Global Financial Development Report -2017-18

Global Financial Development Report is a series of annual reports by world bank on key developments in financial world. The latest in the series “Global Financial Development Report 2017-18: Bankers without Borders” was released in the second week of November 2017. They key takeaways from this report for your examination are as follows:

• Since 2007-09, Restrictions on Foreign Banks have increased in developing countries
• Growing restrictions have hampered better growth
• Time has come that developing countries unshackle the restrictions
• Financial Globalization has reversed the trend
• In last two decades, the International Microfinance Institutions, particularly Greenfield MFIs have proliferated

The above points are discussed briefly here along with a discussion on whether RBI should relax controls on International Banks here in India.

Since 2007-09, Restrictions on Foreign Banks have increased in developing countries

In the aftermath of global financial crisis 2007-09, the developing countries have put more and more restrictions on international banks. Such restrictions were based on two premises. Firstly, the foreign banks bring with themselves the risk of exporting instability. Secondly, the dangers of large and complex financial institutons and structures needed to be addressed and lastly, they bring with themselves risk of lasting financial damage.

Growing restrictions have hampered better growth

The report says that the growing restrictions have limited the flow of much needed finance to the firms and households and thus has hampered the better growth.

Time has come that developing countries unshackle the restictions

Thus, the report makes strong argument that now the time has come to unshackle the restrictions and allow foreign banks. The developing countries can maximize their benefits. However, to reap the benefits of an stronger international finance system, the developing countries need to make some reforms. These reforms are:

• They should improve the information sharing through credit registries
• They should vigorously enforce property and contract rights
• They should guarantee strong supervision of banks.

Financial Globalization has reversed the trend

As per the report, the global financial crisis resulted in reversal of the globalization of financial markets. This was evident from the below trends:

• The ultra mega size multinational banks contracted and scaled down their international operations.
• The general backlash against globalization and increased restrictions accelerated their scaling down.

The international banks scaled down maximum in high income countries. The void left by them was filled by some developing country banks that entered into new markets.

In last two decades, the International Microfinance Institutions have proliferated

Over the last two decades, international microfinance institutions (MFIs) have emerged and have focused on expanding access to financial services around the world. This growth basically follows a so called Greenfield business model and are so called “Greenfield MFIs”.

Greenfield MFIs are the institutons that are newly created without preexisting infrastructure, staff, clients, or portfolios. Generally, they are created by central organizing bodies called holding companies.

Greenfield MFIs are typically driven by a mission to expand access to financial services and to promote economic development while offering commercial success for their shareholders. Shareholders and investors in these MFIs are primarily development finance institutions, including the African Development Bank (AfDB), European Investment Bank (EIB), International Finance Corporation (IFC), and KfW Development Bank.

Fact Box: How Foreign Banks are regulated in India?

India had released its first policy on foreign banks in 2005 and had chalked out an approach which had two key elements:

• There must be a consolidation of public and private banks before opening up sector for foreign banks
• allow foreign banks only through wholly owned subsidiaries in India.

In 2009, RBI had to review and further allow more banks but then the global financial crisis happed and RBI did not go further. Further, the WTO commitments to issue at least 12 foreign banks branch approvals were also relaxed in the wake of global financial crisis.

Post crisis, RBI’s policy towards foreign banks was based on some premises:

• RBI was in support of local incorporations of foreign banks with local board of directors
• It should be a separate legal entity, unlike a branch of a foreign bank.

Some other policy guidelines of RBI towards foreign banks are as follows:

• Banks have to adhere to mandated Capital Adequacy requirements as per Basel Standard.
• They should have to meet minimum capital requirement of Rs. 5 billion.
• They should need to maintain minimum CRAR at 10%
• Priority sector targets for foreign banks in India is 40%.

Further, the foreign banks have to follow other norms as set by Reserve Bank of India.

Discussion: Should RBI dilute the restrictions imposed on foreign banks?

As mentioned above, the report recommends the developing countries or the emerging markets to remove restrictions imposed on foreign banks. The same applies for India also. India started drawing its roadmap for foreign banks in 2005 when it sought to first consolidate the public and private sector banks before opening the market for foreign banks. It required being unfolded in a synchronized manner, in phases. The first phase got disrupted with the UPA coming into power. There were two views: while one wanted the amendment of laws to at least allow foreign banks to acquire private banks, the other sought to work with caution as the step could act as hurdle for development of local banks.
But there is also validity in the argument. The big foreign banks have recently started to look for promising and new countries for investment, for which the developing countries provide a perfect prospect. So, there are two benefits. Firstly, these banks can provide the much needed finance to firms and households that national banks are not able to provide. The restrictions hamper these prospects. Secondly, it’s an undoubted fact that risk of financial instability created by these banks, especially in the countries where the regulations and institutions are not strong now. But at the same time the presence of a competitive banking sector can mitigate the situation as it will increase access to basic financial services by the poor.