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INTERNATIONAL FINANCE

ASSIGNMENT 2
(10MBI0039)
Why regulate operations of foreign bank in a country by the central bank of that
country?
There is no realistic prospect for having a global banking regulator and consequently, the
responsibility and authority for financial stability will continue to rest with the national or
regional authorities. The issue of the appropriate roles of home and host countries has to be
addressed, that was the key motivation for the creation of Basel Committee in the 1975
following the failures of the Herstatt and Franklin National banks. Basel Committee’s early
activities were focused on the supervision of the internationally active banks; it was evident
from the fact that Basel “Concordats” on supervision followed by Basel “Accords” and
“Frameworks” on capital and other subjects where developed. This regulatory framework of
Basel was ongoing as there were gaps in supervisory coverage and as the scale and scope of
internationally active banks grew. The principle of consolidated supervision emerged in the
early 1980s to ensure that some specific banking authority--generally the home-country
regulator--had a complete view of the assets and liabilities of the bank. This principle was
reinforced and elaborated following the Bank of Credit and Commerce International episode
in the early 1990s.
It is important to note that each Basel Committee declaration on the importance of homecountry consolidated oversight has also included a statement of the obligations and
prerogatives of host states in which significant foreign bank operations are located. This
feature of the Basel Committee's approach makes sense as a reflection both of the host
authority's responsibility for stability of its financial system and of the practical point that a
host authority will be more familiar with the characteristics and risks in its market. In
accordance with this history, the current version of the "Core Principles for Effective Banking
Supervision" sets out as one of its "essential criteria" for home-host relationships that "the
host supervisor's national laws or regulations require that the cross-border operations of
foreign banks are subject to prudential, inspection and regulatory reporting requirements
similar to those for domestic banks."
Now we know the ideology why host country should regulate its foreign banks operations lets
look into other macro economical aspects of the operations of foreign banks in the host
country.
Fear of foreign domination:
A stated fear in the minds of central bankers and governments is that unrestricted entry of
foreign banks may result in their assuming dominant positions in the domestic market, by
driving out less efficient or less resourceful domestic banks. They fear that local depositors
may have more faith in a big international bank than in smaller domestic banks. This is

And from such major state utilities as Renfe. Anti-protection arguments claim that domestic banks could be “cutting prices” to compete more efficiently. large international banks have an exceptional aura of safety around them. this probably suggests that foreign banks in India concentrate their loan business mainly on growing private corporate sector. the protection of these domestic firms is justified by an infant industry argument.especially true in economies plagued by large domestic bank failures or panics. This reasoning suffers from at least two drawbacks: first. it may be properly viewed as a signal of low future bank profitability in the home country rather than as a sign of ‘poor commitment’. Secondly. At first they concentrated on the corporate treasurers and finance directors of the subsidiaries of major US and European companies in Spain such as Ford and General Motors.” In Spain. Lack of local commitment: The argument here is in two parts. only if foreign operations are not expected to be sufficiently profitable. taking a disproportionate share of the best of local business away from domestic banks. during a local recession) than domestic banks. they cream-skim the market. But with their fresh ideas and new products. constitutes the upper/richer segment of the market. As has been discussed before. foreign banks will selectively wind-up foreign operations when the parent is in financial distress.Consequently. it is relatively painless to suffer shut-down losses (resulting from unrecoupable fixed costs”. the resultant dog –eat dog situation may not be socially desirable. it is believed that foreign banks will be the first ones to ‘leave the ship’. foreign banks were invited ‘as friends’ to help tide over the banking system crisis in the early 80’s”. while it is not the case for smaller domestic banks. in times of distress (ex: bad recession) in the foreign banks’ home country. which in India. demand for banking services may be quite price in elastic. The evidence from the Australia is mixed. first. Secondly. large international banks with solid financial strength may better withstand the jolts of a few bad business years (especially. and secondly. Overall. and rarely extend their services outside (ex: To the retail segments of the market). under times of local distress. the national railway company and . About 70% of total loans from foreign banks are advanced in the “above 16% and up to 18% category. but even otherwise. First. (Thus if foreign banks leave a country. “Most loans by US banks are focused on top corporate with efforts being made to move into the middle market category. The above argument suffers from at least two drawbacks. The reason is that for a large international bank with solid financial strength. foreign banks may wind-up foreign operations in order to stabilize earnings at home. Cream-skimming behaviour: Another concern of policy makers and domestic bankers has been that foreign banks carve out a niche for themselves in the upper/richer end of the market. foreign bankers were soon won business from Spanish corporate treasurers. given the public good nature of bank services. US banks are the most active in both the largest ($50 mil plus) and the smallest category (less the $1 million).

