Ashish Chatrath Final Dissertation

8/9/2019 Ashish Chatrath Final Dissertation

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A REPORTON

IMPLICATIONS OF WTO ONINDIAN BANKING

By:

Ashish Chatrath

PGDM 07-09

FT-07-529


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FINAL DISSERTATION

DECLARATION FORM

I hereby declare that the Project work entitled

IMPLICATIONS OF WTO ON INDIAN BANKING

submitted by me for the partial fulfillment of the Post Graduate Diploma in Business

ManagementProgram to Institute for Integrated Learning in Management, Greater

Noida is my own original work and has not been submitted earlier either to IILM GSM

or to any other Institution for the fulfillment of the requirement for any course of study. I

also declare that no chapter of this manuscript in whole or in part is lifted and

incorporated in this report from any earlier / other work done by me or others.

Place : Greater Noida

Date : 23rd April 2009 Signature of Student

Name of Student : Ashish Chatrath

Address : 1804, Gandhi Lane, Islamabad, Amritsar.


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IMPLICATIONS OF WTO ON INDIAN BANKING

Dissertation submitted in partial fulfillment of the requirements of the

two year full-time Post Graduate Diploma in Business Management

Programme.

Submitted by

Ashish Chatrath

Roll No: FT-07-529

Batch: 2007-2009

Institute for Integrated Learning in Management

Graduate School of Management

16, Knowledge Park

Greater Noida 201 306

Month & Year


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Contents

FINAL DISSERTATION .........................................................................2DECLARATION FORM ..........................................................................2

1. The Project ......................................................... 71.1 Introduction ..................................................................................71.2 Objectives ....................................................................................81.3 Limitations ...................................................................................81.4 Methodology ................................................................................8

2. WTO ...............................................................102.1 Introduction ..............................................................................102.2 WTO & Developing Economies ...................................................102.3 Special& Differential Treatment Under the WTO .......................122.4 Functions of WTO .......................................................................132.5 GENERAL AGREEMENT ON TARIFFS AND TRADE (GATT) ..........13

2.6 WTO & GATT ............................................................................143. GENERAL AGREEMENT ON TRADE IN SERVICES

(GATS) ...................................................................143.1 Principles of GATS ......................................................................153.2 Advantages of GATS ...................................................................173.3 Disadvantages of GATS ..............................................................18

3.4 Modes of GATS .........................................................................193.5 Pillars of GATS ..........................................................................21

3.6 GATS Schedule ...........................................................................213.7 Indias Commitments under GATS .............................................22

4. FINDINGS & OBSERVATIONS ............................. 234. Financial sector & banking service ...............................................234.2 Major reform initiatives in Indian banking sector ....................254.3 Foreign investments in capital of Indian banks .......................274.4 Mergers& Acquisitions in banking sector ..................................294.5 WTO Requirements & Indian Banking ........................................314.6 Regulations for foreign banks in India ........................................334.7 WTO financial services agreement, 1997 banking commitments..........................................................................................................354.8 Banking Services in United States .............................................374.9 Banking services in India & United States ..................................384.10 Banking services in China ........................................................384.11 Challenges against Indian banking sector ...............................46

5. SUGGESTIONS AND RECOMMENDATIONS ............ 505.1 WTO & future of Indian Banking Sector .....................................50

6. CONCLUSION .................................................... 537. ANNEXURE ...................................................... 558. REFERENCES .................................................... 63

LIST OF TABLES


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Table

No.

Subject Page

No.Table 1 Foreign investment in public sector banks in 2004

and 2006

28

Table 2 Foreign investment in private sector banks in 2004

and 2006

28

Table 3 Return on Net Worth% of Indian and foreign banks

in 2006 and 2007

43

Table 4 Operating Profit of Indian and foreign banks in 2006

and 2007

44

Table 5 ROA% of Indian and foreign banks in 2006 and 2007 45Table 6 Net Profit of Indian and foreign banks in 2006 and

2007

46

Table 7 Interest Income of Indian and foreign banks in 2006

and 2007

47

Table 8 Total Income of Indian and foreign banks in 2006

and 2007

47

Table 9 TIER I Capital of Indian and foreign banks in 2006

and 2007

48


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The project deals with analyzing the impact of WTO on the Indian

banking sector. The need of growth of the developing economies gives

opportunities to the foreign banking players to enter into the new markets

in new economies and expand their businesses on global level. The entry

of the foreign banks in the developing economies helps them to grow at a

faster pace. Foreign banks also bring with them the latest technology

being used in the developed economies which helps the developing

economies to take advantage of the technological advancements being

used in the other nations. Hence it is very essential for the developing

economies to open their economies for the international trade by allowing

foreign banks to establish their businesses over there.

In this project, the major concern was to analyze the implications

of WTO on the Indian banking system. The future projections have been

made by analyzing the change in the foreign capital investments in public

sector banks and private sector banks from the year 2004 to the year 2006

and by analyzing the change in the earnings or profits earned by the

foreign banks in the year 200 and 2007. The project required a detailed

study of the Indian banking sector with respect to the presence of foreignbanks. The main purpose of the project was to find out the impact of the

agreements governing under WTO which has a direct impact on the Indian

banking sector. GATS (General Agreement on Trade in Services) govern

the negotiations regarding services between the member nations. In

different round of negotiations happened under GATS, Government of India

removed many barriers for the foreign banks to enter into the Indian

banking market. This has proved to be one of the major reasons for the

increase in the growth rate of the Indian economy.

This project will help the reader to know about the change in the

regulations made by RBI for the foreign banks to liberalize the trade in

services in the Indian banking sector. The reader will also come to know

about the future prospects of the Indian banking system and the

improvement in the financial performance of Indian and foreign banks.

ABSTRACT


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1. The Project

1.1 Introduction

The WTO came into existence on January 1, 1995, with many countries

joining it with immediate effect. It has its headquarters in Geneva,

Switzerland. The WTO was born to usher in a new era of global economic

cooperation, reflecting the widespread desire to operate in a fairer and

more open multilateral trading system for the benefit and welfare of

member countries principles.

According to the Planning Commission, the population of India will be 130

crores by the year 2020, out of which 40 percent will be urban, highly

educated, healthier and prosperous as compared to 28 percent in 2004.

Only 40 per cent of the population will be engaged in agriculture as

against 60 percent now. Share of agriculture in GDP will be a nominal 6 per

cent as against 18.5 percent according to Economic Survey 2006-07. Small

and Medium Enterprises (SMEs) will emerge as a vibrant sector and primejob provider. Exports will constitute 35 per cent of GDP as against 15 per

cent at present. The economy will be indeed, market driven, productive

and competitive. In this competitive market, banking system will naturally

have a dominant and controlling role to play and the Indian Financial

System should be inherently strong, functionally diverse and flexible.

WTO has opened up a lot of opportunities to the banks in the

world to enter into the new markets in different economies by lowering

down the trade barriers. This has helped the banking sector to grow at arapid pace which in turn has helped the world economy to grow faster. The

banking sector of any economy plays a vital role in the circulation of

money by facilitating the different modes of payment. Therefore, it is

crucial for every economy to have a sound and healthy financial sector.

WTO has helped in liberalizing the trade between different countries by

facilitating negotiations between different countries. WTO has also played

an important role in setting the global standards for the banks to improve

their performances with the help of investment in other countries. FDIs

(Foreign Direct Investments) and FIIs (Foreign Institutional Investments) inbanking sector of different economies has facilitated the banks to make


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use of the latest technology available in the world and to improve their

profitability by providing better services to the customers. The banking

activities these days are concentrated around major foreign banks, niche

banks, and community-based banks. The quality of assets with the banks

has improved in the past few decades and the Indian banks these days arealso concentrating towards establishing their global presence. Today, the

focus areas of banks for investment and lending are infrastructure,

education, tourism, entertainment, and health services.

1.2 Objectives

To access the role of WTO in helping trade flow of banks with no

undesirable side-effects. To study the organizational structures of banks with global

requirements.

To analyze the simplification and harmonization of international

banking trade procedures to trade in a more effective manner.

