIs reluctance to allow them a larger play is indeed one of the reasons behind this. The other reason could be foreign banks reluctance to be more innovative. In fact, I often feel these banks use RBIs restrictive branch licensing norm as an excuse for their lack of innovation. Under a 1997 commitment given to the World Trade Organization, RBI needs to give 12 new branch licenses to foreign banks every year, including those given to new entrants and existing players, but the Indian regulator has all along been allowing foreign banks to open more branches, going beyond its commitment. According to the Reserve Bank, foreign banks gave out total advances of Rs 1, 63,260 crore during 2009-10. This was 1.28 per cent less than Rs 1,65,385 crore of loans given by the banks in 2008-09.In addition, overseas banks had 27,742 employees in India as on March 31, 2010, a fall of 6.22 per cent compared to the previous fiscal, RBI said in its latest 'Profile of Banks'. However, the total number of offices operated by foreign lenders in the country went up to 310 in the last fiscal, from 295 in 2008-09, it added. There are 32 overseas banks operating in the country. Among major foreign lenders, Citibank gave out advances of Rs 36,655 crore in 200910, down from Rs 39,920 crore in the previous fiscal, while Barclays Bank's lending fell to Rs 7,565 crore in the last fiscal from Rs 10,551 crore in FY09.

Hong Kong & Shanghai Banking Corp gave out Rs 23,475 crore in India last fiscal, down from Rs 27,589 crore in the year before that. Royal Bank of Scotland NV's lending in the country fell to Rs 13,406 crore in 2009-10 from Rs 16,660 crore. However, Deutsche Bank's advances to Indian customers went up to Rs 12,923 crore in the fiscal ending March 2010, from Rs 8,798 in the previous year. Standard Chartered Bank had the largest payroll among foreign banks in India as on March 31, 2010. It employed 7,903 staff in the country, which was a small rise from 7,825 in the previous fiscal. But many of the other overseas banks reduced their staff strength substantially last fiscal.

Hong Kong & Shanghai Banking Corp cut staff numbers to 6,685 last fiscal. It had 7,746 employees in India in 2008-09.Royal Bank of Scotland NV's workforce in India came down to 2,716 in 2009-10 from 3,241 in the previous fiscal, while Citibank's went down to 4,613 from 4,795.Barclays reduced India payroll by a third and ended 2009-10 with 1,083 employees against 1,534 in 2008-09.Even as they shed staff in India, overseas banks added more branches in the country last fiscal. Standard Chartered Bank increased the number of its offices to 95 from 91, while Hong Kong & Shanghai Banking Corp touched the 50 mark from 47 a year-ago. Citibank's total branches in the country went up to 43 in 2009-10 from 41 in the previous fiscal.

Foreign banks have opened up several options for the developing countries to attain economic growth. The achievement of this objective has been made possible partly by foreign exchanges transactions. Like every other facility, the foreign banks also create both advantages and disadvantages. The advantage is that the foreign banks help finance exports and imports under letter of credit, the medium of D.A. Bills and D.P. Bills, and by promoting internal trade. In this way they help in earning foreign exchange. As the foreign banks have branches in almost all the other countries of the world, they are able to maintain business links with all those countries for various purposes. Thus, through these banks, Indian businessmen are also able to maintain their contacts with their counterparts in other countries. So far as standard of performance is concerned foreign banks are considered to be more efficient and more competent than their Indian counterparts. However, one great disadvantage of foreign banks is that their attitude towards Indian businessmen is discriminatory. These banks have more or less monopolized the financing of Indias external trade through which they earn large sums of money as commission or brokerage, etc. They also extend preferential treatment to foreign institutions in the matter of grant of loans and advances. They also charge excessive commission for the currencies of those countries which do not have their own bank branches in India. The Indian capital invested in these banks is misused in the sense that their capital, instead of being utilised for the benefit of Indian business, is used for the purchase of shares and bonds from road, thus diminishing the profit share of India. Foreign banks are required to obtain license from the Reserve Bank of India but the RBI has failed to exercise an effective control over these banks, with the result that these

