“Various issues associated with the increased presence of foreign banks such as impact on the domestic banks, supervisory and regulatory challenges in view of their sophisticated operations and their involvement in complex and sophisticated products, financial inclusion, credit to agriculture and SMEs, and public policy on credit delivery, cost and allocation would need to be weighed,” the RBI said in its ‘Report on Currency and Finance 2006-08’.

The issues relating to co-ordination between home and host countries’ regulators would also pose a challenge, it said. In the roadmap by the RBI released in February 2005, the opening up of the domestic banking sector to foreign banks was envisioned in two phases. The first phase envisaged that foreign banks wishing to establish presence in India for the first time could either choose to operate through branch presence or set up a 100 per cent wholly owned subsidiary following the one-mode presence criterion.

Saying that liberalisation of financial services industry raised concerns, the report said the potential of increased foreign bank presence could expose a country to external shocks. “Opening the domestic financial system to foreign financial services providers without any restrictions also raises the possibility of domestic financial institutions being taken over by foreign banks,” the report said.

However, it admitted that the entry of foreign banks would increase efficiency and infuse technology, skill management and superior risk management practices.

The report also pointed out that the majority ownership in public sector banks was a hurdle that needed a solution. The present floor of 51 per cent government holding in state-owned banks was an issue that merited consideration in view of the need of these banks to raise capital and the changing environment.

In terms of the present provisions of the law, government equity in public sector banks cannot be less than 51 per cent. This can become an issue hampering the growth of public sector banks if the government is not able to provide adequate capital for expansion of public sector banks. Thus, there would be need to find a durable solution to the problem, whereby either the government contributes to the capital of banks or allows banks to raise capital from the market, the RBI report said.

Advocating mergers and acquisitions in the Indian banking sector, RBI, based on empirical evidence, has found out that the industry could be characterised as a “monopolistic competitive structure”.

The consolidation process in the banking sector that is already underway could accelerate in future in view of several developments such as the planned review of the roadmap of foreign banks and implementation of Basel II.

RBI cautions Government

The RBI has a word of caution for the finance ministry. It has warned that Central finances might come under pressure this fiscal on account of implementation of the Sixth Pay Commission award including payment of arrears, higher oil subsidies, increase in fertiliser subsidy due to a sharp rise in the price of raw materials and fertiliser in the international market. It also said volatile food and energy prices were other concerns.