To evaluate the implications of WTO and services agreement on

the Indian banking system.

To evaluate the performance of foreign banks in the Indian

economy.

1.3 Limitations

The quantified data regarding banks available may have been

manipulated.

The study is limited and does not cover all banks considering thetime frame.

1.4 Methodology

Usage of Secondary Data: The secondary data has been

collected from the various sources like journals, articles, magazines,newspapers and internet. The magazines studied includes magazines


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dealing in the financial services like Business World, Business India and

newspapers like Financial Times, Economic Times, Business Line,

Financial Review, The Hindu. The data collected was then analyzed in

respect of the impact of policies laid down by WTO and its effects on

the Indian banking sector which indirectly affects the financial sector ofthe whole Indian economy. The data

regarding foreign capital investments in banks was collected with

the help of internet for analyzing the increase in the foreign

investment in both public and private sector banks in India.

Comparative study of performance of Indian banks and

foreign banks in Indian economy: This report also includes a

comparative study of the banking sector of a developed economy i.e.

U.S. economy with the banking sector of the Indian economy. In this,

the foreign capital employed in various banks was studied to know

the liberalization of services and foreign investment allowed in the

capital of the banks in different economies.


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2.1 Introduction

The WTO is an international organization of 151 member countries that is a

forum for negotiating international trade agreements and the monitoring

and regulating body for enforcing agreements. The WTO was created in

1995, by the passage of the provisions of the "Uruguay Round" of the

General Agreement on Tariffs and Trade (GATT). Prior to the UruguayRound, GATT focused on promoting world trade by pressuring countries to

reduce

Tariffs. But with the creation of the WTO, this corporate-inspired agenda

was significantly ratcheted up by targeting so-called "non-tariff barriers to

trade" - essentially any national or local protective legislation that might

be construed as impacting trade.

WTO is the only global international organization dealing with the global

rules of trade between nations and ensuring trade flows as smoothly,predictably and freely as possible therefore resulting into a more

prosperous, peaceful and accountable economic world.

2.2 WTO & Developing Economies

The gains accruing to the developing countries from liberalization in world

trade under the multilateral trade regime of the WTO has been an issue

2. WTO


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largely debated. Realizing that the playing field is not level before opening

up for competition, the provisions for Special and Differential Treatment to

developing countries are inherent in the Uruguay Round (UR) Agreements

of the WTO. The preface to the WTO agreement claims that efforts are

designed to ensure a share in the growth in international trade adequatewith the needs of their economic development. The special treatment is

embedded in all the agreements of WTO like the Agreement on Agriculture

(AOA). Trade Related Intellectual Property Rights (TRIPS), Trade Related

Investment Measures (TRIMS), Anti-dumping measures, Technical Barriers

to Trade, Agreement on Textiles and Clothing and the Trade in Services.

The concessions given to developing countries are seen in terms of lower

reduction commitments of support, flexibility in terms of export subsidies,

longer time period for reducing the support, implementing TRIPS, TRIMS,

special concessions on Sanitary and Phytosanitary measures technical

barriers to trade, etc.

Recognizing the fact that three-fourths of the membership of the WTO is

formed by the developing countries, and their interests cannot be

neglected, the fourth WTO Ministerial meeting held in Doha in November

2001 launched a comprehensive set of multilateral trade negotiations

known as the Doha Development Agenda. The launch of these negotiations

claimed to ensure that the trading system is relevant and responsive to

the needs of the developing countries. The benefits to the developing

countries from the declaration were expected to be largely in terms ofenhanced market access of the developed country products. The

negotiations on the

Doha agenda did not make much headway at the Cancun ministerial in

September 2003 or at Hong Kong in December 2005, despite the fact that

the negotiations are to be completed before the end of year 2005. But

much credibility of WTO now depends on its ability to provide development

opportunities for developing and least developing countries.

As per the definitions under the WTO, there is no unique definition ofdeveloped and developing economies in the WTO. Members announce

for themselves whether they are developed or developing countries.

However, other members can challenge the decision of a member to make

use of provisions available to developing countries. Developing country

status in the WTO brings certain rights. But a WTO member announcing

itself as a developing country does not automatically mean that it will

benefit from the unilateral preference schemes of some of the developed

country members such as the Generalized System of Preferences (GSP). In

practice, it is the preference giving country which decides the list ofdeveloping countries that will benefit from preferences. However, all


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developing countries that are eligible to benefit from technical assistance

provided by the WTO secretariat and WTO members.

2.3 Special& Differential Treatment Underthe WTO

The special provisions in favor of developing countries are incorporated

into the individual agreements and decisions of the Uruguay Round. Within

each section, the special measures have also been grouped under fourheadings which reflect their general nature; those recognizing the interests

of least developed/developing countries in a general manner; those easing

the rules or number of obligations to be met; those providing longer time-

frames for the implementation of certain obligations and those providing

for technical assistance.

The committee on trade and development periodically review the special

provisions in favor of developing country members and particularly the

LDCs which are included in the multilateral trade agreements.

Agreement:General Agreement on Trade in Services

Special provisions for Developing countries:Within two years of the

entry into force of the agreement, developed country members and to the

extent possible all other members are to establish enquiry points to help

suppliers from developing countries get information on the commercial

and technical aspects of supplying different kinds of services, the

registration of suppliers, the obtaining of professional qualifications and

the availability of services technology.

WTO members are allowed to enter economic integration agreements that

liberalize trade in services, provided the agreement has substantial

sectoral coverage and provides for the eliminations of substantially all

discrimination in the covered sectors. The multilateral nature of the WTO

agreement is especially attractive to small developing countries that would

otherwise have difficult time negotiating many different bilateral trade

agreements. In addition, there are benefits associated with the dispute

settlement of the WTO which provides a legal backup to deal with inter-


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country trade laws which cannot be handled by countries independently.

However, the gains to the developing countries could be accrued only

under the condition that trade is not just sufficiently free but fair,

recognizing the interests of the developing countries.

2.4 Functions of WTO

Administering and implementing the

multilateral trade agreements.

Acting as a forum for multilateral negotiations.

Seeking to resolve trade disputes.

Overseeing national trade policies. Cooperating with other international institutions

involved in global economic presence.

2.5 GENERAL AGREEMENT ON TARIFFSAND TRADE (GATT)

Uruguay Round (1986-1983) marks a watershed, and for the first time,

multilateral trade negotiations under General Agreement in Tariff and

Trade (GATT) encompass not only the traditional goods sector, but alsoextended to three new areas, namely investment, intellectual property

rights and services.

The final act was signed on 1 April 1994, at Marrakech in Morocco, which

resulted in the formation of World Trade Organization (WTO) w.e.f. January

1, 1995 with 123 members, including India. Now there are 151 members

including China, Vietnam and Saudi Arabia.


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2.6 WTO & GATT

Decisions of the Dispute Resolution Mechanism are binding onmember countries. Therefore provides a neutral forum for grievance

redress to all countries irrespective of economic clout.

A rules-based, member-driven organization all decisions aremade by the member governments, and the rules are the outcome of

negotiations among members. In effect, every member country has a

veto, i.e. a no vote from any member can scuttle a deal.

3. GENERAL AGREEMENT ON TRADE INSERVICES (GATS)

The General Agreement on Trade in Services (GATS) came into existenceas a result of the Uruguay Round of negotiations and entered into force on

1 January 1995, with the establishment of the WTO. GATS is the first ever

set of multilateral, legally-enforceable rules covering international trade in

services. The multilateral legal instruments resulting from the Uruguay

Round were treated as a single undertaking. India also signed all the WTO

agreements under the single undertaking rule and GATS is a part of this

whole package. The WTO was born to usher in a new era of global

economic cooperation, reflecting the widespread desire to operate in a

fairer and more open multilateral trading system for the benefit and

welfare of member countries. Like the agreements on goods, GATS


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operates on three levels: the main text containing general principles and

obligations; annexes dealing with rules for specific sectors; and individual

countries specific commitments to provide access to their markets.

The obligations under GATS may be categorized into two groups:

General obligations: General obligations apply directly and

automatically to all member countries of the WTO and it includes most

favored nation (MFN) treatment and transparency.

