LIBERALISATION OF TRADE IN
FINANCIAL SERVICES AND
FINANCIAL CRISIS:
A CASE STUDY OF INDIA
IDEAs
India
Coverage of Financial Services under
GATS
Broad and “circular” (Gould, 2008) definition of financial services
“A financial service is any service of a financial nature offered by a financial
service supplier of a Member” and a “financial service supplier” is any
individual or corporation in the private sector “wishing to supply or supplying
financial services.
Financial services broadly cover
Banking
 Acceptance of deposits
 Lending
 Derivatives
 Securities underwriting
 Provision of financial information
Insurance
 Life and non-life insurance
 Reinsurance
Financial Services Trade Negotiations under
GATS
Special status evident from
 Own negotiating forum within GATS – negotiations
follow Financial Services Agreement
 One of the most heavily committed sectors within
GATS
 Considerable lobbying for developing countries for
further market access
Concerns about Financial Services Trade
Negotiations
“Understanding on Commitments in Financial Services “
– ambitious provisions
 Implement
 Automatic
stand-still
permission to new services to be supplied by
established firms
Concerns about Financial Services Trade
Negotiations

Prudential Carve out under GATS
“Notwithstanding any other provisions of the Agreement, a Member
shall not be prevented from taking measures for prudential reasons,
including for the protection of investors, depositors, policy holders or
persons to whom a fiduciary duty is owed by a financial service
supplier, or to ensure the integrity and stability of the financial
system.”

However, less reliable as a means of protection because
Disputes about what is protectionist and prudential across
WTO members
 Countries cannot use prudential regulations as a means of
avoiding their obligations under the GATS

“Where such measures do not conform with the provisions of the
Agreement, they shall not be used as a means of avoiding the
Member’s commitments or obligations under the Agreement”.
Concerns about Financial Services
Trade Negotiations

Domestic regulations are to be based on “objective”
and transparent criteria –
 Public
interest
 Basel norms – risk weights
Financial Services Liberalisation,
Capital Flows, Financial Reforms

Financial services liberalisation (WTO)
 Market
access – Allowing entry of foreign producers of
services

Liberalisation of capital flows (IMF)
 Allowing

cross border inflows and outflows of capital
Financial “reforms”
 Deregulation
and privatisation of domestic financial
sector
 Reduced
role of public sector in banking
 Deregulation of interest rates and regulations on credit
allocation
Financial Services Liberalisation and
Capital Flows

Liberalisation of financial services and capital account
closely associated
Repatriation of profits
 Foreign investments


Sequencing differs from country to country


India – Capital account liberalised partially with restrictions
on market access to foreign financial institutions
Domestic financial liberalisation central to liberalisation
of capital account and financial services
Financial Liberalisation, Capital Flows and
Financial (In)stability
Occurrence of a crisis
“In both banking and currency crises, a shock to financial institutions (possibly
financial liberalisation and/or increased access to international capital
markets) fuels the boom phase of the cycle by providing access to financing.
The financial vulnerability of the economy increases as the unbacked liabilities
of the banking-system climb to lofty levels”. “Crises may have common origins
in the deregulation of the financial system and the boom-bust cycles and asset
bubbles that, all too often, accompany financial liberalisation (Kaminsky and
Reinhart, 1999).
“Inadequate regulation and lack of supervision at the time of the liberalisation
may play a key role in explaining why deregulation and banking crises are so
closely entwined” (Caprio and Klingebiel, 1996).
Empirically, in 18 out of 25 cases of banking crisis studied by Kaminsky and
Reinhart (1999), financial liberalisation had occurred some time in the
previous five years.
Financial Liberalisation, Capital Flows and
Financial (In)stability
Occurrence of a crisis
Consolidation of banking sector for better
competition with foreign entities – creation of toobig-to-fail institutions (more often, in the private
sector)
Financial Liberalisation, Capital Flows
and Financial (In)stability
Management of a crisis
Restrictions on nationalisation (of banking sector) or bail outs of
public enterprises – Hefty compensations
Inability to step up credit to SMEs – Dominance of foreign banks
Limitation on implementation of stimulus package/social security Loss of revenue from tariffs (as a major source for LDC
governments)
About the Recent Financial Crisis






Global macro-economic imbalances
Financial market innovations – growth in securitised
transactions
Creation of inadequately appreciated credit and
liquidity risks
Excessive deregulation of financial markets (creation of
too-big-to-fail institutions)
Pro-cyclical risk measurement, regulation and accounting
Regulatory lapse and arbitrage – shadow banking
Recent Crisis and Misconceptions about Financial
Transactions/Markets
•
•
•
•
“Sophisticated maths” helped in countering financial
risks (Turner Review, 2009)
Financial markets were efficient and self-correcting if
left to themselves
Individuals and financial institutions always behaved
rationally (herd behaviour, disaster myopia)
Financial crises generally had roots in developing
countries
Major Perspectives from the Crisis