000. The problem is usually traceable to macroeconomics incentives that arise from say an imminent devaluation prospect or the presence of an substantial interest rate differential. RBI states.Telefonica.000. accurate capital flight measurements are difficult to perform. In the past. Changes in the regulation of foreign banks carried on by RBI (India) and People’s Bank of China. the branch shall receive from its parent bank a non-callable allocation of no less than 100 million Yuan ($16 million) or an equivalent amount in convertible currencies as its operating capital. and in any case the specific claim that presence of foreign banks induces capital flight is even harder to substantiate. Whereas PBC states that the minimum amount of registered capital of a solely foreign-funded bank or Sino-foreign equity joint bank shall be RMB 1 billion Yuan or freely convertible currency of the equivalent value. The above are some of the reasons why a country/Central bank should regulate entry/operations of the foreign banks in their economy to safeguard their own interest.450.” Capital flight: Foreign banks are often blamed for encouraging an increase in capital flight (from less developed countries to more developed ones).00 INR = 507. Adverse political environments may also exacerbate this problem. this can put added pressure on the exchange rate. as Duwendag and others have pointed out. and one of the countries highest rated international borrowers. In times of an external crisis. Paid up-capital.000. PBC’s changes in the regulation of foreign bank: When a wholly foreign-funded bank or a Chinese-foreign joint venture bank establishes a branch in China.00 CNY). Where the PBC minimum capital requirement for the foreign banks to operate is almost half of the capital requirement for foreign banks to operate in India according to RBI (5. Spain’s telephone company. That requirement on the amount of no callable allocation of operating capital has been removed from the revised regulations. the initial minimum paid-up capital for a WOS shall be 5 billion rupees and existing branches of foreign banks desiring to convert into WOS shall have a minimum net worth of 5 billion. That . effective as of Jan 1. a foreign bank should have maintained a representative office in China for more than two years before the bank applied to establish its first branch in the country.000. Closer scrutiny however reveals again that the problem is not peculiar to foreign banks but to all domestic banks with an open capital account. In any case.

Indian banking regulation makes it mandatory for banks to transfer parts of profits to reserves. this will be subject not only to regulatory approval for the transaction. said officials from the Legislative Affairs Office of the State Council and the China Banking Regulatory Commission. list on Indian exchanges and enter into M&A with private sector banks.restriction has also been removed. As per the new guidelines. but also to an assessment of the overall foreign bank participation and its success in Indian banking sector. thus increasing the depth of their business in India. foreign banks that choose to adopt the WOS model will be permitted to enter into mergers and acquisitions with Indian banks. It will not be mandatory for existing foreign banks (i. subject to the overall investment limit of 74%. The Wholly Owned Subsidiaries (WOSs) would be given near-national treatment. greater trade interconnectivity of Asia.. including in the opening of branches. and the window of opportunity to grow as a . banks with less than 20 branches were allowed to continue with fulfilling 32% requirement largely through export finance. However. Rebalancing of global capital. banks set up before August 2010) to convert into WOSs. Africa. this must be a welcome relief. they will be incentivised to convert into WOSs by the attractiveness of the near-national treatment afforded to WOSs. Foreign banks present in India prior to 2010 will have the option to subsidiarise or continue to operate as branch. Both before and after the financial crisis. However. These measures limit the likelihood of free capital repatriation to parent by branches. Repatriation of such profits to the head office requires RBI approval. Foreign banks with more than 20 branches in India were brought on par with domestic banks for PSL compliance purpose. regulations have been issued under FEMA and the Banking Regulation Act to restrict cross border movement of liquidity. Given the macroeconomic and political condition as well as uncertainties of global economic recovery. migrating populations and geopolitical realignment are likely to lead to changes in the foreign bank landscape in India. The initial minimum paid-up voting equity capital or net worth for a WOS shall be `5 billion. The implication in the banking sector of the country and Macro economic implications are: The recently released WOS guidelines provide foreign banks with the option to open new branches.e. RBI’s changes in the regulation of foreign bank: Subsidiarisation of foreign banks in India. Australia and the Middle East. In countries with relative ease of capital movement. this is one of the important tenets driving the agenda on local incorporation. which may present wider prospects for inorganic growth.

