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Benefits of local incorporation

The discussion paper on the presence of foreign banks in India circulated by the Reserve Bank of India draws heavily on the experiences of the global financial sector during the crisis period. A road map for foreign banks drawn up in 2005 had recommended a two-track approach aimed at, on the one hand, increasing the stability and pace of consolidation of both private and public banks in India and, on the other, enhancing foreign bank presence in a synchronised manner. An action plan to be executed in two phases was stalled in the wake of the global financial crisis. There have been valuable lessons from the crisis — among them, the desirability of “subsidiarisation” of significant cross-border presence, which brings with it the advantages of greater regulatory control and comfort to the host jurisdiction. The crisis was exacerbated by complex structures and the implicit belief that certain financial institutions are either too big or too connected to be allowed to fail. The risks can be minimised, although not entirely eliminated, by asking foreign banks to incorporate subsidiaries locally rather than operate as branches. Unlike branches, subsidiaries will have their own capital and boards of directors and be subject to domestic legislation such as the Companies Act.

While opting for the subsidiary model, the discussion paper does not downplay the advantages of foreign banks functioning as branches. These include greater operational flexibility and an enhanced lending capability based on the ability to leverage the capital of their head offices. However, the much-vaunted strengths of major international banks were of no avail during the crisis and, in India especially, their branches seemed to be in a far better shape than the bank as a whole. In the post-crisis period, a majority of regulators are stipulating local incorporation requirements to protect retail depositors and to limit the impact of operations of systemically important banks. A clear demarcation of assets and liabilities between branches of subsidiaries and the head offices is possible. It also becomes easier to define laws of jurisdiction and, in general, enhance the capabilities of the domestic regulators. One important lesson from the crisis is that a foreign bank's support to either its branches or subsidiaries need not be automatic. Given the perceived reluctance of foreign banks to incorporate subsidiaries, certain incentives can be offered without relaxing the entry level requirements suggested in the discussion paper. The issue of reciprocity will also come up, with Indian banks operating branches in many jurisdictions.

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