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November 15, 2009

Banking Sector In India

FDI in banking
The Reserve Bank of India (RBI), has allowed foreign players to set up branches in rural India and take over weak banks with an investment of up to 74 per cent, and further relaxations are on the anvil by 2010, with the second phase of opening expected to com¬¬mence in April 2009.The RBI roadmap demarcates two phases for foreign bank presence. During the first phase, between March 2005 and March 2009, permission for acquisition of share holding in Indian private sector banks by eligible foreign banks will be limited to banks identified by RBI for restructuring. RBI may, if it is satisfied that such investment by the foreign bank concerned will be in the long term interest of all the stakeholders in the investee bank, permit such acquisition subject to the overall investment limit of 74 percent of the paid up capital of the private bank. Appropriate amending legislation will also be proposed to the Banking Regulation Act, 1949, in order to provide that the economic ownership of investors is reflected in the voting rights. Further, the notification announces that foreign banks will be permitted to establish presence by way of setting up a wholly owned banking subsidiary (WOS) or conversion of the existing branches into WOS. A clause on one-mode-presence, i.e. one form of banking presence, as branches or as WOS or as a subsidiary with a foreign investment in a private bank, has been added as the only safeguard against concentration. There are no caps specified for individual ownership (except the 74 per cent overall limit), which in the first phase would be left to RBI’s discretion. The second phase had to commence on April 2009 after a review of the experience of the first phase. This phase would allow much greater freedom to foreign banks. It would extend national treatment to WOS, permit dilution of stake of WOS and allow mergers/acquisitions of any private sector banks in India by a foreign bank subject to the overall investment limit of 74 percent. India’s financial system has very little exposure to foreign assets and their derivative products and it is this feature that is likely to prove an antidote to the financial sector ills that have plagued many other emerging economies.

The global banking industry weathered turbulent times in 2007 and 2008. The impact of the economic slowdown on the banking sector in India has so far been moderate. Owing to at least a decade of reforms, the banking sector in India has seen remarkable improvement in financial health and in providing jobs. Even in the wake of a severe economic downturn, the banking sector continues to be a very dominant sector of the financial system. The aggregate foreign investment in a private bank from all sources is allowed to reach as much as 74% under Indian regulations.
The third quarter of 2008 saw the beginning of negative net capital inflows into the country. Notwithstanding this bleak scenario, the investment pattern with regard to foreign direct investment (FDI) and inflows from non-resident Indians remains resilient and FDI inflows into the country grew by an impressive 145% between fiscal 2006 and 2007 and by a respectable 46.6% between fiscal 2007 and 2008. However, owing to the economic downturn, the growth in FDI inflows in fiscal 2009 slowed to 18.6% from the previous fiscal. Despite the surge in investments, the stringent regulatory framework governing FDI has proved to be a significant hindrance. However, FDI norms have been relaxed to a considerable extent with respect to certain sectors. Private banks, for instance. Foreign investment, in addition to technological innovation and expertise, brings with it a plethora of risks. An unwarranted increase in the size of foreign holding in the banking sector will inevitably expose the country to risks not commensurate with those that an emerging market economy such as ours is equipped to grapple with.
At the same time, it is important to recognize that FDI in banking can address several issues pertaining to the sector such as encouraging development of innovative financial products, improving the efficiency of the banking sector, better capitalization of banks and better ability to adapt to changing financial market conditions.FDI in banking sector can solve various problems of the overall banking sector. Such as –
i) Innovative Financial Products
ii) Technical Developments in the Foreign Markets
iii) Problem of Inefficient Management
iv) Non-performing Assets
v) Financial Instability
vi) Poor Capitalization
vii) Changing Financial Market Conditions
If we consider the root cause of these problems, the reason is low-capital base and all the problems is the outcome of the transactions carried over in a bank without a substantial capital base. In a nutshell, we can say that, as the FDI is a non-debt inflow, which will directly solve the problem of capital base. Along with that it entails the following benefits such as –