Conditional obligations: Conditional obligations apply to sectors where

the member country has assumed market access and national treatment

obligations. Under conditional obligations, GATS follows a positive list

approach under which each member is expected to undertake specific

liberalization commitments through a process called "scheduling". Any

commitment can be added or improved at any time autonomously by the

member concerned but it becomes a binding commitment only if it is

scheduled. The Request-Offer approach is the main method of

negotiations, with the starting point for negotiations being the current

schedules of commitment.

3.1 Principles of GATS

The GATS create certain obligations on all members which they must

follow in the implementation of their obligations under the agreement. The

members are free to state in their schedules the services they intend to

bring under the purview of GATS and the terms and conditions of their

commitments. They may also amend them later after appropriate

negotiations with other members. But once they have made their

commitments they are required to adhere to the following principles.

National Treatment: Under the article XVII this means that amember shall treat the persons belonging to all other members the way


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it treat its own nationals. This means it cannot discriminate between

foreigners and its own nationals in a manner. This could also mean that:

Foreign companies cannot be subjected to additional performance

requirements like meeting environment safeguards.

They cannot be compelled to hire or train local staff or builddomestic capacity.

There can be no compulsion regarding technology transfer.

Foreign person must be extended the same tax exemption or

subsidies that are given to domestic companies.

Foreigner can be placed on foreign companies regarding

acquisition of land and other assets.

Members must provide the equal competitive privileges to both

domestic and foreign companies.

Most-Favored Nation Treatment (MFNT): Under Article II,

MFNT means that every member shall treat all others the way it treats

its best friend among them. That is, member shall extend the best of

the trade terms it offers to a member to all others on an equal footing.

While, national treatment obligates a member not to make any

discrimination between its own nationals and foreign nationals, MFNT

requires a member not to discriminate between other member-states

and that it should offer them uniform treatment. This is also referred toas Generalized System of Trade Preferences (GSP). Sometimes MFNT is

offered on the condition of reciprocity, that is State would extend to

another State MFNT only if the latter also commits itself to extend the

same. But under GATS the MFNT has to be unconditional.

Minimum Treatment: Under Article XVI, amember has to extend to all other members a treatment not less

favorable than what it has committed itself under its schedule. But if it

were to offer to any member a better deal than what it has committed

itself under its schedule, then it has to extend to all other members the

same treatment under MFNT clause. If a member modifies its schedule

and either enhances its commitment, then it has to extend the same to

all other members. This may be in terms of number of service suppliers

in the form of quotas, total value or number of operations, or number of

persons, or specific types of legal entities, etc.

Schedule of Specific Commitments: Under Article XX, each member

is required to set out in a schedule the specific commitments it proposes to


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undertake vis--vis other members. With respect to each sector the

schedule shall specify:

Terms, limitations and conditions on market access;

Conditions and qualifications on national treatment; Undertakings relating to additional commitments; and

The date of entry into force of such commitments.

A member may, however, modify or withdraw its commitments in its

schedule after three years have elapsed and by giving a notice to the

Council for Trade in Services (to be established under Article XXIV) within

three months before the intended modification or withdrawal. The

modifying member is required to enter into negotiations with any affected

member for reaching compensatory adjustment, etc. There are provisionsfor dispute settlement through arbitration, etc. However, GATS creates an

obligation on a member State to progressively enhance its commitments

over a period of time.

3.2 Advantages of GATS Economic Performance: An efficient services infrastructure is

must for economic success. Services such as telecommunications,

banking, insurance and transport supply strategically important inputs

for all sectors, goods and services.

Spur of competition would encourage excellence, quality of

output and reduction in prices. This is evident from the recent Indian

experience in cell phone sector.

Access to world-class services would revolutionize the domestic

production.

The benefit of quality services would penetrate down to the

ultimate consumer.

Liberalization of services sector is bound to generate process and

product innovation.


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Protectionism has led to inefficiency. Liberalization would lead to

greater transparency and stability.

It will lead to greater technology transfer as it would be in the

interest of the investor to utilize local manpower by giving the requisite

training.

In short, GATS would bring in (a) FDI; (b) industrialization;

(c)employment; (d) transfer of technology; and (e) generation of wealth.

GATS do not compel any State either to accept or continue to accept any

obligations under the agreement. Is any State feels it would be beneficialby the GATS, it might accept its obligations Any State is free to opt out of

GATS if its interests are adversely affected.

3.3 Disadvantages of GATS

The GATS has attracted considerable opposition from many developed

countries and various commentators for being a device for wholesale

auction of vital service sectors to MNCs of developed countries. The

following are some of the criticisms that are made against GATS.

Though GATS supporters claim that it is a bottom up treaty in

the sense that a member can progressively enhance its commitments

and that there is no compulsion on any State to accept obligations it is

unwilling to, in reality it is said that the GATS never gave any

opportunity for any democratic debate at the local communities, or

regional and national parliaments. Being an imposed one, it is top-

down agreement.

The whole gamut of obligations under the GATS entrenches into

the culture national resources and vital service sectors of developing

countries.


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The past experience of privatization of resources like water in

Bolivia, Argentina and Puerto Rico has proved to be disastrous, Prices of

water had gone up and the poor suffered.

Indian experience with Enron in privatizing power production in

Maharashtra has not been a happy one.

In sectors like health and education, entry of foreign MNCs is

likely to make healthcare and education beyond the reach of the

common man. The quality of services that they boast of would be the

privilege of the rich and the elite.

Agriculture is another sector where poorer countries might sufferirreparably.

There is no evidence that liberalization would lead to increased

FDI and enhanced competition might snuff out local competition.

What are known as commons i.e., forests, watersheds, culture,

arts, etc, would come under the onslaught of profit-oriented

corporations that have little regard for this common heritage of

mankind. This will result in prioritization of markets and profits overpublic interest and well-being.

3.4 Modes of GATSThe GATS sets out four models of supplying services, namely:

Mode I: Cross-border trade

Mode II: Consumption abroad

Mode III: Commercial presence

Mode IV: Presence of natural persons.

MODE I


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Cross-border trade corresponds with the normal form of trade in goods

and maintains a clear geographical separation between seller and buyer.

In this case, services flow from the territory of another member crossing

national frontiers. (e.g. banking or architectural services transmitted via

telecommunications or mail). For instance, a user in India receives servicesfrom abroad through its telecommunications or postal infrastructure. Such

supplies may include consultancy or market research reports, tele-medical

advice, distance training, or architectural drawings.

MODE II

Consumption abroad refers to situations where a service consumer

moves into another members territory to obtain a service (for example, or

nationals of India moved abroad as tourists, students, or patients to

consume the respective services).

MODE III

Commercial presence is the supply of a service through commercial

presence of the foreign supplier in the territory of another WTO member.

In this case, a service supplier of one member establishes a territorial

presence in another members territory to provide a service. (For example,the services provided within India by a locally-established affiliate,

subsidiary, or representative office of a foreign-owned and controlled

company such as bank, hotel group, construction company, etc.).

MODE IV

Presence of natural persons involves the admission of foreign nationals

to another country to provide services there. An annex to the GATS makesit clear, however, that the agreement has nothing to do with individuals

looking for employment in another country, or with citizenship, residence

or employment requirements. The members still have a right to regulate

the entry and stay of the persons concerned, for instance, by requiring

visas. (For example, a foreign national provides a service within India as an

independent supplier such as consultant, health worker or employee of a

service supplier which can be a consultancy firm, hospital, or a

construction company).


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3.5 Pillars of GATSGATS have three main pillars to rest

The first pillar is the framework agreement, which contains basic

obligations applicable to all member countries.

The second pillar is that of national treatment and national

schedules of commitment on market access.

The third pillar constitutes a number of Annexes and attachments

on special situations of individual service sector.

3.6 GATS Schedule

The commitments by the member countries can be scheduled in one of the

following ways:

1. Full commitment: None or No limitations, which implies that the

member does not seek in any way to limit market access or national

treatment through measures inconsistent with Articles XVI or XVII of GATS.