Foreign banks clearly are focusing on expansion activities in urban areas. hence it is difficult to open branches in rural areas. IT systems are useful to speed up processes: The It development in India at a faster pace than the other countries gives India an advantage and makes it more sought.WOS may be an important strategic imperative in that context. After the financial crisis. investment banking. The regulatory and supervisory approaches are. Indian banks: In India the banks need to go to other banks or markets in order to raise the required money. keeping the country’s needs in perspective. Over the last 20 years the number of rural branches in foreign banks have only increased to about 15 branches (in 1995 there were 3 branches) in comparison to the private sector banks which have more than doubled their rural branches in the same time period. India offers ample scope for growth for the foreign banks in universal banking. India. Therefore the loss. by and large. The permitted and desired structure of foreign banks is in effect as per the current international ethos. However they will also be entitled to open as many branches as they like in bigger cities. approximately 40% are new foreign bank entrants. The regulatory preference for banks as better regulated and therefore safer vehicles for financial services will continue to work for banks for the foreseeable future. which include five Asian. Priority sector: Foreign banks have a smaller priority lending requirement of 32 percent as against 40 percent for government sector banks. Foreign banks can fulfil this through exports. licenses issued by the RBI are few in number. The other markets in the world have already saturated. Raising capital is a difficult problem and most foreign banks go back to headquarters for getting money required. This situation could be corrected if banks opt for wholly owned subsidiary structure. This makes sense because the initial amount of deposit required is also high and would not be feasible for people in rural areas. if any arising from operating rural branches can be absorbed by bigger branches in cities. . 13 new foreign banks have been granted licenses by the RBI. common and non-discriminatory. four Australian and two European banks. in which case banks will be forced to open at least 25% branches in rural area. Conclusion To conclude. treasury banking and personal banking. However. while cautiously allowing its expansion. more specifically in the highly sophisticated and profitable markets of trade finance. concerns around operational and systemic risk from non-bank operators will continue to make banks important partners to innovative technology companies for mutual benefit. India has a long history of welcoming foreign banks. imports and do not have to lend to agricultural sector like the other banks. Fast paced economy: India being a developing economy offers a number of business opportunities to banks which are present here and also for the ones who would like to enter the Indian market. Also the sectors which are a part of the lending sectors allowed are also different for foreign banks. This trend is evident from the fact that of the 75 new bank branches granted to foreign banks since the financial crisis.

4) Return on Assets: This has clearly shown a positive trend bringing into forefront the improvements brought across by the operational improvements through better practices of foreign banks.in/Scripts/bs_viewcontent.pdf http://www.rbi. Also the requirement is mostly satisfied by banks by lending in the export-import sector and not lending in sectors like agriculture which are the actual constituents of the priority sector.org. References: http://www.org.rbi. Only 1 or 2 percent of the total branches of foreign banks are in rural / semirural areas.com/intl/cms/s/0/65934496-032b-11e3-9a4600144feab7de.in . The first ATM in India was brought up by HSBC and from then on foreign banks have contributed to the latest banking practices helping them become more efficient 3) Priority sector lending: The priority sector requirement itself is different for foreign banks and also the percentage rates are lower for them. This is in contrast with the scheduled commercial banks which have grown enormously in the rural sector (currently rural branches account for 58 percent of their total number of branches). 2) Technological development: Foreign banks have helped in bettering the technology used in the banking sector.Looking at the impact of foreign banks over the years.aspx?Id=2758 http://www. For banks with less than 20 branches the requirement is at 32 percent as against 40 percent for the other nationalized banks.%20451.html#axzz3PuG9IPaZ www.ft.ernet. the following characteristics have been observed: 1) Rural presence: Foreign banks have a very small presence in rural and semi-rural areas.in/research/sites/default/files/WP%20No.iimb.