banks have acquired large amounts of money in the London money market, thus rendering the Indian money market ineffective. Under the provisions of Banking Companies Act of 1949, foreign banks are required to keep in India as least 75 per cent of their Demand and Time Deposits in such assets as eligible Bills or Promissory Notes. However, the problem for us is how to regulate the functioning of these banks so as to make them function more effectively in the interest of the development needs of the country. There is urgent need to make both structural as well as functional adjustments so as to fulfill the needs of the dynamic Indian economy. The guidelines issued by the Reserve Bank in this behalf lay down that all banks should be required to have a reasonable minimum reserve in the form of cash or deposits; the number of financial institutions should be kept as small as possible, effective control should be maintained over the foreign banks; foreign banks should be compelled to sell their shares in India and the like. In terms of efficiency, proficiency, profitability, productivity, etc., the top nine banks in the country are the foreign banks. These banks may be having a small number of branches, but they enjoy a sizeable presence in the nonfund business and are earning huge profits. In the days to come, the presence of foreign banks and new private banks in the country is sure to increase. During 1995-96, the deposits with the foreign banks increased by 10.2 per cent and their aggregate profit increased from Rs. 632 crore in 1994-95 to Rs. 757 crore in 1995-96 and it has increase by around 200% in 2005-06. Thus foreign banks also play a significant role in the economic growth of the country. Capital formation is the foremost requirement of economic growth and foreign banks promote capital formation by encouraging savings and investments. They help the entrepreneurs to increase their productive capacity. It will thus be seen that the foreign banks have played a significant role in the growth of Indian economy during the post-Independence period. But at the same time, it is also a fact that in conditions of political and financial instability, especially in developing countries including India, foreign banks, with their vast resources and political influence abroad, can hold the national currencies and economies to ransom. The banking scams of the Harshad Mehta fame could not have been made possible without the manipulation of foreign banks operating within the country. The Indian commercial banks have neither the resources nor the freehand to finance such gigantic and scandalous transactions and deals. In the East-Asian countries also, when the
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foreign banks found the national economies in a state of confusion, they played havoc with the economies of the host countries by suddenly withdrawing huge amounts of money from the national economies thereby engineering economic disasters in those countries. Foreign banks are very helpful in the development of India. It is necessary and desirable for us to maintain and encourage foreign banks in India to promote investments and finance international trade. But we should utilize their loans properly in the productive way as after economic development we have to repay their loans in time. It is equally important to exercise strict vigilance and control over their activities lest they should create another Indonesia or Thailand in India

Major foreign banks in India are:

ABN-AMRO Bank The history of ABN Amro Bank dates back to the year 1924, when King Williem I issued a Royal Decree declaring the establishment of the Nederlandsche Handel-Maatschappij (Netherlands Trading Society, NTS). The NTS had been established with an aim to promote the trade between the Netherlands and the Dutch East Indies.

Abu Dhabi Commercial Bank Ltd. Abu Dhabi Commercial Bank (ADCB) is one of the most prominent nationalized banks of the United Arab Emirates (UAE). Three different banks viz. the Khalij Commercial Bank, the Emirates Commercial Bank and the Federal Commercial Bank merged in the month of July 1985, leading to the incorporation of the Abu Dhabi Commercial Bank. American Express Bank Ltd

With its headquarters located in New York, U.S., American Express company is a global financial services provider, also known as AmEx in short. American Express had been established in the year 1850, and is well known all around the world for its dedicated Credit Card, Travellers Cheque and Charge Card services.
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BNP Paribas BNP Paribas is one of the oldest banks in the continent of Europe, and the largest bank in the Euro zone (consortium of countries having adopted Euro as their primary currency), as reported by The Banker magazine. The bank is present in 87 countries with a 162,700-strong workforce offering its services to the bank. Citibank Citibank is one of the largest banks in the U.S., and is a part of the financial services company Citigroup. Citibank had been founded in the year 1812. Initially its name was City Bank of New York, which was later changed to First National City Bank of New York.