2. Commitment with limitations: The member details the measures

maintained which are inconsistent with market access or national

treatment, and implicitly commits itself to take no other inconsistent

measures.

3. No commitment: Unbound, indicates that the member remains free

to maintain or introduce measures inconsistent with market access or

national treatment.


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4. No commitment technically feasible: Unbound, indicates that in

the sector in question, a particular mode of supply cannot be used.

In banking, no commitment is allowed in Modes 1, 2 and 4. In Mode 3,

grant of branch licenses to foreign banks is subject to a cap of 12 licensesper year both for new and existing banks. Licenses for new foreign banks

may be denied if the share of the assets of foreign banks in the total

banking assets (on and off balance sheet) in India exceeds 15 per cent. In

both insurance and banking, requests received from other countries in

WTO commitments include allowing full market access and national

treatment commitments as well as removal of limitations on foreign equity

participation.

3.7 Indias Commitments under GATS

India is a founder member of WTO and ratified the agreement establishing

the WTO on 30.12.1994. As in the case of other multilateral agreements,

Indias commitments to GATS are guided by the following general

principles in varying degrees:

Gradual Approach: India believes in gradual and step by step

approach and not a Big Bang or short therapy approach.

Human Face: All the reform programs have strong emphasis on

human face and least sacrifice made by the people.

Sovereignty constraint: Indian government tries to minimize

the loss of power for national policy formulation that could result from

international cooperation.

Political Constraint: India is a sovereign democratic republic

with independent judiciary, and all external relations are based on

general political consensus.

Agency constraint: Policies are influenced by the ideology of

the political in power. But once adopted, policies are irreversible.


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Preference for decentralization: India prefers national level

policies that take into account external factors, rather than polled

mechanisms at the international level.

Priority Reforms: Basic purpose of commitment is to strengthen

our economic position and global competitiveness, but not at the cost of

national security, public health and safety, and environmental

protection.

4. Financial sector & banking service

The term financial services is broadly used for a set of services provided

to ensure efficient mobilization and allocation of funds towards the overall

growth of an economy. By directing investment funds to their most

productive use, an efficient financial services sector can significantly

promote growth and income. As a result, the effective provision of these

services is a basic prerequisite for a dynamic and modern economy. Across

most developing countries, including India, financial services constitute a

part of the regulatory system that manages inflow and outflow of foreign

capital, reduces exchange rate volatility and provides credit to socially

desired sectors. Countries such as the United States, Japan, as well as

some members of European Union have, over the years, been vocal

demanders of liberalization of different financial services, arguing that

barriers to entry hinder economic progress and financial stability. They

also have well-developed financial service industries that stand to benefit

from access to international markets. However, the rapid flow of money

out of developing countries in the aftermath of the Latin American crisis in

1980s and the East Asian crisis in 1997, demonstrated that liberalizing

financial markets sans proper planning and management of investment is

not a recipe of success. In fact, given their immense importance in overallstability of an economy, there is a broad disagreement among various

4. FINDINGS & OBSERVATIONS


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countries about further liberalization of financial services. These

disagreements range from both liberalization in additional financial

services sector as well deeper liberalization in a particular sector.

The Indian banking industry is passing through a phase of customersmarket. The customers have more choices in choosing their banks. A

competition has been established within the banks operating in India. With

stiff competition and advancement of technology, the services provided by

banks have become more easy and convenient.

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 most significant achievement of the financial sector reforms

has been the marked improvement in the financial health of commercial

banks in terms of capital adequacy, profitability and asset quality as also

greater attention to risk management. Further, deregulation has opened

up new opportunities for banks to increase revenues by diversifying into

investment banking, insurance, credit cards, depository services,

mortgage financing, securitization, etc. At the same time, liberalization has

brought greater competition among banks, both domestic and foreign, aswell as competition from mutual funds, NBFCs, post office, etc. and the

competition will only get stronger, as large global players emerge on the

scene. Increasing competition is squeezing profitability for the banks and

forcing them to work efficiently on shrinking areas. Increase of competition

means greater choice available to consumers, and the increased level of

sophistication and technology in banks. As banks benchmark themselves

against global standards, there has been a marked increase in disclosures

and transparency in bank balance sheets and greater focus on corporate

governance.

Foreign banks in India now have a share of only around 7 per cent of total

banking assets. The RBI has released an ambitious road map for increasing

the presence of foreign banks in India. As per the guidelines, the

aggregate foreign investment from all sources will be allowed up to a

maximum of 74 per cent of the paid up capital of the private bank. The

roadmap is divided into two phases:

First phase (Between March 2005 and March 2009): Foreign bankswill be permitted to establish presence in the Indian economy by way of


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setting up a wholly owned banking subsidiary (WOS) or conversion of the

existing branches into a WOS. Permission for acquisition of shareholding in

Indian private sector banks by eligible foreign banks will be limited to

banks identified by the RBI for restructuring.

Second phase (commencing in April 2009): The RBI may permit

merger or acquisition of any private sector bank in India by a foreign bank.

4.2 Major reform initiatives in Indianbanking sector

Some of the major reform initiatives in the last decade that have changed

the face of the Indian banking and financial sector are:

1. Interest rate deregulation: Interest rates on deposits and lending

have been deregulated with banks enjoying greater freedom to determine

their rates.

2. Adoption of prudential norms in terms of capital adequacy, asset

classification, income recognition, provisioning, exposure limits,investment fluctuation reserve, etc.

3. Reduction in pre-emption lowering of reserve requirements (SLR and

CRR), thus releasing more resources to lend which banks can deploy

profitably.

4. Government equity in banks has been reduced and strong banks have

been allowed to access the capital market for raising additional capital.

5. Banks now enjoy greater operational freedom in terms of opening and

swapping of branches, and banks with a good track record of profitability

have greater flexibility in recruitment.

6. New private sector banks have been set up and foreign banks permitted

to expand their operations in India including through subsidiaries. Banks

have also been allowed to set up Offshore Banking Units in Special

Economic Zones.


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7.New areas have been opened up for bank financing such as insurance,

credit cards, infrastructure financing, leasing, gold banking, besides

investment banking, asset management, factoring, etc.

8. Several new institutions have been set up including the NationalSecurities Depositories Ltd., Central Depositories Services Ltd., Clearing

Corporation of India Ltd., Credit Information Bureau India Ltd.

9. Limits for investment in overseas markets by banks, mutual fund

companies i.e. Asset Management Companies (AMCs) and corporates have

been liberalized. The overseas investment limit for corporates has been

raised to 100% of net worth and the ceiling of $100 million on prepayment

of external commercial borrowings has been removed. AMCs and

corporates can now undertake FRAs (Forward Rate Agreements) with

banks. Indians are allowed to maintain resident foreign currency

(domestic) accounts and full convertibility for deposit schemes of NRIs has

been introduced.

10. Universal Banking has also been introduced in the Indian banking

sector. With banks permitted to diversify into long-term finance and DFIs

(Direct Foreign Investments) into working capital, guidelines have been put

in place for the evolution of universal banks.

11. Technology infrastructure for the payments and settlement system inthe country has been strengthened with electronic funds transfer,

Centralized Funds Management System, Structured Financial Messaging

Solution, Negotiated Dealing System and move towards Real Time Gross

Settlement.

12. Adoption of global standards: Prudential norms for capital

adequacy, asset classification, income recognition and provisioning are

now close to global standards. RBI has introduced Risk Based Supervision

of banks (against the traditional transaction based approach). Bestinternational practices in accounting systems, corporate governance,

payment and settlement systems, etc. are being adopted.

13. Credit delivery mechanism has been reinforced to increase the flow of

credit to priority sectors through focus on micro credit and Self Help

Groups. The definition of priority sector has been widened to include food

processing and cold storage, software upto Rs 1 crore, housing above Rs

10 lakh, selected lending through NBFCs, etc.


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14. RBI guidelines have been issued for putting in place risk management

systems in banks. Risk Management Committees in banks address credit

risk, market risk and operational risk. Banks have specialized committees

to measure and monitor various risks and have been upgrading their risk

management skills and systems.

