Determinants of Bank Foreign Direct Investment Inflow in India

Foreign Direct Investment (FDI) is considered to be a long-term capital investment. Most of the
countries, irrespective of their being a developed or a developing economy, seek more FDI inflow
for growth and development. According to International Monetary Fund (2013), developing
countries created a history when they received more FDI than the developed countries in 2012.
This is a signal that the developing countries are more attractive investment-wise. In fact, the
increase in the thrust for FDI across countries has created a competition among them to attract
more FDI. India attracted more FDI in the first half of the year 2015–16, leaving behind bigger
economies such as the US and China (Hindustan Times, 2015). India received around 31 billion
rupees in FDI during the year 2014–15. It is 27 per cent more than the previous year (Department
of Industrial Policy and Promotion, 2015). India has attracted FDI in all sectors during its post-
liberalization phase; however, the service sector has been most attractive of all and has bagged 17
per cent of overall FDI inflow. India needs FDI to grow rapidly and develop its infrastructure in
order to improve the standard of living of the people. On the other hand, foreign investors are lured
by high returns promised by the developing economy of India. Even then, different sectors of the
economy attracted FDI due to a variety of reasons.

Integration of global economies has increased cross border banking activities, mergers and
acquisition across boundaries, and bank internationalization. With globalization and development
in the communication systems, most of the developing economies have opened up their banking
sector to FDI, which made it easy for foreign home regulators to monitor over banks in the host
countries (Kim, 2010). With the intensified inflow of bank FDI and entry of foreign banks across
economies, previous studies have raised many questions: What are the motives behind bank FDI
inflow or entry of foreign banks into any host nation? What is or will be the impact of bank FDI
on the host nation’s banking sector and its overall economy? Whether bank FDI follows overall
FDI? Do foreign banks enter the host country to serve their home clients? Which mode of bank
FDI is better for the host county—green field investment or brown field investment? Many
empirical studies have attempted to answer these questions. Yet, empirical studies on the
determinants of FDI in the banking sector are mainly focused on developed countries like the US,
Japan, the UK, or Germany. The literature has hardly covered developing and emerging economies
(Meng, 2009). Even then, recent studies have included several Asian counties, such as Indonesia,
Thailand and South Korea, mainly due to the 100 per cent opening of their banking sector to FDI
(Rajan, 2011).

India opened its banking sector to FDI following the recommendation of Narasimham Committee
in 1991; however, it had phased out bank FDI over a period and Phase I began in 2005 followed
by Phase II in 2013. In the first phase, the investment cap in private sector was raised to 74 per
cent from the earlier 49 per cent. In the second phase, the Reserve Bank of India (RBI) incentivized
foreign banks to enter India by providing them national treatment.1 In a recent reform in November
2013, RBI has allowed foreign banks to open wholly owned subsidiary (WOS) and permitted them
to expand in any Tier I to Tier VI cities in India without seeking RBI’s prior approval. Recently,
taking advantage of this reform, Development Bank of Singapore announced that it will establish
150 WOSs in India. City Bank and Standard Chartered Bank also might follow suit. The
announcement of permitting foreign banks to establish WOS was made in the year 2005, but no
foreign bank has opened any WOS in India till date. This could mean that foreign banks in India
follow their home clients and establish branches to serve them only According to the consolidated
foreign investment policy of 2015 (Department of Industrial Policy and Promotion, 2015), foreign
banks can be present in India through any of the four modes: (i) it can open a branch, (ii) it can
open a WOS, where a foreign bank can invest 100 per cent and have full control over it, (iii) it can
have a representative office, and (iv) it can have a stake in any Indian domestic bank, subject to
the cap of 74 per cent in private sector banks and 20 per cent in public sector banks. Moreover,
there is also a limit of 5 per cent of paid-up capital in an Indian bank for an individual foreign
investor.
RBI has limited the voting rights to 10 per cent for foreign investors in Indian banks. The existing
foreign banks can convert their branches to WOS also, but a foreign bank can be present in India
only in a single mode, either as a branch or as a subsidiary. By March 2014, there were 44 foreign
banks with more than 300 branches from 25 countries. Figure 1 and Figure 2 represent the non-
resident investment in the private and public sector banks of India, respectively. Many banks like
ING Vysya, ICICI and IndusInd have very high foreign investment (Figure 1), and among public
sector banks, PNB, Bank of Baroda and Dena Bank have higher foreign investment (Figure 2).

Table 1: Foreign investment in Indian private sector banks (March 2016)

Share holding by non residents

80.0 72.1 73.4 70.4 71.6

70.0
in Percentage

60.0 47.9 45.6 50.6

50.0 44.6 44.2 45.6
36.6 34.0 36.4
40.0 29.0
30.0 25.2 23.1 27.2
17.4
20.0 12.8
10.0 0.0
0.0

Private Sector Banks

Source: Statistical Tables relating to banks in India published by RBI

Table 2: Foreign investment in Indian public sector banks (March 2016)
Share holdings by non residents
17.0 16.3
18.0
16.0 14.2
12.1
in Percentage

14.0 10.7
12.0 8.7 8.5 8.7
10.0 7.5 8.1 7.7
8.0 5.7 5.0
6.0 3.7 4.0 3.4
2.8 1.9 2.0
4.0 0.6 0.0 1.6
2.0 0.4 0.0 0.0 0.1 0.0

State Bank of…

Bharatiya Mahila…

Indian Overseas…
Oriental Bank of…

State Bank of…

State Bank of…
Punjab National…
0.0
Andhra Bank

Vijaya Bank
Bank of Baroda

Canara Bank

Dena Bank

UCO Bank
Allahabad Bank

Central Bank of India

Indian Bank
Bank of India

State Bank of India

Bank of Maharashtra

Corporation Bank

IDBI Bank Ltd.

State Bank of Mysore

State Bank of Patiala
Syndicate Bank

Union Bank of India

United Bank of India
Punjab & Sind Bank
Public Sector Banks

Source: Statistical Tables relating to banks in India published by RBI

Source: Massand, A. B., & Gopalakrishna, B. V. (2017). Determinants of Bank Foreign Direct
Investment Inflow in India: A Dynamic Panel Data Approach. IIM Kozhikode Society &
Management Review, 6(1), 13-22.

Questions
1) Why countries seek more FDI? What kind of trends are observed in recent time?
2) Differentiate between green field FDI and brownfield FDI in the Indian banking sector.
3) “Whether bank FDI follows overall FDI?” explain.
4) According to you, should RBI and Government liberalize further for FDI in India? Why
do you think so?