DBS Bank Ltd DBS Bank is a Singapore-based bank, and is known to be one of the largest banks to exist in South East Asian region by asset value. The government of Singapore established the DBS Bank in the year 1968, and it was primarily aimed at providing development oriented financial services.

Deutsche Bank Deutsche Bank, headquartered at Frankfurt in Germany, ranks among the global leaders in corporate banking and securities, transaction banking, asset management, and private wealth management. It is one the world's leading international financial service providers with roughly EURO 2.2 trillion in assets and approximately 80,000 employees.

HSBC Ltd HSBC Bank is a subsidiary of HSBC Holdings plc, a London based banking giant which, according to the Forbes magazine, is the largest banking group in the world, and the 6th largest company in the world as of April 2009.

Standard Chartered Bank Standard Chartered Bank is a London based bank, currently operational within over 70 nations
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with more than 1,700 branches and 73,000 strong workforce as of April 2009. Although the bank is located in Britain, still a huge chunk of its revenues originate from the continents of Asia, Africa and Middle East.

Barclays Bank Barclays GRCB India is led by Samir Bhatia as its Managing Director. In a short period of just two and a half years, Barclays GRCB India has placed itself amongst the most respected foreign banks in the country that is serving more than 830,000 clients.

Foreign banks have brought latest technology and latest banking practices in India. They have helped made Indian Banking system more competitive and efficient. Government has come up with a road map for expansion of foreign banks in India. The road map has two phases. During the first phase between March 2005 and March 2009, foreign banks may establish a presence by way of setting up a wholly owned subsidiary (WOS) or conversion of existing branches into a WOS. The second phase will commence in April 2009 after a review of the experience gained after due consultation with all the stake holders in the banking sector. The review would examine issues concerning extension of national treatment to WOS, dilution of stake and permitting mergers/acquisitions of any private sector banks in India by a foreign bank.

RBI Moves: Various measures taken by the RBI after 1991 once Financial Sector Reforms introduced were: (1) Disclosures and transparency in Balance Sheet (2) Capital Adequacy requirements (3) 4-way classification of Assets (Loans and Investments) (4) Gradual reduction of SLR (from 39-25) and CRR (From 15-4.5) stipulations (5) Provisioning Norms (like provision for NPA, etc)
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(6) Deregulation of Interest Rates (7) Creation of Debt Recovery Tribunals, Board for Industrial & financial Reconstruction (BIFR) (8) Enactment of new laws or amendments to Negotiable Instruments Act, and others by Government (9) Implementation of Asset Liability Management (ALM) measures and Basel norms (10) Introduction of Risk Management in Banks and Risk Based Supervision (RBS) -

CAMELS (11) Recovery measures like Compromise Settlements, Corporate Debt Restructuring,

Rehabilitation facilities to sick units (12) (13) (14) (15) (16) Computerization of branches Closure or shifting or combining of loss making branches Voluntary Retirement Scheme for employees Investment in Hardware, Software and training of staff Permission for Online Banking, Internet Banking, ATMs, etc.

All these measures have definitely aided in reduction of costs, improving productivity and profitability of banks, strengthening of capital and funds base of banks, reduction of multi- tier decision making levels, speedier collection and transfer of funds, investor education and information dissemination through use of Internet, offering innovative products and services, spread of banking habits among all sections of society, competition with foreign and new generation private sector banks, etc. Customer is now seriously considered as king and all efforts are being made to suit his needs and meet the demands by tailoring various products and services.

Measures and Guidelines for Foreign Banks: New foreign banks are allowed to conduct business in India after taking into consideration the financial soundness of the bank, international and home country ranking, rating, international presence, and economic and political relations between the countries.

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India issues a single class banking license to foreign banks and does not require them to graduate from a lower to a higher category of banking license over a number of years. This single class of license places them virtually on the same footing as an Indian bank and does not place any restrictions on the scope of their operations. Thus, a foreign bank can undertake, from the very first day of its operations, any or all of the activities permitted to an Indian bank and all foreign banks can carry on both retail as well as wholesale banking business.