15. The limit for foreign direct investment in private banks has been

increased from 49% to 74% and the 10% cap on voting rights has been

removed. In addition, the limit for foreign institutional investment in

private banks is 49%.

4.3 Foreign investments in capital ofIndian banks

PUBLIC SECTOR BANKS

Na Name of the Bank No. of

Shares (aas on 31.03.

.2 04)

% to Paid

up C apital

N No. of

Shares (a Oson

31.03.2006)

% T o Paid

up Cacapital

Andhra Bank 2,15,77,223 5.39 8,40,30,646 17.32Bank of Baroda 4,75,40,615 16.14 73,33,56,892 20.13Bank of India 2,37,64,900 4.86 6,44,68,034 13.19Canara Bank 4,36,00,569 10.63 7,49,35,787 18.27Corporation Bank 1,10,83,135 7.72 1,44,47,387 10.07Indian Overseas Bank 11,31,795 0.20 9,49,49,445 17.42

Oriental Bank of

Commerce

2,53,75,968 13.17 4,97,68,926 19.86

Punjab National Bank 2,96,25,795 11.16 6,32,47,778 20.00State Bank of India 6,01,97,755 11.43 6,25,03,693 11.87Syndicate Bank 36,83,407 0.78 6,37,89,100 13.51UCO Bank 6,25,000 0.07 1,45,71,873 1.82Union Bank 5,39,07,074 11.71 10,06,13,918 19.91Vijaya Bank 2,19,71,273 5.06 6,94,62,629 16.02

Table 1: Foreign investment in public sector banks in the year 2004 and 2006.

PRIVATE SECTOR BANKS


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Name of the Bank No. of

Shares (as on

31.03.2004)

% to Paid

up Capital

No. of

Shares (as on

31.03.2006)

% to Paid

up Capital

Centurian Bank 76,73,437 5.37 27,75,78,001 21.67Federal Bank 10,65,637 4.80 1,83,15,281 27.53HDFC Bank 7,67,38,812 27.02 10,22,08,872 32.71ICICI Bank 28,33,78,082 38.63 41,48,16,138 46.63Indusind Bank 1,36,76,792 4.70 3,75,20,769 12.90ING Vysya Bank 46,45,021 20.53 1,55,02,328 17.03Jammu & Kashmir

Bank

77,12,696 15.90 1,45,49,707 29.99

Karnataka Bank 18,98,653 4.68 2,29,13,805 18.88Karur Vysya Bank 9.19,613 5.10 29,43,356 16.35

Kotak Mahindra Bank 94,35,947 7.92 6,45,43,383 20.93UTI Bank 3,31,63,474 14.27 9,69,84,197 34.87

Table 2: Foreign investment in private sector banks in the year 2004 and 2006.

The above tables indicate that the foreign investment in the capital of

Indian banks (Both public and private sector banks) has increased because

of the liberalization policy of the government and WTO norms. This growth

in investment by foreign countries will continue for long and it will also

provide better opportunities for the Indian banks to utilize the foreign

capital efficiently so as to compete strongly with the other banks.Encouraging foreign investment in the Indian banks will also develop

friendly relations with the other countries. The financial subsidiaries of

foreign banks have a big hand in these investments and at appropriate

time they will make their presence felt in many Indian banks after 2009,

whereafter under WTO rules these foreign banks could acquire 74 percent

shares of Indian private banks. The Indian government has acted

thoughtfully by permitting this cap already. In the same spirit the

government intends to amend the Banking Regulation Act to do away with

the restriction of voting rights to maximum 10 percent. These rules andregulations are protected and preserved in the developed countries. The

foreign multinational banks objective is to acquire the local banks

private and public. The banking policy pursued by Indian government has

encouraged the foreign banks to step up pressure. In the meanwhile,

situations are created permitting the foreign banks and their financial

subsidiaries to indulge in trading and services to increase their income and

profits. They are exempted from social banking and agricultural credit.

These burdens are put solely on the public sector banks, sapping their

income and profits. If this adverse playing field continue, they will berendered week and face the risk of being acquired by foreign banks.


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This disturbing banking policy must be changed. Rules and regulations

applicable to public sector banks must be applied to all the banks. Existing

common regulations for payment of interest on savings account should be

governed by common rules ensuring uniform implementation. In the samemanner, common rules should govern service charges. Foreign banks

should not be permitted to establish financial subsidiaries since such

subsidiaries are being used as banking and trading companies. The

globally prevalent regulation of capping on ownership of shares and voting

rights as it exists now in India should not be disturbed. Disinvestment must

be stopped once for all and alternate mechanism of issuing bonds and

preference shares ought to be adopted to strengthen the capital base.

Each Public Sector Bank should further expand by opening new branches

since household savings are increasing significantly as can be seen from

more than 32 percent increase in bank deposits and demand for credit is

about 80 percent of deposits. These measures will go a long way in

strengthening public sector banks and will help tremendously in the

development of the overall Indian economy.

4.4 Mergers& Acquisitions in bankingsector

Whether it is an Industrial Sector or Services Sector, mergers &

acquisitions have become way forward in todays world. In a free market

economy, companies have to keep evolving to remain competitive.

Adaptability to changes in the market becomes a crucial factor for survival.

Banking system is the bloodline of any economy and banks are trustees of

public money. The depositors therefore, have more stakes in the welfare of

banks than the share holders. Failure of a bank has more systemic

implications than say, the failure of a manufacturing company. Laws

governing regulation and supervision of banks in all countries therefore

focus on protecting the interests of depositors.

Mergers and Acquisitions are not an unknown phenomenon in Indian

Banking. The predecessor of State Bank of India, the Imperial Bank of India

was born out of consolidation of three Presidency Banks way back in 1920.

Merger of Times Bank with HDFC Bank was the first of such consolidations

after financial sector reforms ushered in 1991. Merger of Bank of Madura

with ICICI Bank, reverse merger of ICICI with ICICI bank, coming together of


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Centurion Bank and Bank of Punjab to form Centurion Bank of Punjab and

the merger of Lord Krishna Bank and Federal Bank are voluntary efforts by

banks to consolidate and grow.

Hong Kong allowed 100% FDI in banking sector and this facilitated takeover of several banks by Singapore and Taiwanese banks.

Indonesia witnessed large scale infusion of public funds into the banking

system through a specialized restructuring agency. The banks which had

Capital adequacy ratio reduced to below 25% were marked for immediate

closure. Consolidation among banks was actively encouraged and FDI was

allowed up to 99%.

In Malaysia, the Central Bank implemented a well crafted financial master

plan aimed at strengthening the domestic banks by creating a level

playing field for foreign banks and open banking sector to global

competition.

In Singapore, there are 3 main banking groups and they have given boost

to consolidation process not only within the country, but also in South

Korea and Malaysia.

Thailand has implemented a Financial Sector Master Plan aimed at

removing obstructions to Mergers & Acquisitions and also allows FDI flowto strengthen the banking system.

Consolidation or merger can be done with two basic motives:

1. Maximize value for shareholders or stakeholders: All the

activities of any bank will be to earn huge profits to maximize

stakeholders value and the value maximization can only be achieved

through a reduction in cost or an increase in revenue.

1.1 Achieving cost reduction

a) Cost reduction through economy of Scale:

Consolidation helps in scaling in up operations, there by reducing per unit

cost.

b) Cost reduction through economy of Scope: This

is achieved through synergy involved in the ability to offer multiple

products using the same infrastructure. Example: Banks can offer

insurance and investment products using their branch network andthereby achieve economy of scope.


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c) Cost reduction through rationalization of man

power: The merged entity will be able to identify the right persons to

manage critical functions from a larger pool of human resources.

d) Reduction in risk: The merged entity will be able

to reduce credit risk through spreading it across wider geographies orproduct range.

e) Cost reduction through possible reduction in tax

obligations.

f) Cheaper sourcing of inputs with increased

bargaining power with vendors and suppliers.

g) Ability to enter new business areas with reduced

initial cost as compared to a new set up.

1.2 Increasing Revenue

A bigger entity will be able to serve a large customer base. By offering

more services and taking bigger share in the business of the customer,

the bank will be able to increase the

.

