The presence of foreign players in India's banking sector is set to increase. As the competition unleashed by financial liberalisation squeezes margins and forces banks to build their bottom line by expanding the volume of their business, a process of consolidation in the banking business seem inevitably underway. And since financial liberalisation has permitted an increase in the stake held by foreign investors in Indian banks from 20 to 49 per cent, the expectation is that this consolidation would also see an increase in the presence of foreign banks in the domestic market.

Foreign banks have existed in the domestic market, with some like Citibank and Standard Chartered (which through a global arrangement acquired ANZ Grindlays in India) having seen a substantial expansion of their operations in recent years. But these have largely been in the nature of subsidiaries with a focus on corporate and merchant banking. The presence of these banks in the retail market has been limited. However, the new liberalised environment where entry conditions are easier and profits depend on expansion is seeing a change in strategy.

The most recent indication of this was Hong Kong and Shanghai Banking Corporation's (HSBC) acquisition in early December of a 20 per cent stake in UTI bank from the Commonwealth Development Corporation (CDC). HSBC is understood to have bought the 20.08 per cent stake from two private funds - 12.37 per cent from CDC Financial Services (Mauritius) Ltd and 7.71 per cent from the CDC-controlled South Asia Regional Fund. Though this was a transfer from one foreign investor to another, the implications were significant because HSBC is a foreign bank looking to expand its presence in the Indian market. UTI Bank's Chairman and Managing Director, P.J. Nayak optimistically declared that he believed that HSBC's picking up stake in the bank was "an investment" and that UTI Bank would prefer to remain a standalone bank.

But there are a number of factors that militate against this prospect. First, HSBC's stake is likely to soon exceed 20 per cent since it would, as per SEBI guidelines, have to make an open offer to other minority shareholders, and could end up acquiring another bunch of shares. At the time of acquisition, the shareholding pattern of the bank included the following players: Citicorp Banking Corporation 3.83 per cent, Chryscapital 3.83 per cent, Karur Vysya Bank one per cent, South Asia Regional Fund 7.71 per cent and 16.91 per cent with the public. Second, if acquisition aimed at realising economies of scale is an objective that is driving banking strategy in India, then HSBC would have an interest in merging its operations with UTI bank. When such considerations lead to a reverse merger even between ICICI and ICICI bank, it would be naïve not to expect it to happen with the more aggressive foreign banks, if circumstances permit.

Third, indications are that the government would be soon revising upwards the cap on foreign shareholding in private banks from the prevailing 49 per cent (raised from 20 per cent in 2001). In a reply to Parliament on December 16, the Finance Minister, Mr Jaswant Singh, said that the Government has in principle decided to enhance the limit of foreign direct investment (FDI) in banking companies. This, he felt, would invite greater foreign investment in private banks. Though he did not indicate any fresh limit, the Government had announced in its 2003-04 Budget that non-resident equity in private banks could be raised to 74 per cent. In fact, this is known to have triggered the interest of foreign banks in the acquisition of a stake in private Indian entities. Finally, other experiences suggest that once the acquisition process begins in a particular bank, it is bound to continue.

A classic case is that of the acquisition of a stake by ING bank in Vysya bank. The ING Group initially acquired 54.36 lakh fully paid-up equity shares of Rs 10 each of Vysya Bank, representing 23.99 per cent, from GMR group. These shares where purchased by its wholly-owned subsidiary — Banque Brusells Lambert (BBL) Mauritius Holdings. In September 2002, following the revision in the foreign equity cap in banking to 49 per cent, ING increased its equity share to that level. Since then the effort has been to convince the government to permit an increase in equity holding initially to 51 per cent, so as to ensure full Dutch control and then to 74 per cent, as and when the new regulations announced in the 2003-04 budget are put in place.

There is no reason to expect that HSBC's strategy would be any different. In fact, when recently asked whether HSBC's stake in UTI Bank would increase, Niall S.K. Booker, CEO, India Region, HSBC, reportedly said: "Quoting Mark Twain, let me say, as facts change so will our opinions." On a more cautious note he indicated: "The legislation would have to change and there should also be shareholder's consent from the Indian promoters, UTI, LIC and GIC for HSBC to increase stake. The FDI limit should ideally be lifted to 74 per cent and voting rights should be aligned with it." Voting rights are currently restricted to 10 per cent.

Based on the premise that such expectations regarding policy would be realised, there is a growing interest in private bank acquisition by foreign firms. Development Bank of Singapore (DBS) is at an advanced stage of discussions with the Global Trust Bank (GTB) to pick up 49 per cent equity holding. DBS has thus far just one branch in Mumbai primarily engaged in the corporate and treasury businesses. Similarly, Bank Muscat is reportedly merging operations with Centurion Bank.

The acquisition drive by foreign players is increasing the pressure on other banks, including the public sector banks to look to business expansion, capital infusion and mergers. There is talk of a merger of Ashok Leyland Finance with IndusInd Bank and the entry of Reliance Capital into the banking business. These marriages between NBFCs and banks are problematic inasmuch as the existing law does not impose any obligation on the part of either the bank or the NBFC to seek the RBI's approval before filing the scheme of amalgamation in the courts. This, RBI governor Venugopal Reddy admitted, is a lacuna that needs to be redressed and the RBI has proposed amendments to the Banking Regulation Act, which require that amalgamation of an NBFC with a banking company is on the same lines and requires the same clearances as the merger of two banking companies.
The spate of mergers has resulted in a rise in the value of bank stocks, with investors expecting to make a profit when any acquiring institution makes an open offer. The speculative factor cannot be ruled out here, as indicated by a number of large "block deals" in shares of banking companies. In early December, on a single day there occurred block deals in ICICI bank stock valued at 700 crore. That was possibly the largest transaction to take place in any one scrip on a single day. There were four deals involved: one for 15 lakh shares, the second for 1.99 crore shares, the third for 40 lakh shares and the last for 9.98 lakh shares. A total of around 2.63 crore shares of ICICI Bank were traded in these transactions accounting for 4.28 per cent of the banks' equity.

A few days later, as many as 20,00,800 shares of Global Trust Bank changed hands in the Bombay Stock Exchange in a single transaction. Overall, as many as 35,94,686 shares were traded on BSE at a value of Rs 10.09 crore, while 28,65,546 shares changed hands on NSE amounting to Rs 8.09 crore. These transactions occurred at prices that were the highest they had touched over a whole year.

Thus clearly, trading in bank shares, often through proxy buyers is on the increase, indicating strong buyer interest. While those looking for speculative gains are partly responsible, the whole process is being driven by the interest in acquisitions that accompanies the consolidation wave in the banking sector. That consolidation has been unleashed by the process of liberalisation, which is also easing the conditions for entry of foreign players and paving the way for foreign acquisitions of private Indian banks. While these changes are currently restricted to the private banks, changes in policy are likely to see the process affecting the public sector banks as well. In the months to come, therefore, a significant change in the institutional structure of the Indian banking system is likely.

These developments are occurring at a time when the build up of reserves due to large inflows of foreign capital is leading to a substantial relaxation of restrictions on foreign exchange utilisation. With a much larger international network, foreign banks would be in a position to facilitate foreign exchange transactions to a much greater degree, exploiting the loopholes available under the diluted regulations governing foreign exchange use. This would render the fine distinction the government makes between partial and full convertibility difficult to sustain. Since the resulting larger outflows are not likely to be covered by foreign exchange earnings alone, India's dependence on foreign capital inflows would be substantial. Unfortunately, the full implications of this would emerge only when unforeseen conditions generate a climate encouraging capital flight. But, as experience the world over indicates, that would be too late.