Technology transfer:- Due to the globalization local banks are competing in the global market, where innovative financial products of multinational banks is the key limiting factor in the development of local bank. They are trying to keep pace with the technological development in the banks. It may need additional information and techniques to monitor for financial vulnerabilities. FDI's tech transfers, information sharing, training programs and other forms of technical assistance may help meet this need (e.g in consumer lending – credit management).
Better risk management :- As the banks are expanding their area of operation, there is a need to change their strategies including reassessing business practises, local lending practises as the whole banking sector is in need of a strategic policy for risk management. Through FDI, the host countries will know efficient management technique. The best example is Basel II. Most of the banks are opting Basel II for making their financial system more safer. Risk management is the process where we can minimize controllable risk and should take precautions for uncontrollable risks. Banking operations are complicated and are difficult for supervisor to monitor and control. It is always not only mandatory that bank should have adequate capital to cover their risk but also that they employ better risk management practices. As risk has become a predominant factor, Basel II norms find some solutions for risk management. Basel committee has given Risk Based Supervision (RBS). The focus of RBS is on the assessment of inherent risks in the business undertaken by a bank and efficacy of the systems to identify, measure, monitor and control the risks.
Basel II norms include the wide area of risk measurement and risk management. Many foreign banks have started adopting Basel II as their risk management tool. It helps in pricing of loan in against with their actual risk. It follows advanced techniques and software for calculation of risk. As in today's situations almost all the banks and its branches are computerized .So risk can be better managed by adopting these advanced technologies.
Basel II is a unique approach for banks to modernize and upgrade their risk practices. Basel II is popular for its three pillars. The first pillar is compatible with the credit risk, market risk and operational risk. The regulatory capital will be focused on these three risks. The second pillar gives the bank responsibility to exercise the best ways to manage the risk specific to that bank. Concurrently, it also casts responsibility on the supervisors to review and validate banks' risk measurement models. The third pillar on market discipline is used to leverage the influence that other market players can bring. These are aimed at improving the transparency in banks and improve reporting.
Basel II norms can be summarized as follows. Basically it specifies the minimum regulatory capital requirement and contains new rules to calculate more refined risk weights for different kinds of loans. Secondly these norms specify supervisor where there should be methodical evaluation of risk. And supervisory authority should have expertise in quantitative and qualitative terms. Thirdly it speaks about market discipline through enhance disclosure of banks.
Financial sector reforms were initiated as part of overall economic reforms in the country and wide ranging reforms covering industry, trade, taxation, external sector, banking and financial markets have been carried out since mid 1991. A decade of economic and financial sector reforms has strengthened the fundamentals of the Indian economy and transformed the operating environment for banks and financial institutions in the country. The sustained and gradual pace of reforms has helped avoid any crisis and has actually fuelled growth.

India has 79 scheduled commercial banks with 28 public sector banks, 23 private banks and 28 foreign banks. They have a combined network of over 67,000 branches and 914,241 employees, according to a release by Reserve Bank of India published on Sep 24, 2008. According to a report by ICRA Limited, a rating agency, the public sector banks hold around 75.3 per cent of total assets of the banking industry and the private and foreign banks hold of 18.2 per cent and 6.5 per cent respectively.

Impact of Technology
In Indian banking, technology has become an ‘enabler’ and is moving on to become a ‘driver’ of business. Large scale computerization of branches and operations has enabled the banks to capture more of their business on computers resulting in operational efficiencies including better customer service. this can be called the ‘first phase’ of technology adoption, Banks have now taken up the ‘second phase’ where they are aiming at achieving connectivity between branches, setting up of Central Data Repository, generation of MIS, prevention of frauds, evolving value-added products, reducing transaction costs, and new initiatives like cross selling, CRM, etc. The current emphasis is on providing alternative channels of delivery like ATMs, telebanking, internet banking, etc. The provision of a host of financial services through a versatile technology platform will enable banks to acquire more customers, cut costs, and improve service delivery.
In 1994, the Reserve Bank of India issued a policy of liberalization to license limited number of private banks, which came to be known as New Generation tech-savvy banks. Global Trust Bank was, thus, the first private bank after liberalization; it was later amalgamated with Oriental Bank of Commerce (OBC). Then Housing Development Finance Corporation Limited (HDFC) became the first (still existing) to receive an 'in principle' approval from the Reserve Bank of India (RBI) to set up a bank in the private sector. Undoubtedly, being tech-savvy and full of expertise, private banks have played a major role in the development of Indian banking industry. They have made banking more efficient and customer friendly. In the process they have jolted public sector banks out of complacency and forced them to become more competitive. At present, Private Banks in India include leading banks like ICICI Banks, ING Vysya Bank, Jammu & Kashmir Bank, Karnataka Bank, Kotak Mahindra Bank, SBI Commercial and International Bank, IDBI, Indusind Bank

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