Part I (April 11)
Since 2007, India and the European Union (EU) have been negotiating a free trade agreement (FTA). The negotiations not only cover trade in goods but also services, rules pertaining to intellectual property rights, cross-border investments, competition policy, government procurement and regulatory issues.
The EU as a bloc is India’s largest trading partner, accounting for 23% of India’s total trade in 2007. India contributes only 1.8% of the total EU trade and is its 10th largest partner. Services are an emerging area of EU-India trade. The EU is also one of the largest sources of foreign direct investment (FDI) in India, with major investments in energy, telecommunications and transport. Of late, many Indian private companies are also undertaking substantial investments in several European countries.
An FTA with India is a key component of the EU’s « Global Europe » policy framework based on several long-term economic and strategic goals. India currently leads the list of Asian countries with 30 FTAs, followed by Singapore with 26, China and Korea with 22 each and Japan with 19. Out of India’s 30 FTAs, eight are within Asia. Apart from closer economic ties, India sees potential geopolitical gains in forging FTAs, particularly within Asia.
One of the major underlying themes in the India-EU talks is the liberalisation of trade and investment in financial services. Financial services cover a wide range from banking to insurance to brokerage and asset management. Global trade in financial services has registered rapid growth in the past two decades on account of growing internationalisation of trade and finance. Financial services firms see regulation as the biggest obstacle to their global ambitions.
The liberalisation of trade and investment in financial services is a part of wider financial sector liberalisation that consists of domestic (e.g. interest rate deregulation) as well as external (e.g. capital account liberalisation) reforms.
Bilateral agreements have generally led to increased financial services liberalisation commitments compared with those made under the Gats (General Agreement on Trade in Services) framework of the WTO. For instance, the US-Singapore FTA signed in 2003 led to deeper opening of cross-border trade and investment in financial services in Singapore. More importantly, the FTA incorporates strong discipline on the use of capital controls during a crisis.
With the help of an FTA with India, the EU would like to achieve significant liberalisation of India’s banking sector, well beyond what has been achieved under the Gats framework. The EU is seeking greater market access and export gains for its large banks through cross-border supply and direct investments.
Some of the key demands emanating from the EU include complete market access for banks (commercial presence, cross-border supply and consumption) and national treatment commitments. It has sought removal of regulations pertaining to bank branches, numerical quotas, foreign ownership, equity ceilings, voting rights and investment by state-owned companies in foreign banks in India.
Since 2000, several European economies have registered significant growth in their net exports of financial services. Banking services are a key component. The UK remains the world’s leading exporter of financial services, reaching a record 38.8 billion (net) in 2007, up from 29.8 billion in 2006. This was despite the turmoil in the credit markets that began in mid-2007. Banks were the largest contributor, at 23.2 billion in 2007.
In terms of the UK’s balance of trade in goods and services in 2007, trade surpluses generated by financial services (36.9 billion) partially offset large deficits in goods (89 billion) and travel (17 billion).
According to the reserve bank of India’s Annual Survey on International Trade in Banking Services (2006-07), the fee income of the Indian banks operating abroad was 18.9 billion rupees in 2006-07. Total fee income generated by foreign banks operating in India was much higher at 60.83 billion rupees. Thus, Indian banks were no match to foreign banks in generating income through trade in banking services.
The commercial motives behind entering banking markets in India are obvious as they provide immense profit opportunities to foreign banks. However, the big European banks are particularly interested in serving three niche-market segments in India : upmarket consumer retail finance, wealth management services and investment banking.
Despite wide-ranging asymmetries between India and the EU, the negotiations in the banking services cannot be simply construed as a one-way process. Apart from big European banks seeking greater market access to India, a number of big Indian banks (both state-owned and private) are also seeking increased presence in European countries (particularly in the UK and Germany) as they aim to serve the non-resident Indians (NRIs) in these countries.
In India, the presence of foreign banks dates back to the pre-independence period. Since 1991, the entry of foreign banks has been liberalised. By asset size, six of the top 10 foreign banks in India are EU-based. The nine EU-based banks together controlled 65% of total assets of foreign banks in India in 2008.
Under the WTO agreement, India has made commitments to offer 12 new licences every year to foreign banks. However, the number of branches permitted each year to foreign banks has been higher than the WTO commitments. From July 2006 to June 2007, India allowed seven established foreign banks (including ABN Amro Bank, Barclays Bank and Deutsche Bank) to open 20 new branches, and an additional seven foreign banks to set up representative offices.
