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Foreign banks could also be given the flexibility to choose between the branch and subsidiary models based on their operational focus and client base
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India’s banking sector grapples with a multifaceted challenge concerning the establishment and operations of foreign banks. In a pivotal reform introduced by the RBI in 2013, foreign banks were authorised to establish wholly-owned subsidiaries (WOS) rather than functioning exclusively through branch networks. This strategic initiative was designed to bolster their operational independence while simultaneously fortifying regulatory supervision and governance.
Furthermore, foreign banks operating under the WOS framework in India are mandated to allocate a designated proportion of their total credit towards Priority Sector Lending (PSL). Notably, the prescribed 40 per cent target remains applicable irrespective of the number of branches a foreign bank maintains within the country, ensuring uniform compliance with financial inclusion objectives.
To address these challenges, regulators may consider the need to deliberate allowing dual presence — both as a branch and a WOS — similar to jurisdictions like Australia. Foreign banks could also be given the flexibility to choose between the branch and subsidiary models based on their operational focus and client base. Additionally, allowing more time to meet PSL targets by gradually increasing them over four to five years instead of requiring immediate full compliance would ease the transition.
Governance and growth
With governance as a central focus, the RBI introduced a provision which expanded the scope of the regulations pertaining to restrictions on loans and advances to corporates and its directors. Per the directives, loans/ advances provided by a bank to entities associated with the directors of other unrelated banks require prior approval from the board of directors (or a designated management committee) of the lending bank.
This restriction may lead to banks losing the opportunity to appoint skilled and experienced individuals as directors due to delays in obtaining board approval. To mitigate this, regulators could consider eliminating the derivative provision that extends restrictions on loans and advances to entities or directors by an unrelated bank. Rather than imposing outright restrictions, board participation could be permitted with strict disclosure requirements.
More clarity is required on the voting rights in the case of a WOS after the initial dilution. A clarification that the WOS continues to be a WOS for voting rights, even post dilution to 74 per cent, would encourage WOSs to push for domestic investor participation.
The Bank Investment (Holding) Company (BIC) structure, proposed by the PJ Nayak committee, could be considered to manage Government’s stakes in PSBs. The BIC would be a holding company for Government’s shares in PSBs. The structure of BIC could potentially draw inspiration from a globally successful model of Temasek Holding — Singapore’s sovereign wealth fund that manages the government’s equity investments in a range of businesses, including banks.
The proposed framework and process for BIC formation involve diluting government shareholding in individual PSU banks to approximately 52-55 per cent through either the Qualified Institutional Placement (QIP) route or a follow-on public offering (FPO) at prevailing market valuations. A BIC (Holding) company could be formed under the Companies Act, with 100 per cent ownership by the Consolidated Fund of India, which currently holds the government’s equity stake in PSU banks and transfer the Government holding in respective PSU banks to this holding company.
Following the transfer of the government stake to BIC, a divestment of BIC’s stake through the secondary market could be undertaken to bring down the holding company’s stake, to raise the capital. This initiative has the potential to enhance BIC’s capacity to stable capital inflows from long-term foreign investors.
The writer is Partner and National Leader – Financial Services, EY India
Published on April 8, 2025
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