2. Non-value maximizing motives: Non-value maximizing motives

could very often be ego factors of personal ambitions of managers. It could

even be to ward of take over by another company.

Indian economy is growing at 8-10% and the growth rate is second only to

that of China. Bank credit has been increasing at a rapid pace of over 30%

in the past 2 to 3 years. The Indian economy is slowly and steadily

integrating with the global economy. The recent report of Tarapore

Committee on Fuller Capital Account Convertibility has laid a road map for

total integration with global financial markets. Trade barriers are getting

removed under WTO and the accord on services would eventually open up

Indian banking system fully to global competition. The road map forpresence of foreign banks in India announced by Reserve Bank of India

envisages a regime after 2009 when foreign banks will be allowed to

operate in India like any other private sector bank in the country.

4.5 WTO Requirements & Indian Banking


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Since 1941 several nations of the world have attempted to evolve a

system under which multilateral trade among nations is carried out

smoothly without any hindrance. Since the first round in 1941 at Geneva

with 23 participant nations, several rounds have been conducted again at

Geneva between 1986 and 1993 with 117 member nations. At the end ofthese meetings, GATT (General Agreement on Tariffs and Trade) gave way

to the establishment of a permanent organization to guide multilateral

trade, namely World Trade Organization. Given the wide variance among

member nations in the state of their economies, member nations were

classified into three categories, namely, developed, developing and least

developed nations. At the end of the Uruguay Round, all members

including India agreed on the following:

To offer the Most Favored Nation (MFN) treatment to all member

countries;

To offer reduced tariffs;

To remove all subsidies to domestic industries and agriculture;

To remove all quantitative restrictions on imports and exports;

To ensure intellectual property rights of member nations; and

To ensure that exports satisfy phytosanitary measures agree on.

Basically, the agreement signed during June 1995 in Geneva givesopportunity for banks in 140 member countries to offer their banking

services to Indian consumers using all or any of the four modes of GATS.

By the same token, Indian banks now have the freedom and opportunity to

enter other member countries of WTO, to provide their services to the

nationals of these countries using any of the four modes. Following this

agreement, Government of India has liberalized shareholding of foreign

banks in Indian banks. Foreign banks are now allowed to pick-up as much

as 74%, of the equity shares of an Indian bank, against only 20% permitted

earlier. As foreign Institutional Investors (FIIs) can hold upto 49%. Till

recently, the RBI has been restricting branch expansion of foreign banks.

All the above actions of Government of India, under the veil of

economic reforms in the financial sector, will have far-reaching

implications to Indian banks. The first implication is that Indian banks will

be expected to take on international banks, some of whose sheer size is

frightening.

To succeed under WTO requirements, Indian banks need much higher

levels of operational efficiency, increase operating income by providing avariety of new services, ensure efficient cost control, take speedy


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commercial decisions and possess knowledge and ability to face

uncertainties and emerging new challenges. After making these

adjustments to retain and further gain in the domestic market, Indian

banks need to aggressively enter other member countries and provide

their services to enable marketing of Indian goods and professionalservices to these countries. The banking system in India, which helped

transform the poor Indian economy of the 1950s to become one of the

largest economies in the world, in terms of Purchasing Power Parity (PPP),

will rise to the occasion and continue to contribute to Indias growth

through its dynamism and expanded activities, not only within India, but in

other member countries of the World Trade Organization.

4.6 R egulations for foreign banks in India

At present, there are 29 foreign banks operating in India with a network of

273 branches and 871 off-site ATMs. The major foreign banks in India are

the Standard Chartered Bank, Citibank, Hong Kong & Shanghai Banking

Corporation, ABN Amro Bank and the Deutsche Bank. The primary activity

of most foreign banks in India had been corporate banking. However, since

mid-1990s, foreign banks added consumer financing to their portfolio and

today the foreign banks offer a wide-range of products such as automobile,

home and household consumer loans as well as credit cards.

Besides foreign banks, there are two large Indian private sector banks in

which the non-resident ownership is very close to the 74 per cent

permitted, which can be considered as incorporated in India but

predominantly foreign-owned banks. These banks together with the

foreign banks, have a combined market share in the deposits, advances

and off-balance-sheet business of 17.46, 18.65 and 76.63 per cent,

respectively. Moreover, there are also about 10 large listed public sector

banks (PSBs) in which the non-resident/FII (Foreign InstitutionalInvestment) shareholding was close to the permitted ceiling of 20 per cent,

as on March 2007. In these PSBs, resident private shareholding would thus

be close to 30 per cent only. In the foreign exchange market, these banks

had a 41 per cent share in the total forex turnover in 2005-06 and this rose

to 52 per cent in the first half of 2007-08.

Another dimension of the foreign banks' functioning in India is the returns

generated from their Indian operations. The net profit per branch for

foreign banks in India for the year 2005-06 was Rs 11.99 crore (Rs 119.9

million) as against the corresponding figure of Rs 0.33 crore (Rs 3.3million) for PSBs.


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For the year 2006-07, the Return on Assets (ROA) of foreign banks was

1.65 percent while the Return on Equity (ROE) was 14.02 percent, as

against the corresponding figures of 0.82 percent and 13.62 percent for

PSBs.

India issues a single class of banking license to banks and hence does not

place any undue restrictions on their operations merely on the ground that

in some countries there are requirements of multiple licenses for dealing in

local currency and foreign currencies with different categories of clientele.

Banks in India, both Indian and foreign, enjoy full and equal access to the

payments and settlement systems and are full members of the clearing

houses and payments system. Before granting any license, RBI may

require to satisfy that the Government or the law of the country in which it

is incorporated does not discriminate in any way against banks from India.

Unlike the restrictive practices of certain foreign countries, India is liberal

in respect of the licensing and operation of the foreign bank branches as

illustrated by the following:

All banks including foreign banks can carry on both retail and

wholesale banking.

Deposit insurance cover is uniformly available to all foreign banks

at a non-discriminatory rate of premium.

The norms for capital adequacy, income recognition and asset

classification are by and large the same. Other prudential norms such

as exposure limits are the same as those applicable to Indian banks.

The branch authorization policy for Indian banks has been made applicable

to foreign banks subject to the following:

Foreign banks are required to bring an assigned capital of US $25

million up front at the time of opening the first branch in India.

Existing foreign banks having only one branch would have to

comply with the above requirement before their request for opening of

second branch is considered.

Foreign banks may submit their branch expansion plan on an

annual basis.

In terms of Indias commitment to WTO, as a part of market access, India

is committed to permit opening of 12 branches of foreign banks every

year. As against these commitments, Reserve Bank of India has permitted

upto 17- 18 branches in the past. The Bank follows a liberal policy where

the branches are sought to be opened in unbanked/under-banked areas.Off-site ATMs are not counted in the above limit. Including off-site ATMs,


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foreign banks are having (as on October 15, 2007) place of business at 933

locations (273 branches + 660 off site ATMs).

The procedure regarding approval of proposals for opening branches of

foreign banks in India has been simplified and streamlined for the sake ofexpeditious disposal. A license under the provisions of B.R. Act, 1949

enables the foreign banks to carry out any activity which is permissible to

a bank in India. This is in contrast with practices adopted in many

countries, where foreign banks can carry out only a limited menu of

activities.

As against the requirements of achieving 40 per cent of net bank credit as

target for lending to priority sector in case of domestic banks, it has been

made mandatory for the foreign banks to achieve the minimum target of

32% of net bank credit for priority sector lending. Within the target of 32%,

two sub targets in respect of advances (a) to small scale sector(minimum

of 10%), and (b) exports (minimum of 12%) have been fixed. The foreign

banks are not mandated for targeted credit in respect of agricultural

advances. There is no regulatory prescription in respect of foreign banks to

open branches in rural and semi-urban centers.

4.7 WTO financial services agreement, 1997 banking commitments

India ratified the agreement establishing the WTO in December 1994. Its

original schedule in the Financial Services Agreement committed foreign

bank presence only through branches at the rate of five licenses per year.

