Why Are Foreign Banks Leaving India?

Yesterday, FirstRand Bank, South Africa’s second-largest bank, declared its exit from India (later clarified to “scaling back presence by turning into a representative office”).

The bank began its India operations in 2009 and progressed into the retail lending business by 2012. It has ₹2,083cr ($281m) of assets in the country and as of March 2020, the total value of its deposits stood at ₹318cr ($42.1m) and advances at ₹420cr ($55.7m) with Capital Adequacy Ratio (CAR) at 29.09%.

This is the second announcement by a foreign bank scaling back its India business in under a week. Earlier, Citibank announced its retreat from the consumer businesses in 13 countries including India saying “it lacks the necessary bandwidth to compete in these markets”.

These announcements bring to light yet another problematic facet of the banking industry in India. Are they forming a pattern of topical departures by foreign banks from the country? If so, what might be the reasons driving them away?

Foreign Banks in India 101

By foreign banks, one means the scheduled commercial banks who are based out of their home countries abroad but have opened up shops in India. These “shops” may not always resemble the branches that we associate banks with. In fact, there are three ways of entry available to foreign banks in India and as of July 2020, the following number of foreign banks operate under each of these entry routes as mentioned below:

• Through branch offices — 46
• Through wholly-owned subsidiaries (WOS) which are incorporated in India but 100% owned by their parent company abroad — 2
• Through representative or liaison offices which are rightly so, representative in nature, mostly conducting marketing and non-transactional operations — 37

The two banks which operate under the WOS route are DBS Bank of Singapore and the State Bank of Mauritius. The RBI has encouraged foreign banks to enter India through this way because it would allow better supervision for them and more entrenchment into the banking business in India. It would also insulate the economy from any challenges faced by the parent companies of these banks because of their governance being primarily under the Indian setting.

The banks aren’t sold on the encouragement though. It involves stricter regulations and more intense capital rules compared to the other routes. In addition, it involves the chances of being called upon to rescue ailing Indian banks as dictated by the RBI, as it did for DBS taking over Lakshmi Vilas Bank last year.

This explains why there are only two banks licensed to operate under the WOS route. But even the ones operating through branch offices have persistently cut back operations or left the scene altogether.

The Exodus Spree

Since the early 2010s, there has been a steady retreat of foreign banks from India. The approach towards emerging markets that began swiftly in the aftermath of the 2008 financial crisis lost steam. All the reasons that made India a lucrative market — fast-growing economy, rising credit-savvy population, removal of entry barriers post the 1991 liberalisation — were gradually unseated by a host of emerging issues.

In 2005, foreign banks’ share of advances in the country declined to 6.55% and kept declining further to 4.65% and 4.41% in 2010 and 2015 respectively. With the rise in the number of domestic private banks, the market share of foreign banks has also decreased from 5.7% to 4% in FY17.

Possible Factors Behind the Bank-scapade

It would be fair to say that the inclusion of foreign banks in India started under a somewhat different narrative to the “universal banking” policy regime. They were more relied on for their specialisation in global investment and banking operations and seen as “niche” providers as compared to the traditional banks which operated more with the intent of promoting domestic banking inclusivity.

By effect of these designs, a rise in “cream skimming” came to be observed in the lending patterns of foreign banks with relatively higher client focus among wealthy, urban consumers. Although their businesses were capital-hefty (wealth management, institutional lending etc.) they may have missed out on marginal lending and large retail servicing practices to a great extent.

And that was okay, considering there are many banks and shadow lenders who have gladly stepped in to fulfil these services and the needs of the retail banking segment.

Except one thing.

In spite of limited financial operation, the foreign banks didn’t have much leeway in terms of operational compliance.

The RBI has repeatedly insisted on maintaining a single class of banking license and uniformity in deposit insurance cover, capital adequacy ratio, exposure limit, asset classification norms etc. That are expected of both domestic as well as foreign banks.

Add to that the recent moratorium on interest payments punctuated by the pandemic, the rise in bad loans and a banking landscape dotted with scandals and downfalls (IL&FS, DHFL, PMC, Yes Bank, Lakshmi Vilas Bank etc.), and you begin to see the reasons why foreign banks find it less and less enticing to continue their businesses in India.

One thing worth mentioning is that in spite of the decrease in foreign bank’s share of advances mentioned earlier, it remains true that over the last two decades, the quantum of their advances has steadily increased as shown below.

And so have their assets, barring the sudden drop post 2019 as illustrated below.

But, this is not enough to outrun the growth of a new breed of private sector banks (plus NBFCs, fintechs and digital banking institutions) in India which have out-valued their foreign counterparts with time. For instance, back in 2016, HDFC Bank overtook European majors like Deutsche, Credit Suisse and Societe Generale in market capitalisation.

The same year Kotak Mahindra Bank, with only 1% of Deutsche’s assets, trailed the bank by only $1bn in market cap, a trail that stretched as much as $24bn just one year before then. The Indian banking industry may be stressed and non-performing, but it sure outperforms the foreign banks by a huge margin.

Quit While You’re Trailing, Is It?

The trend seems quite clear. As India grows, so do its banking woes. Most of these woes remain confined to the domestic lending and NBFC segments, segments which have larger market presence. In these circumstances, foreign banks perhaps find it more suitable to retreat into their own domestic markets to cut down costs and protect profitability. The stricter regulatory framework has also led them to become less ambitious.

There are some, though, like Citibank, who in spite of their ambition couldn’t manage to stick it out in the markets. Citibank was a pioneer in India’s credit card movement in the late 1980s and 1990s and soon progressed into mortgage and personal loan offerings.

Its recent exit may have been a result of the change in corporate management and policy restructuring, but even its peers like HSBC and Standard Chartered are also finding it increasingly difficult to stay and compete with the massive retail franchise powers of homegrown lenders like HDFC, Axis Bank, ICICI, SBI etc.

At a time when the economy is heavily compromised and lending institutions face immense pressure to adhere to the capital norms, foreign banks’ contribution (and much-needed capital) could’ve offered a different type of debt capital. They are backed by their domestic economies which may support their lending abilities better than the Indian banks.

However, things may turn out for the better, in light of increasing participation by foreign banks like DBS. The Bank has invested more than $1bn in the country since 2018 but remains a clear outlier.

Other instances like the US-based Oaktree that came close to rescuing DHFL, instil hope for a reaffirmation from foreign lending players. Even if it is under different private equity mandates, they perhaps, may increasingly migrate to India in the coming years.

(Originally published April 23rd 2021 in transfin.in)