Part II (April 18)
In the first part of this article last week, we outlined some of the issues at stake as India debates whether it should open its banking sector under a planned free trade agreement with the European Union. One of the key policy issues determining market access is reciprocity. How much market access are Indian banks getting in return ?
In the case of India-Singapore Comprehensive Economic Co-operation Agreement (CECA,) the principle of reciprocity has not been followed. Though the Reserve Bank of India (RBI) has allowed market access to Singapore banks, the Monetary Authority of Singapore (MAS) has failed to fulfill its commitment to provide qualified full bank (QFB) licence status to three Indian banks. Currently, DBS operates 10 branches in India along with other Singapore banks, whereas only State Bank of India has QFB status in Singapore.
There is a popular perception that the entry of foreign banks in the Indian market is very restricted and the regulatory framework discriminates against them. A closer examination reveals that regulations are no longer discriminatory and in many important ways put foreign banks on the same footing as Indian banks. Unlike in the US, Singapore and China, foreign banks are free to undertake any activity in India (e.g., wholesale, retail, private banking, investment banking, foreign exchange, etc) that is allowed to domestic banks.
The prudential norms applicable to foreign banks for capital adequacy, reserve requirements and asset classification are the same as for the Indian banks. Foreign banks also are given undue favour when it comes to priority-sector lending. Indian authorities have imposed a lower priority-sector lending requirement at 32% (of adjusted net bank credit or credit equivalent amount of off-balance sheet exposures, whichever is higher) for foreign banks as against 40% for Indian banks.
In the case of branch licensing, there is no rule saying foreign banks must open branches in rural and semi-urban areas. They have the freedom to decide where to locate branches. For new private banks, the licensing policy stipulates that they need not necessarily open branches in rural or semi-urban areas during the first three years. But once the moratorium is over, one out of four new branches must be opened in such centres.
This lopsided policy works in favour of foreign banks because rural branches generate less profit. Most branches in rural areas are operated by Indian state-owned banks.
No EU-based bank operating in India has opened a branch in a rural area so far. This is despite the fact that several EU banks (such as Standard Chartered, BNP Paribas and HSBC) have been operating in India for more than 140 years.
It is important to note that even without branch licences, foreign banks have been able to expand through off-site ATMs, non-banking finance companies and off-balance sheet exposures (e.g., derivatives).
The track record of European banks in promoting financial inclusion has been extremely poor in India. Since foreign banks have no branches in rural areas, they are not obliged to serve this vast market that is excluded from the formal banking system.
Typically, foreign (and domestic private) banks are averse to serving the poor because they are less lucrative. Foreign banks tend to follow exclusive banking by offering services to a few clients, instead of inclusive banking. For instance, BNP Paribas maintains a strong clientele among large companies only. It does not cater at all to small companies in India. Its wealth management service serves just 800 clients with net worth of above 10 million rupees each.
Foreign banks also charge higher fees for services, and maintaining a bank account requires substantial financial resources.
It is not the lack of market or regulatory discrimination that is hindering the delivery of banking services by European banks in India, but primarily their business model and bias against the poor in general.
Recent trends suggest that huge losses suffered by European banks in their home markets may not deter them to enter India. Despite severe crisis at home, many European banks (including BNP Paribas, Barclays Bank, Cre’dit Agricole, Deutsche Bank, HSBC, Rabobank Group and Royal Bank of Scotland) are seeking licences to expand in India. Profit opportunities in India are much higher than in mature European markets.
It is a fact that foreign banks tend to shift their focus to overseas markets (particularly those with strong GDP or income growth prospects) if their parent banks become weak because of a crisis. As a counterweight to ailing domestic markets, the big EU-based banks would like to get out of the recession by exploring newer markets, where the engines of economic growth are located.
Are big European banks going to augment the reach of the banking system to millions of Indians citizens who do not have access to basic banking services ? Are EU-based banks going to meet the developmental needs of unbanked and underbanked regions of India ? Can European banks meet the targets of financial inclusion for rural households, as suggested by the Committee on Financial Inclusion ? In which locations will European banks open branches within metro politan areas ? What extraordinary services will they provide to serve unbanked Indian people ?
The liberalised entry of European banks may further constrict the access of banking services in the country : geographically, socially and functionally.
The fact is that in India, the much-touted benefits associated with European banks have yet to materialise. The urban-centric European banks largely serve wealthy and corporate niche markets.
Keeping these important developments in view, Indian policymakers should rethink the benefits of opening up of banking and financial services under the framework of the India-EU FTA.