FDI: Breathing New Life Into Indian Banking

Foreign Direct Investment (FDI) is becoming increasingly important for global growth. FDI from investors in developed nations provides funding and expertise to help emerging market players to expand their business. In the Indian banking industry, this has led to the emergence of internet, e-banking, ATMs, credit cards and mobile banking, which helps banks attract and retain customers. 

FDI plays a vital role in economies. Not only does it bring opportunities to the host countries to enhance their economic development, it also opens up new vistas to the home countries to optimise their earnings by employing their idle resources. 

Since 1991, India has sought to increase the FDI inflows with a liberal economic policy after decades of a cautious attitude. The 1990s saw a sustained rise in the annual FDI inflows to India. Basically, opening up of the economy after 1991 by way of liberalisation, privatisation and globalisation did not leave much choice but to attract foreign investment as an engine of dynamic growth.

Current FDI Limits In Indian Banking

In recent times, the government has been pushing to increase the role of multinational banks in the banking and insurance sectors despite the concerns expressed by the Left parties. FDI in the banking sector has been liberalised by raising the FDI limit in private sector banks to 74 per cent under the automatic route, including investment by foreign investors in India. The aggregate foreign investment in a private bank from all sources will be 74 per cent of paid- up capital of the bank. FDI and portfolio investment in nationalised banks are subject to an overall statutory limit of 20 per cent. The same ceiling also applies in respect of such investment in the State Bank of India (SBI) and its associate banks.

Need For Enhanced FDI Cap

The impending implementation of the Basel III norms requires substantial infusion of capital in the banking sector. According to an estimate made by Standard & Poor’s, Indian banks are slated to need additional capital of upto Rs.2.6 lakh crore by 2018 as they migrate to the Basel III framework. Nearly 70 per cent of equity in PSBs is contributed by the Central Government. Definitely, contributing the proportionate amount of additional capital by the government is a huge task. So, capital from all avenues is more than welome. FDI is also especially beneficial in the current context as it will help to ease pressure on the falling rupee. 

PSBs are heavily dependent on the government for infusion of capital as the limits for FDI in PSBs were capped at 20 per cent. Hence, upping the limit even in PSBs will greatly help them to meet their capital requirement.

Increase In FII Stake In Indian Banks

FIIs have been on a selling spree in the last quarter, and the banking sector has been no exception to this. On a sequential basis, 22 out of the 39 listed banks have been witnessed a decline in their FII holdings. Dhanlaxmi Bank has witnessed the most FII selling, with the holdings dipping to 25.75 per cent in Q1FY14 from 31.26 per cent as of Q4FY13. IndusInd Bank saw the highest gain in its shareholding by FIIs, with the stake going up by 179 basis points to 42.28 per cent on a sequential basis for the quarter ended June 2013.
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Benefits of FDI In Banking

Some of the pain points for banks in the country are: 

• Management issues
• Instability in financial matters 
• Need for innovation in financial products and schemes 
• Need for technical developments 
• Non-performing areas/properties 
• Poor marketing strategies
• Changing financial market conditions

FDI helps address these issues. The banking sector receives the following benefits of foreign money coming in: Transfer of technology: In this era of globalisation, one need to keep pace with the advancement of technologies, which itself is dynamic in nature. With the increased FDI threshold, technological advancement is bound to pick up in India. This, in turn, will help the country’s banks to keep pace with growing technological requirements and expertise in the Indian space. 

Also, the many structured products available abroad have already started making inroads to India, and we will see more of these in the future too.

Ensuring better risk management: The one problem that the Indian banks are facing at this point of time is of managing risk in a better way. We need to understand that with FDI coming in, banks will surely expand their area of operation. There is also a need to change their strategies, which will minimise their competitive pressure. Here, the best example is Basel II. Through FDI, countries will be able to manage their risk efficiently. The host countries that are coming in with FDI are well adapted with the techniques to make the financial system safer.

Assures better capitalisation: The banks in the country that will receive FDI may benefit immediately from foreign entry. If a foreign bank recapitalises a struggling local institution, it also provides the much-needed balance of payment finance. It enables more efficient allocation of credit in the financial sector, better capitalisation and wider diversification of foreign banks along with the access of local operations to parent funding. This, in turn, may reduce the sensitivity of the country’s banking system and lead to financial stability.

Conclusion

The resilience of our banking system was well demonstrated in last financial crisis, which brought even many well-known international banking giants to their knees. However, increasing the FDI cap is a much needed step in the direction of enhancing banking operations in the country.