It denied the entry of foreign banks if the market share of assets of foreign

banks exceeds 15 per cent of the total assets of the banking system. It

treated an ATM outside branch premises as a separate branch. India also

invoked a MFN exemption in all areas of financial services meaning that its

offers are based on reciprocity.

India offered to improve upon some of its commitments provided its major

trading partners were also prepared to make substantial improvements in

their stance on the movement of natural persons. It was felt that India

possessed a fair advantage in the availability of skilled manpower in

several hi-tech areas such as computer software, engineering consultancy,

etc. and it was in Indias interest that free movement of these personnel

was allowed into the developed markets abroad. Indias improved

negotiating brief included a liberalized policy on ATMs (i.e., an ATM will not


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be treated as a separate branch) and increasing the number of new

branches to eight.

In the negotiations that took place in June 1995, Indias major trading

partners made the following demands on India:

India should lift its MFN exemptions if other members do the

same.

India should increase the number of licenses and provide a

gradual increase in the market share on assets of the foreign banks.

Market share itself should be defined properly in terms of the

fund-based assets or total assets on and off the balance sheet.

Subsidiaries and joint ventures should be allowed in banking.

Discrimination against foreign banks in terms of higher rate of

taxation, and in placement of surplus funds by public sector units (i.e.

national treatment) should be removed.

Against these considerations, during the final round of negotiations that

was held in December 1997, India made the following commitments:

It deleted MFN exemption in all areas of financial services.

India increased the limit on the number of bank licenses granted

per year from eight to 12 but kept the market share unchanged at 15per cent for foreign banks. But this share of assets is computed as a

total of on- and off-balance sheet basis. Licenses issued for ATMs

installed by foreign banks were not included in the ceiling of 12

licenses.

Foreign banks already operating in India can invest no more than

10 per cent of owned funds in other financial service companies or 30

per cent of the invested companys capital, whichever is lower.

While the entry of foreign banks brings with it benefits, it also carries

certain risks for the host countries. Benefits are in the form of better

quality banking services that are offered by foreign banks themselves and

also through spurring competition and efficiency in the domestic markets.

The arrival of foreign banks with better accounting and disclosure

standards could lead to an improvement in prudential regulations in

domestic markets. The presence of foreign banks with more sophisticated

products could put pressure on domestic supervisory authorities to

augment their quality and size of domestic supervisory staff.


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The entry of foreign banks has also potential risks associated with it.

Another concern relating to foreign entry is that of foreign banks quickly

becoming dominant in the domestic banking system. This fear has led to

Singapore authorities, while announcing a major liberalization programmed

recently, to state explicitly that they wanted local banks to hold at leasthalf of the market. Also, the Philippines has stipulated that the market

share of foreign-majority owned banks should not exceed 30 per cent of

banking industry. Mexico also restricted foreign ownership to 30 per cent

with a cap of individual foreign bank at 5 per cent when it started selling

state-owned commercial banks in the early 1990s, but later these

restrictions were relaxed and finally removed.

4.8 Banking Services in United States

The United States was an original signatory to the GATT and a leading

proponent of the GATTs free-market principles. It continues to be among

the countries urging further discussions on opening markets to trade.

Although decisions in the WTO are by consensus, the United States has a

highly influential role in the WTO, because it is the largest trader in the

world. The U.S. banking sector is deep, competitive, and supported by a

strong economy and prudent supervision. The banking industry serves a

diverse market, providing wholesale and retail financial services to

corporations, small and medium-sized enterprises (SMEs), and individuals.

The banking sector includes deposit-taking commercial banks and thrifts.

The U.S. banking sector has mirrored consolidation trends in other major

economies but is still relatively unique in its significant number of regional

and community banks.

According to the World Bank the U.S. banking sector provided credit equal

to 215 percent of GDP in 2004, more than for most OECD and developing

countries. Globally, banking is one of the more mature industries, withglobal banking growth of 6 percent in 2004 (according to a June 2006

USITC report). The United States status as a leader in its domestic and

international development of the banking sector, and the expected steady

but slow growth of banking globally, suggests that room for revenue

growth through new branches is only moderate. In the United States,

however, most regional and large U.S. banks have successfully increased

revenue growth through consolidation.

From end of year 1998-2005 foreign banks assets in the U.S. market grewby 77 percent (versus 67 percent for all FDIC insured assets), with foreign


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banks currently holding approximately 19 percent of total U.S. banking

assets (U.S. Federal Reserve). Foreign banking investment largely reflects

inflow from large multinational banks with appropriate experience, skills,

capital and a customer-base, which enhances the desirability of expanding

cross-border investments.

The long-term demand for banking services in the U.S. market is likely to

continue to increase at a relatively stable rate. Compared to other

developed economies, the U.S. banking sector remains relatively

fragmented, suggesting that that further consolidation of the industry

through mergers and acquisitions is a real possibility. U.S. banks are

standard-bearers in terms of both profitability and efficiency, and the U.S.

banking market is highly competitive.

4.9 Banking services in India & UnitedStates

While 19 U.S. based banks had Indian branches approved between 2003

and October 2007, no Indian banks had received U.S. approval in the

period. Indian banks had applied to set up three branches, two subsidiaries

and nine representative offices in U.S. territory, with some requestspending for more than five years. The regulatory regime in India provided

a level playing field for foreign and domestic banks. Prudential rules were

the same as for local banks, and foreign banks even enjoyed a lower

priority-sector lending requirement of 32 percent of adjusted bank credit

against 40 percent for Indian banks. Foreign banks had 6.1 percent of

deposits and 6.8 percent of advances in the commercial banking system

as at the end of June, 2007. Foreign banks dominated the off-balance

sheet business with a market share of as high as 72.7 percent, and they

had 52 percent of total foreign exchange turnover in the first half of 2007-

08 (April-March) from 41 percent in 2005-06. Foreign banks also recorded

a higher rate of return than local banks from local operations. Net profit

per branch for foreign banks in 2005-06 was 119.9 million rupees ($30.3

million) compared to 3.3 million rupees for local banks.

4.10 Banking services in China


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As an important component to the country's overall economic system, the

Chinas banking industry has seen rapid growth in line with the economic

development of the Peoples Republic of China (PRC). Banks have

historically been, and continue to be, a significant source of capital for the

economy and the primary choice for domestic savings. The Chinesebanking sector comprises broad categories of banking institutions, namely

joint stock commercial banks, urban commercial banks, urban credit

cooperatives, rural credit cooperatives, foreign-invested commercial banks

and other financial institutions.

As of the year 2006 end, the total assets of the Chinas banking

sector amounted to Yuan 43.95 Trillion (US$ 5.812 Trillion), an increase of

Yuan 16.31 Trillion (US$ 2.16 Trillion) from 2003. During the same period,

the total liabilities of the banking sector reached Yuan 41.71 Trillion (US$

5.516 Trillion), an increase of Yuan 15.14 Trillion (US$ 2.0 Trillion).

.

China's banking sector has taken concrete steps already to meet the

challenges brought about by the country's accession to the World Trade

Organization (WTO).

The Shanghai Bank welcomed three international shareholders in the year

2002, including the global banking giant Hong Kong and Shanghai Banking

Corporation (HSBC) and the International Finance Corporation (IFC) underthe World Bank, which hold 8 percent and 7 percent respectively of the

Shanghai Bank's shares.

According to China's WTO accession agreement in 2001, Beijing agreed to

open its banking sector to full foreign competition from December 11,

2006. But Chinese authorities are formulating new regulations that could

hamper the efforts of overseas banks to attract retail customers. The

banking analysts speculated that Beijing has drafted the new rules in a bid

to contain the influence of foreign banks in China, according to theInternational Herald Tribune.

Chinese financial regulators planned to impose tighter restrictions on

foreign banks trying to get a slice of the country's huge pile of local

currency deposits, worth an estimated US$2 trillion. For the more than 70

foreign banks that operate about 230 branches in the country, the new

regulations could limit future expansion plans into smaller second- and

third-tier cities.