A priority sector obligation of foreign banks is presently at 32% of their total advances. Priority sector consists of agriculture, small businesses and Export loans (part of priority sector loans only for foreign banks). To meet their quarterly and yearly targets, foreign banks adjust the rates drastically and lend at a much cheaper rate to the medium and small enterprises and exporters.

The capital requirement for a foreign bank to open a branch in India is $25 million (around Rs117 crore).

India had committed to the World Trade Organization (WTO) in 1997 to give 12 new branch licenses to foreign banks every year, including those given to new entrants and the existing players. However, the Indian regulator has all along been allowing foreign banks to open more branches, going beyond its commitment to WTO. In fact, till October 2007, it has given its nod to 75 new foreign bank branches and many more ATMs (which do not come under WTO norms).

Under the roadmap for foreign banks released by the RBI in 2005, branches of foreign banks were allowed to convert into wholly-owned subsidiaries (WOSs). The roadmap was divided into two phases, the first phase spanning the period March 2005 - March 2009, and the second phase beginning after a review of the experience gained in the first phase. The first track was the consolidation of the domestic banking system, both in the private and public sectors, and the second track was the gradual enhancement of foreign banks in a synchronized manner. Foreign banks already operating in India were also allowed to convert their existing branches to WOS while following the one-mode presence criterion. The WOS is to be treated at par with the existing branches of foreign banks for branch expansion in India. No foreign bank, however, applied to establish itself
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as a WOS or to convert to a WOS during the first phase. Reason may be, once they become subsidiaries of overseas parent, they should have separate balance sheets and their capital will be treated separately. Compensation Guidelines to Foreign Banks: Till July 1, 2010 the salaries of top executives in private and foreign banks are approved by the central bank after the respective banks board gives a go-ahead to the proposal. In the G-20 meet last year, the world leaders expressed concern over the high compensation packages of top bank executives, which, they argued was a not positive sign in a healthy financial system. With a view to align the compensation with long-term value creation, the G-20 leaders asked the central banks to formulate compensation policies. However, each country will have to come out with its own rules. The agreements reached at the G20 summit discourage bonus guarantees extending more than a year. Besides, the bonuses should be linked to the CEOs individual contribution and performance in the organization. In this background, RBI issued guidelines to foreign banks on sound compensation policy. Foreign Banks would be required to submit a declaration annually from their Head Offices to the effect that their compensation structure in India, including that of CEOs is in conformity with the Financial Stability Board (FSB) principles and standards. RBI would take this into account while according approval of CEOs compensation. In case it is observed that compensation is not properly aligned to risks or there are other regulatory and supervisory compliance issues in relation to the Indian operations, the compensation issue would be appropriately taken up with the RBI, on case to case basis. RBI is keen on local incorporation & listing on local bourses as it wants to ring-fence foreign banks in India play from their global operations. The foreign parent now can take the money outif their global balance sheet needs itfrom an Indian branch, but cannot do so when the branch becomes an Indian subsidiary.

The RBI has made it clear that the acquisition by foreigners of shareholding in Indian private sector banks can only relate to certain much specified banks that are in very bad
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shape already. The guidelines state that In order to allow Indian Banks sufficient time to prepare themselves for global competition, initially entry of foreign banks will be permitted only in private sector banks that are identified by RBI for restructuring. In such banks, foreign banks would be allowed to acquire a controlling stake in a phased manner.Therefore, as on 2009, foreign acquisition of Indian banks, subject to the overall investment limit of 74 per cent, is to be limited to those that are anyway about to collapse and have been vetted by the RBI for restructuring. The Reserve Bank of India (RBI) has decided to run a detailed assessment of the riskmanagement capabilities and evaluate the transparency in financial affairs of all foreign banks operating in India. The move is aimed at ensuring they do not pose any systemic risk to the banking sector. Till this process is completed, foreign banks are unlikely to be allowed to open more branches in the country. The present inspection system under RBS for foreign banks is based on Capital Adequacy, Asset Quality, Liquidity, Compliance and Systems (CALCS) As the FDI policy document issued by the GOI, FDI up to 74% from all sources will be permitted in foreign banks on the automatic route, subject to conformity with the guidelines issued by RBI from time to time. Deduction in case of foreign banks, having branches in India, for Head Office expenses (currently available at 5% of adjusted total income or attributable HO expenses whichever is lower) now proposed to be 0.5% of total sales/ turnover/ gross receipts under the provision of DTC Bill 2010. The DTC Bill 2010 proposes to do away with the deduction for provision for bad and doubtful debts (PDD) with reference to the advances by rural branches as well as with reference to a percentage of total income. Instead the deduction would be available on the entire advances at a rate of 1%. The Code mandates that trade debt written off as irrecoverable should be debited to PDD account. Hence, a view could emerge that in case of debts written off without being 'provided for', no deduction may be allowed.

