Mumbai, Nov. 6: The RBI today set new ground rules for foreign banks operating in India.

The central bank said banks that started operations after August 2010 would have to establish wholly-owned banking subsidiaries rather than operate through branches as they have done till now.

In 2005, the RBI had prepared a road map for foreign banks that had given them the option to either operate through branches or form wholly-owned subsidiaries. None of the 43 foreign banks operating in the country have opted to form subsidiaries.

This is the first time that the RBI has laid down guidelines that will require several — but not all — foreign banks to set up wholly-owned subsidiaries.

The guidelines set other criteria, which will determine which foreign banks will be required to switch over to the subsidiary route.

The guidelines state that banks belonging to jurisdictions that have legislation that give a preferential claim to deposits in the home country in a winding-up proceeding would have to set up a wholly-owned subsidiary (WOS).

The WOS rule would also apply to banks with a complex structure (which it didn’t clearly define), those that were not widely held and banks where the RBI was not satisfied with the supervisory arrangements.

According to the RBI’s proposed framework, foreign banks that entered India before August 2010 and do not fail the other litmus tests detailed above, will have the option to either continue their banking business through the branch mode or convert those branches into a WOS.

A banking subsidiary will create a separate legal entity, which will have its own capital base and local board of directors. It will also ensure that there is a clear delineation between the assets and liabilities of the domestic bank and those of its foreign parent, thus providing for ring-fenced capital and assets.

Bait for conversion

While trying to nudge foreign banks to set up subsidiaries, the RBI dangled a few carrots: it said these banks would be granted freedom in deciding where to open their branches and would also be allowed to acquire a domestic private sector bank. It also gave them a transition period of five years starting from April 1, 2013 to comply with priority sector lending targets. This relaxation is being extended to foreign banks that have 20 or more branches.

The RBI said the minimum paid-up voting equity capital for a wholly-owned subsidiary would be Rs 500 crore. A newly formed WOS will be required to bring in the entire initial capital upfront.

Foreign banks that already operate in the country have been given some leeway on the capital front. The WOS in this case must have a net worth of Rs 500 crore and will have to maintain a minimum capital adequacy ratio of 10 per cent on a continuous basis for an initial period of three years —which is one percentage point higher than that required under the phased implementation of Basel III capital norms.

The RBI laid down strict rules for the composition of the board of directors of these subsidiaries. It said that not less than 50 per cent of the directors should be Indian nationals/non-resident Indians or persons of Indian origin.