AN ANALYSIS OF RBIS FRAMEWORK FOR SETTING UP OF WHOLLY OWNED

SUBSIDIARIES BY FOREIGN BANKS IN INDIA

1. BACKGROUND
In 2004, Government of India with a view to liberalising foreign direct investments (FDI) in
private sector banks raised the FDI limit to 74 per cent in the private sector banks under the
automatic route and also permitted foreign banks, regulated by a banking supervisory
authority in the home country and meeting the Reserve Banks licensing criteria to hold 100
per cent paid up capital, to set up a WOS in India. To operationalise the FDI guidelines, the
Reserve Bank released the roadmap for presence of foreign banks in India in consultation
with the Government of India on February 28, 2005. The roadmap was divided into two
phases the first phase spanning the period March 2005 to March 2009 and the second phase
beginning after a review of experience gained in the first phase. In the first phase, foreign
banks already operating in India were allowed to convert their existing branches to WOS
while following the one-mode presence criterion and the WOS was to be treated at par with
the existing branches of foreign banks for branch expansion in India. The second phase of the
roadmap which was to commence in April 2009 envisaged removal of limitations on the
operations of WOS and treating them on par with the domestic banks to the extent
appropriate. During the first phase no foreign bank came forward to set up or convert their
branches into WOS in the absence of adequate incentives. As a sequel to the roadmap of 2005
and pursuant to the announcements made in the Annual Policy Statement for 2010-11, the
Reserve Bank issued a Discussion Paper in January 2011 on the mode of presence of foreign
banks in India. The framework for setting up of WOS by foreign banks in India has now been
finalised taking into account the feedback received on the Discussion Paper and factoring in
the lessons from the crisis which favours a subsidiary mode of presence from financial
stability perspective.

2. KEY FEATURES OF THE FRAMEWORK

Banks with complex structures, banks which do not provide adequate disclosure in their
home jurisdiction, banks which are not widely held, banks from jurisdictions having
legislation giving a preferential claim to depositors of home country in a winding up
proceedings, etc., would be mandated entry into India only in the WOS mode. Foreign banks
in whose case the above conditions do not apply can opt for a branch or WOS form of
presence. A foreign bank opting for branch form of presence shall convert into a WOS as and
when the above conditions become applicable to it or it becomes systemically important on
account of its balance sheet size in India. Foreign banks which commenced banking business
in India before August 2010 shall have the option to continue their banking business through
the branch mode. However, they will be incentivised to convert into WOS because of the
attractiveness of the near national treatment afforded to WOS. To prevent domination by
foreign banks, restrictions would be placed on further entry of new WOSs of foreign banks/
capital infusion, when the capital and reserves of the WOSs and foreign bank branches in
India exceed 20 per cent of the capital and reserves of the banking system. The initial
minimum paid-up voting equity capital for a WOS shall be Rs. 5 billion for new entrants.
Existing branches of foreign banks desiring to convert into WOS shall have a minimum net
worth of Rs. 5 billion. The parent of the WOS would be required to issue a letter of comfort

to the RBI for meeting the liabilities of the WOS. Corporate Governance (i) not less than
two-third of the directors should be non-executive directors; (ii) a minimum of one-third of
the directors should be independent of the management of the subsidiary in India, its parent
or associates; (iii) not less than fifty per cent of the directors should be Indian nationals
/NRIs/PIOs subject to the condition that not less than 1/3rd of the directors are Indian
nationals resident in India. The branch expansion guidelines as applicable to domestic
scheduled commercial banks would generally be applicable to WOSs of foreign banks except
that they will require prior approval of RBI for opening branches at certain locations that are
sensitive from the perspective of national security. Priority Sector lending requirement would
be 40 per cent for WOS like domestic scheduled commercial banks with adequate transition
period for existing foreign bank branches converting into WOS. On arms length basis, WOS
would be permitted to use parental guarantee/ credit rating only for the purpose of providing
custodial services in India and for their international operations. However, WOS should not
provide counter guarantee to its parent for such support. WOSs may, at their option, dilute
their stake to 74 per cent or less in accordance with the existing FDI policy. In the event of
dilution, they will have to list themselves. The issue of permitting WOS to enter into M&A
transactions with any private sector bank in India subject to the overall investment limit of 74
per cent would be considered after a review is made with regard to the extent of penetration
of foreign investment in Indian banks and functioning of foreign banks (branch mode and
WOS).
3. ADVANTAGES OF WOS MODEL OVER BRANCH MODEL
The RBI in order to incentivize conversion to a subsidiary model has contemplated offering
certain advantages to WOS banks vis--vis branch banks, these include1. Preferential treatment vis--vis branch model banks- Though full national treatment as
envisioned by WTO wont be provided to foreign banks entering India via the WOS model in
comparison to domestic Private Banks. However, they will be in a much better position in
comparison to banks operating under the branch model. The advantages proffered would
include, easier branch expansion, raising non-equity capital in India etc.
2. Easier Capital adequacy norms- The WOSs will have capital requirements in line with
those prescribed for New Private Sector banks. As per the RBIs guidelines for licensing of
new Banks in the private sector dated February 22, 2013 the initial minimum paid up voting
capital of a bank should be Rs. 5 Billion. As per the framework, the Minimum Capital
Adequacy Ration of the WOSs will be 10% of the Risk Weighted Assets. The same would
apply to Banks converting from Branches to WOSs. Branch model banks, existing and new
will have to have a minimum of 25 Million dollars.
3. Raising of Non-equity capital in India- foreign banks setting up as WOSs or converting
their branches to WOSs will be allowed to raise rupee resources through issue of non equity
capital instruments in the form of IPDI, Tier I and Tier II Preference Shares and subordinate
debt as allowed to domestic Private sector banks. (the RBI Master Circular on Basel III
norms, outlaws IPDIs, reference may be made to annexure).
4. Branch Expansion- The WOSs (converted from branches or otherwise) will be treated at
par with domestic banks when it comes to the issue of branch expansion. Hence, theyll be
allowed to open branches in Tier 3 to 6 centers except a few sensitive centers. Although the
framework makes reference to the branch expansion policy dated January 1, 2010, I made
reference to the Branch Authorization master circular dated 1 July, 2013. The salient
paragraphs of the master circular were paragraphs 3, 4 and 6 which dealt with the branch