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The DTC Bill 2010 provides an income-tax rate of 30% for banks and the effective income-tax rate for a branch of the foreign bank would be 40.5% as branch profit tax (BPT) would be levied at 15% on the branch profits after reducing the income-tax paid from such profits.

If an overseas bank has taken a loan outside India and then onwards lent this amount to an Indian corporate (for permissible purposes), the interest paid by the overseas bank to the ultimate overseas lender should not be taxable in India, unless the overseas bank claims such interest as a deduction from its income in India.

No restrictions have been placed on establishment of non-banking financial subsidiaries (NBFCs) in India by the foreign banks or of their group companies. Unlike banks, where RBI gives not more than two to three branch licenses, there are no such restrictions on NBFCs. RBI has been concerned that foreign banks were using a combination of the banking and NBFC license to defeat the purpose of branch licensing and was, therefore, going slow on these licenses. In November 2006, the Reserve Bank of India not only disallowed banks from holding 5% of the equity of any NBFC; it also limited any bank's credit exposure to all NBFCs to 40% of the bank's net worth.

Deposit insurance cover is uniformly available to all foreign banks at a nondiscriminatory rate of premium.

Advantages of Foreign Banks

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Foreign Banks & Private Banks cover 65% of the foreign exchange transactions in India. Foreign banks have considerable international exposure and can launch new products (e.g., ATM, credit card, etc) besides providing better services. Foreign banks are also going to dominate the highly lucrative trade-related businesses.

Some international banks even provide lifestyle benefits such as access to exclusive clubs, concierge services and leisure activities to their customers in India.

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Foreign Banks in India always brought an explanation about the prompt services to customers. After the set up foreign banks in India, the banking sector in India also become competitive and accretive.

With Indian firms increasingly looking for investments overseas, foreign banks will play a critical role in raising money for them, connecting them with a global clientele and consumers.

Disadvantages
o o

They have limited number of branches. Lending habits of foreign banks are not so prudential and healthy outside India. If the parent banks don't survive, the foreign banks in India will not be able to survive here.

The function like Electronic transfer is offered by these banks to other banks, but there is no way to know who has sent the amount.

Foreign banks charge higher fees from customers for providing banking services and also, maintaining a bank account requires substantial financial resources. In rural areas if they ask depositors to keep a minimum balance of Rs10, 000 or more in their accounts most of them cannot afford it as is a princely sum by the Indian income standards which only affluent customers can afford.

Big foreign banks are not going to lend money to small and medium-sized enterprises (SMEs), small traders, informal sector and farmers. They tend to serve less risky businesses such as PSUs and big corporate groups. This has serious consequences for economic growth.

As the consumer level, foreign banks have a bias towards providing services to wealthy and affluent customers in the developing world. The up market retail business is the primary focus of foreign banks in most developing countries. For instance, consumer retail loans (which are also the riskier) are the fastest growing financial services market in India. The poor and middle class households and the rural sector are not the attention of foreign banks.

Foreign banks tend to follow exclusive banking by offering services to a small number of clients, instead of inclusive banking, given the fact that the average private banking customer can be ten times more profitable than the average mass-market retail customer.
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It is highly unlikely that the commercial interests of foreign banks would match with the developmental needs of unbanked regions of India.

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