Foreign Direct Investment in Banking Sector
- A Boon in Disguise

By

Dr. Kunal Badade
Head, Dept of Commerce, PG & Research Center
Ms. Medha Katkar
Research Student, PG & Research Center
Dayanand College of Commerce
Latur-413 512
 

Foreign Direct Investment as seen as an important source of non-debt inflows, and is increasing being sought as a vehicle for technology flows and as a means of attaining competitive efficiency by creating a meaningful network of global interconnections.

FDI plays a vital role in the economy because it does not only provide opportunities to host countries to enhance their economic development but also opens new vistas to home countries to optimize their earnings by employing their ideal resources.

India has sought to increase inflows of FDI with a much liberal policy since 1991 after decade's cautious attitude. The 1990's have witnessed a sustained rise in annual inflows to India. Basically, opening of the economy after 1991 does not live much choice but to attract the foreign investment, as an engine of dynamic growth especially in view of fast paced movement of the world forward Liberalization, Privatization and Globalization.

Limits for FDI

FDI in the banking sector has been liberalized by raising FDI limit in private sector banks to 74 per cent under automatic root including investment by foreign investment in India. The aggregate foreign investment in a private bank from all sources will be 74 per cent of paid-up capital of the bank.

FDI and Portfolio investment in nationalized banks are subject to overall statutory limit of 20 per cent. The same ceiling also applies in respect of such investment in State Bank of India and its associate banks.

The Present Banking Scenario

In recent times economy is been pushing to increase the role of multi-national banks in the banking and insurance sector, despite, the concern expressed by the left communist parties are opposing the finance minister move to raise overseas investment limits in the insurance business. The government wants to fulfill a pledge to allow companies like New York Life Insurance, Met Life Insurance to raise investment in local companies to 49 per cent from 26 per cent.

But it is opposed on the front that it will lead to state run insurers loosing business and workers their job. Left do not want foreign investors to have greater voting rights in private banks and oppose the privatization of state run pension fund.

There are several reasons why such move is fraught with dangers. When domestic or foreign investors acquire a large share holding in any bank and exercise proportionate voting rights, it creates potential problems not only of excursive concentration in the banking sector but also can expose the economy to more intensive financial crises at the slightest hint of panic.

Opposition is not considering the need of present situation. FDI in banking sector can solve various problems of the overall banking sector. Such as –

i) Innovative Financial Products
ii) Technical Developments in the Foreign Markets
iii) Problem of Inefficient Management
iv) Non-performing Assets
v) Financial Instability
vi) Poor Capitalization
vii) Changing Financial Market Conditions

If we consider the root cause of these problems, the reason is low-capital base and all the problems is the outcome of the transactions carried over in a bank without a substantial capital base. In a nutshell, we can say that, as the FDI is a non-debt inflow, which will directly solve the problem of capital base. Along with that it entails the following benefits such as –

Technology Transfer

As due to the globalization local banks are competing in the global market, where innovative financial products of multinational banks is the key limiting factor in the development of local bank. They are trying to keep pace with the technological development in the banks. Now a days banks have been prominent and prudent in the rapid expansion of consumer lending in domestic as well as in foreign markets. It needs appropriate tools to assess (how such credit is managed) credit management of the banks and authorities in charge of financial stability. It may need additional information and techniques to monitor for financial vulnerabilities. FDI's tech transfers, information sharing, training programs and other forms of technical assistance may help meet this need.

Better Risk Management

As the banks are expanding their area of operation, there is a need to change their strategies exert competitive pressures and demonstration effect on local institutions, often including them to reassess business practices, including local lending practices as the whole banking sector is crying for a strategic policy for risk management.

Through FDI, the host countries will know efficient management technique. The best example is Basel II. Most of the banks are opting Basel II for making their financial system more safer.

Financial Stability and Better Capitalization

Host countries may benefit immediately. From foreign entry, if the foreign bank re-capitalize a struggling local institution. In the process also provides needed balance of payment finance. In general; more efficient allocation of credit in the financial sector, better capitalization and wider diversification of foreign banks along with the access of local operations to parent funding, may reduce the sensitivity of the host country banking system and lead towards financial stability.

Dr. Kunal Badade
Head, Dept of Commerce, PG & Research Center
Ms. Medha Katkar
Research Student, PG & Research Center
Dayanand College of Commerce
Latur-413 512
 

Source: E-mail December 28, 2006

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