FDI in banking can revitalise sector

Nobel laureate Abhijit Banerjee’s suggestion that foreign investment be allowed in the beleaguered banking sector is just the help it needs. It will boost the economy and lead to efficient use of resources.

By Shivanand Pandit

Nobel prize winner Abhijit Banerjee has stated that India must permit foreign investment in the banking sector and that confining capital infusion in this segment to Indian industrialists is a blunder. He said that nobody other than foreign financiers would have the fund strength to write down the debt of the Indian banking structure.

Banerjee said it was erroneous to consider that Indian capitalists were better than overseas ones. He said that the books of accounts of Indian banks reveal their unhealthy condition, with the sector in the red. He said that numerous payment evasions by Indian entrepreneurs led to huge liability and the banks were in a mess.

“The Indian banking sector is half-dead and capital-starved. It has no money to lend money and capital can come easily from foreign businessmen in the banking sector. We are afraid of competition, but faced with it, we come out good,” the Nobel laureate said. He said that a massive part of government fiscal effort, declared as a response to the pandemic, was to bail out borrowers, and banks would have to be recapitalised to lift development, as at present, credit was very expensive in India. He also mentioned that the variance between lending rate and borrowing one was very high.

Foreign direct investment (FDI) is the investment of money by an establishment from one nation to another with the objective of founding long-lasting interest. FDI has shown an increasing trend in India. It was around $56 billion, $60 billion, $61 billion, $62 billion and $74 billion from 2015-2016 to 2019-2020, respectively. Gross FDI inflows in the past 20 years (April 2000 to June 2020) were $693 billion, while total FDI inflows in the last five years (April 2014 to September 2019) were $319 billion. This is approximately 50 percent of the total FDI inflow in the previous 20 years. During 2020-2021, total FDI inflow was around $36 billion, which is the highest ever for the first five months of the financial year and 13 percent more as compared to the previous one.

Currently, 20 percent of FDI is allowed in PSU banks under the government approval route. Private banks have a higher FDI cap at 74 percent, provided there is no change of control and management. RBI regulations do not permit a single entity to invest more than 10 percent in a bank. Foreign investment includes FDI and overseas portfolio investment through various routes. The modes of entry available to foreign banks are branch office, company and representative office.

There is no specific time prescribed for the RBI to issue such a decision, but typically, this process takes about 18 months or longer. Further, it also depends on discussions with the RBI, clarifications and information sought by it and how quickly these are resolved.

There are various regulatory acts that govern the functionning of foreign banks in India such as Companies Act, 2013, Banking Regulation Act, 1949, Reserve Bank of India Act, 1934, Foreign Ex­change Management Act, 1999, and Payment and Settlement Systems Act, 2007. Till 1993, most Indian banks were 100 percent owned by the centre, and private investment was permitted only in a few private banks founded around the 1940s.

Presently, FDI is permitted up to a maximum threshold of 74 percent of the paid-up capital of the bank, provided there is no modification of control and management in the private banking sector of India. On the other hand, in PSU banks, FDI and portfolio investment are allowed to a limit of 20 percent in entirety under the government consent route. As per the regulations of the RBI, no single entity can invest above 10 percent in a bank.

In 2018, the Modi administration held talks to increase the foreign investment limit in private sector banks to 100 percent from 74 percent and in state-run banks to 49 percent from 20 percent. Many brokerage houses such as Morgan Stanley, Edelweiss and ICICI Direct appreciated the government’s decision and said that large, state-owned banks would benefit the most if the government implements its plan. They also predicted substantial upsurge in the banking sector weight in MSCI Index, a market index, given the greater overseas investment headroom.

In 2019, attempting to give new life to India’s struggling banking sector, the government again thought of raising the FDI limit in public sector banks from the existing 20 percent to 30 percent. However, both the proposals were rejected. This was not the first time the plans were rejected and in 2015, exhibiting reluctance to open up the sector, the RBI rejected a similar proposal. Continuous flow of foreign exchange assists the RBI to maintain a relaxed reserve of foreign exchange and this guarantees steady exchange rates.

FDI can be the vaccine to the bedridden banking sector. It will help boost the nation’s economy via funds transfer of capital. This would result in efficient utilisation of resources along with entry to the local market by the parent organisation. This will eventually lead to improved capitalisation and diversification. Capital inflow is advantageous for nations with restricted domestic resources and opportunities to raise funds in worldwide capital markets.

FDI promotes better customer services. Competition in the banking sector aids the borrowers the most as they can select suitable schemes among the variety offered to them. The emphasis on customer satisfaction is a paradigm change in the formation of better and beneficial services to the customers.

For the economic progression and development of any nation, a vigorous and robust banking sector is important. The power of financial institutes is a chief parameter for adjudicating economic evolution in the world. Additional banks help to invest more within the country in crucial sectors such as infrastructure development, mining, real estate and construction, etc.

Allowing FDI in the banking sector will help in the transfer of technology and best administration practices. Foreign players may allow Indian banks to absorb advanced technology with regard to credit management, market dynamics, lending and transfer, etc. Thus, banks get access to modern financing tools, technologies and operational practices from across the world. This will enhance their efficiency and effectiveness.

By implementing Banerjee’s proposal, the government can protect the bleeding sector which needs enormous capital infusion to stay worthwhile. As he said, when the government knows that private ownership is necessary in the banking sector; limiting it to only Indian ownership will be an intentional error. Fearfulness towards foreign capital infusion comes from an outdated colonial mindset.

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We are a $3 trillion economy now. Moreover, greater FDI bounds would help as banks march to Basel-III capital adequacy standards. At present, the financial sector is the largest stress point and there is no denial that the government should bolster the sector. The government is not in a position to bail out the banking sector. Therefore, it should frame an appropriate FDI policy for it and the RBI should be comfortable with such a change, bearing in mind the sensitivity of the sector.

—The writer is a financial and tax specialist, author and public speaker based in Margao, Goa

Lead Picture: UNI

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