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Foreign banks are eyeing entering the potentially lucrative consumer

banking market where they could seek Yuan-denominated deposits, issue

credit cards, and offer home loans. The proposed rules would call for

foreign banks to incorporate in China with a minimum of RMB1 billion, or

US$123.3 million, in capital before they could compete with domesticbanks for retail customers.

Foreigners are facing growing regulatory hurdles across the financial

sector. In September 2006, international firms were denied the opportunity

to acquire domestic brokerages. The China Securities Regulatory

Commission announced it would stop issuing licenses to foreigners to open

new branches in an effort to give domestic players more time to improve

profitability.

The ban appears to alter plans by Beijing to draw on foreign investors'

capital and management expertise to help clean up a sector plagued for

years by poor management and heavy losses. Under its WTO

commitments, China must allow foreign investors to hold stakes of as

much as 49 percent in local brokerages by December 2006. The current

ceiling is 33 percent.

Foreign banks usually set up their branches in China - initially from special

economic zones to coastal areas and then to regional capital cities, as well

as major economic cities in domestic areas. This kind of distribution isconsistent with the country's opening-up initiatives.

Currently, there are more than 30 cities that are permitted to establish

operational foreign institutions, among which foreign financial institutions

are concentrated in Beijing, Shanghai, Guangzhou, Dalian, Shenzhen,

Tianjin and Xiamen. The Japanese Bank took the initial step by setting up

the first representative office of foreign financial institutions in China in

1979. Since then, Chinese banks began taking advantage of foreign

investment. In 1982 the Hongkong Nanyang Commercial Bank established

its first foreign branch in Shenzhen. Xiamen International Bank, the firstSino-foreign joint venture (JV) bank was set up in 1985. With a rapid

increase of foreign investment in China since the 1990s, more and more

foreign financial institutions have entered the Chinese market.

SMEs are becoming valuable clients to both the Chinese and foreign banks.

In comparison with Chinese banks, foreign banks have more experience in

market segmentation, better credit and risk control, good access to the

international market and more simplified procedures for credit approvals,

all of which serve to attract Chinese enterprises as clients.

In 2003, a qualified foreign institutional investors (QFII) scheme wasintroduced to allow foreign institutional investors, such as UBS, Deutsche


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Bank and Citigroup Global and others to engage in the securities sector on

the Chinese mainland. At present there are 50 approved QFII entities.

At the same time, a total of 17 foreign and Chinese banks have been

approved to invest clients' assets overseas under the qualified domestic

institutional investor (QDII) program. So far, they have launched nine QDIIproducts, with sales of 2.3 billion Yuan (USD291 million) in RMB-

denominated transactions and USD87 million in US dollar-based

transactions.

BANKS PERFORMANCE IN INDIAN ECONOMY(Amount in Rs. Crore)

Indian Banks

State Bank of India Canara Bank Punjab National Bank

Net Worth Return % Net Worth Return % Net Worth Return %

566565.24 15.41 165961.04 18.78 162422.5 16.03

Foreign Banks

ABN Amro

Standard Chartered

Bank HSBC

Net Worth Return % Net Worth Return % Net Worth Return %

32077.67 21.63 58853.18 31.35 54987.15 17.6

Table 3: Return on Net Worth% of Indian and foreign banks in 2006 and 2007

The above table shows the total assets employed by few Indian and

foreign banks in Indian banking sector and their return on net worth % for

the year 2007. It is cleared from the table that the return on net worth %

earned by the foreign banks is higher than the Indian banks. State Bank of

India showed a return on net worth of 15.41% with the total assets of Rs.

566565.24 crore whereas ABN Amro showed a return on net worth of

21.63% with the total assets of Rs. 32077.67 crore in the Indian banking

sector. In the same way, Standard Chartered and HSBC have also shown

better returns comparative to the Indian banks. The reason for the better

performance of foreign banks can be updated technology used, risk

management tools, better operational efficiency, relaxation in the

regulations of RBI, etc. Although the Indian banks have a high amount of

investment in the Indian banking sector but the foreign banks have a

competitive edge of better use of the capital as compared to foreign banks

which is the main reason for their better efficiency. (Refer Annexure 1 &

2)

(Amount in Rs. Crore)Indian Banks


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State Bank of India Punjab National Bank

2006 2007 % change 2006 2007 % change

11299.23 9999.94 -11.5 2917.11 3230.65 10.75

Foreign Banks

Citibank HSBC

2006 2007 % change 2006 2007 % change

1577.1 2180.45 38.26 1277.07 1922.39 50.53

Table 4:Operating Profit of Indian and foreign banks in 2006 and 2007

As shown in Table 2, State Bank of India showed a decline in its operating

profit from Rs. 11299.23 crore in the year 2006 to Rs. 9999.94 crore in the

year 2007 i.e. a decrease of 11.5% whereas Punjab National Bank showed

an increase its operating profit from Rs. 2917.11 crore in the year 2006 toRs. 3230.65 crore in the year 2007 i.e. an increase of 10.75%. These

figures depict that the operational efficiency of PNB has increased in the

year 2007 whereas the operational efficiency of SBI has decreased. Now if

we compare the change in operating profit of Indian banks with foreign

banks, it can be clearly identified that the foreign banks enjoy better

operational efficiency as compared to Indian banks. Citibank showed an

increase in its operating profit from Rs. 1577.1 crore in the year 2006 to

Rs. 2180.45 crore in the year 2007 i.e. an increase of 38.26% and HSBC

showed an increase in its operating profit from Rs. 1277.07 crore in the

year 2006 to Rs. 1922.39 crore in the year 2007 i.e. an increase of

50.53%. Therefore, it is cleared from the above data that Indian banks are

falling behind the foreign banks in its operational efficiency. Foreign banks

operational efficiency is higher than the Indian banks which is the reason

for a higher increase in the operating profits of foreign banks when

compared with Indian banks.

(Refer Annexure 3 & 4)

(Amount in Rs. Crore)

Indian Banks

State Bank of India Canara Bank

Punjab National

Bank

Total AssetsROA %Total Assets ROA % Total AssetsROA %

566565.24 0.84 165961.04 0.98 162422.5 1.03

Foreign Banks

ABN Amro

Standard Chartered

Bank HSBC

Total AssetsROA %Total Assets ROA % Total AssetsROA %32077.67 1.37 58853.18 3.06 54987.15 1.82


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Table 5:ROA% (Return on Assets) of Indian and foreign banks in 2006 and 2007

The above table shows the ROA (Return on Assets %) of different banks in

Indian banking market. ROA indicates the ability of the entity to generatepercentage return on the value of assets employed in the market. SBI had

shown ROA of 0.84 in the year 2007 whereas Canara Bank and PNB have

shown ROA of 0.98 and 1.03 respectively in the same year. Now if we have

a look at the ROA of foreign banks operating in India, ABN Amro had shown

ROA of 1.37 in the year 2007 whereas Standard Chartered Bank and HSBC

had shown ROA of 3.06 and 1.82 in the same year. It is clear from the

figures that ROA generated by the foreign banks in India is higher than the

Indian banks operating in the same market. But the value of assets

possessed by the Indian banks in the Indian banking system is higher thanthe value of assets possessed by the foreign banks. But still, foreign banks

have been able to generate very high profits proportionate to the value of

assets owned by them in the Indian market. This depicts that the foreign

banks have used their assets in a better way as compared to Indian banks.

One of the major reasons for their high efficiency in generating better

returns proportionate to their assets is the regulations or benefits enjoyed

by the foreign banks in the Indian banking segment. (Refer Annexure 5

& 6)

(Amount in Rs. Crore)

Indian Banks

State Bank of India Punjab National Bank

2006 2007 % change 2006 2007 % change

4406.67 4541.31 3.06 1439.31 1540.08 7.00

Foreign Banks

Citibank JP Morgan Chase Bank

2006 2007 % change 2006 2007 % change

705.55 900.00 27.56 72.93 106.79 46.43

Table 6: Net Profit of Indian and foreign banks in 2006 and 2007

The table indicates the net profit earned by few Indian and foreign banks


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in the years 2006 and 2007 in the Indian banking sector. SBI had reported

the net profit of Rs. 44

Ashish Chatrath Final Dissertation

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