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The government has incorporated a clause in the recent policy changes on FDI in banking, under which the acquisition of 100% equity in a local bank will be open only to a wholly-owned subsidiary of a foreign banking company.

The Cabinet had cleared the proposal to allow fully-owned subsidiaries of banking companies regulated by a financial regulator in the host country to hold 100% equity in a banking company in India. However, this route to acquire a local bank and control 100% of the equity can be adopted only by the subsidiary of foreign banks which do not have branches in the country, according to officials.

In other words, foreign banks operating in India will have to either convert the existing branches into a wholly-owned subsidiary of their parent banking company if they wish to acquire or control 100% of the equity in an Indian banking company or operate on a standalone basis with branches. In the latter case, their equity holding must be capped at 74% if they acquire a private sector bank in India .

The government and the RBI will shortly announce the capital norm for setting up such a subsidiary. Indications are that it will be a minimum of $50m. This move is expected to help attract more FDI flows. Some of the smaller listed private sector banks may now be acquisition targets for foreign bank subsidiaries as they would have access to a wider branch network.

The policy on opening up the subsidiary route is in line with the WTO commitments on setting up of subsidiaries by foreign banks. In his '03 budget, Jaswant Singh had said that foreign banks would be allowed to set up subsidiaries in India . The subsidiary route is expected to help banks expand faster without the restrictions imposed on them if they operate with a branch network. Foreign banks operating in India have to adhere to capital norms for each branch it sets up. Currently it is pegged at $10m for each branch. Opening up of fresh branches is linked to the size of capital.

By incorporating a company locally, a foreign bank can hope to expand faster. However, it will still be bound to follow priority sector lending norms and other regulatory prescriptions. For the government and the banking regulator, the new norms will mean that foreign banks setting up subsidiaries in India will also be bound to adhere to the rules and regulations of the banking regulator of its country of origin.

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