authorization policy and the application process thereof. Paragraph 3 and 6 dont seem
applicable to foreign banks in its entirety as it lists scenarios in which banks will be allowed
to set up branches in Tier-2 to tier-6 cities. As per my perusal of the framework it seems
apparent that foreign banks (WOSs and converts to WOSs) will be entitled to a less restrictive
branching policy vis--vis foreign banks operating as branches but not as liberal as Domestic
Private Banks, hence, the policy should not be applied in its entirety and it should only be
used as a basis to understand the entire gamut of branches and practices foreign banks which
convert to WOSs will be allowed to undertake. The present framework also states that
processing of applications for setting up branches by foreign banks with WOSs and converts
to WOSs will be in a manner similar to domestic banks. Also, the RBI will not allow foreign
banks to set up more than 12 branches per year in case the foreign bank operates via a branch
model, in keeping with its commitment to the WTO.
5. Incentives for banks converting from branch to WOS model- converts to the WOS system
will be allowed a period of 5 years after incorporation to meet the 40% priority Sector
Lending Requirements.
6. Issuance of letter of comfort by the parent- the RBI is worried that if the parent bank issued
SBLCs in favor of the creditors and depositors, it would prove to be an advantage for the
foreign banks vis--vis domestic banks, hence, only a letter of comfort is required, issued in
favor of the RBI by the parent bank.
7. Accounting, prudential norms and Other Requirements- The WOS will be subject to the
licensing requirements and conditions broadly consistent for new private sector banks.
8. Tax- No tax applicable on conversion from branch to WOS model as it falls under 47(iv) of
the Income Tax Act, 1961. However, it further states that foreign banks may approach the
appropriate authority for suitable clarifications.
4. DISADVANTAGES OF THE WOS MODEL
Following are some of the disadvantages inherent in the WOS model1. Insistence on independent directors and restrictive corporate governance- the framework
stipulates that foreign banks which are WOSs (i) will need not less than 50% Indian nationals
as directors, (ii) not less than 50% directors should be non-executive directors. (iii) a
minimum of 1/3rd directors must be totally independent of the management of the subsidiary
in India and its parents or associates. (iv) the directors should conform to the fit and proper
criteria.
2. Dominance containment measures- if the assets (balance sheet as well as off-balance sheet)
of foreign banks operating as WOS and branches exceeds 25% of the capital of the banking
system, restrictions will be placed on (i) further entry of new foreign banks, (ii) branch
expansion in tier 1 and tier II centres of WOS and (iii) capital infusion into the WOS may
require RBIs prior approval.
3. Priority sector lending norms for WOSs- The WOSs have priority sector lending norms
similar to domestic banks, they must lend 40% of the Adjusted Net Bank Credit or credit
equivalent amount of off-balance sheet exposure, whichever is higher. Export finance may be
allowed to form a part of Priority Sector Lending (PSL) (allowed up to 125). The agricultural
sub target is 10% and only 25% of this may be indirect agricultural finance. (agricultural sub
target for domestic banks is 18%).

4. Declaration of dividends- since no remittance is possible under the WOS model, the profits
will be distributed as dividends. These will be taxable under 115-O of the Income Tax Act,
1961 up to 15% and the banks can only issue dividends if they conform to the following.

The bank has a CRAR of 9% for past two years and the accounting year for which it
proposes to declare dividends and net NPA less than 7%.
If it doesnt conform to the above but has a CRAR in the accounting year for which it
seeks to declare dividends of at least 9%, it can declare dividends if its NPA is less
than 5%.
It must conform with section 15 and 17 of the Banking Regulation Act, 1949.
The bank should comply with the prevailing regulations/ guidelines issued by RBI,
including creating adequate provisions for impairment of assets and staff retirement
benefits, transfer of profits to Statutory Reserves etc.
The proposed dividend should be payable out of the current year's profit.
The Reserve Bank should not have placed any explicit restrictions on the bank for
declaration of dividends.

5. No differential licensing- Banks wont be allowed differential licenses to allow them to

enter niche markets.
5. CONCLUSION
The recent move of RBI to allow foreign banks to expand their operations in India is
welcome with caution .WOS model has certain advantages over branch mechanism. India has
a lot of business opportunities and stiff competition must prevail to improve efficiency of
banking operations. Along with efficiency, foreign banks must understand the dynamic socio
economic development process of our people. Financial inclusion should not take back seat.
How these banks can facilitate SMEs in rural areas: would be a main parameter of evaluation
of their performance. New Governor of RBI, in his hurry must not sacrifice the interest of
deep rooted prudent banking system in our country. We dont need financial muscle power
alone but long CRM to serve the individuals on the lines of banker to every Indian and
Relationship beyond Banking.