Strengthen counter-cyclical macro-economic policy





Prudential regulatory policy (Reforms in BCBS)
Fiscal policy
Design structural policies to consonance with their domestic
realities (Stiglitz Commission, 2009) – Protectionist versus
Prudential
Recognise importance of regulating financial systems (role of
governments)
Provide greater attention to productive sectors of the
economy in allocation of credit (particularly those affected
by the crisis)
Each perspective has implications for future liberalisation of
trade in general, and trade in financial services in particular.
Financial Liberalisation after Crisis
Financial services trade openings can be useful by bringing fresh capital inflows – Pascal Lamy
(2008).
However, the experiences with foreign banks operating in developing countries shows that the
banks have actually increased the exposure of developing countries to toxic assets. Besides, after
the crisis, foreign banks cut down their finances to the domestic sectors adding the shortage of
capital.
Trade is a part of the solution to the crisis and WTO can contribute to finding this solution.
Conclusion of the Doha round … would give a much needed boost of confidence to economic
cooperation - Pascal Lamy (2008).
However, Doha round till now has seen greater push to financial liberalisation from developed
world and hence, this would imply a continuation of the thrust on financial liberalisation
notwithstanding the crisis.
Financial Liberalisation: A Case Study of
India
Features of the Indian financial system



Bank dominated financial system
Public sector dominated banking system (comprising
more than 75 per cent of total bank assets)- Bank
nationalisation in 1969
Share of banking and insurance services in value
added on a sharp increase over last decade
 Services
– 64.5 per cent in 2008-09 from 48.8 in 1990-91
 Banking, insurance – 7.1 per cent in 2008-09 from 5.4 per
cent in 1993-94
Domestic Banking Sector Liberalisation

Rapid pace of domestic banking liberalisation since
1991 in contrast to the earlier policy of
developmental banking
 Liberalisation
in branch licensing policy
 Liberalisation of interest rates
 Significant dilution of priority sector lending norms
Phases of Banking Services Liberalisation
under GATS
Banking system opened partially through two phased
roadmap since 2005.
During the first phase (2005-09)
 Foreign
banks to operate through branches or set up
100 per cent wholly-owned subsidiaries (WOS).
 For new and existing foreign banks, commitment to
provide 12 licenses in a year.
 Retained the option of restricting entry of foreign banks
if their market share exceeded 15 per cent.
 M&A of foreign banks only in private sector banks
identified for restructuring.
Phases of Banking Services Liberalisation
under GATS

During phase II (was to be reviewed in April 2009),
it was proposed to
 To
allow WOS to list and dilute their stake so that at
least 26 per cent of the paid up capital of the
subsidiary is held by resident Indians at all times.
Dilution either by way of Initial Public Offer or as an
offer for Sale.
 To permit foreign banks to enter into mergers and
acquisitions with any private sector bank in India subject
to the overall investment limit of 74 per cent.
Stand on Banking Services Liberalisation
after Crisis
“In view of the current global financial market turmoil,
… it is considered advisable, for the time being, to
continue with the current policy and procedures
governing the presence of foreign banks in India. The
proposed review will be taken up … once there is
greater clarity regarding stability, recovery of the
global financial system, and a shared understanding
on the regulatory and supervisory architecture around
the world” (Annual Monetary and Credit Policy,
2009).
Status of Trade in Banking Services

In reality, India has






Exceeded limit of 12 licenses a year (15 during 2008-09)
31 foreign banks with 279 branches in 2009
Market share of foreign banks at 47 per cent in 2009 (not
invoked restriction of 15 per cent)
Foreign banks lower priority sector lending target (32 per
cent)
India’s negotiations aggressively pro-service (including
financial) – seen aligning with EU, US at Hong Kong.
Expansion in Indian banks’ operations abroad relatively slow
– In 2009, 20 Indian banks with 141 branches abroad – on
an average, less than 6 branches a year.
Indian Banking during Crisis
Indian banking withstood the crisis to a large extent due
to




Limited direct exposure to crisis ridden assets and institutions
Limited spread of securitised transactions
Dominant presence of public sector
 During the recent crisis, “public ownership proved out to be a
source of strength than weakness for the Indian banking
system” (Report on Trend and Progress of Banking in India2008-09)
Extensive use of counter-cyclical prudential measures
Country-wise Banking Efficiency and Soundness Indicators after Crisis
(Per cent in Oct 2009)
Country
Return on Assets
Gross NPA to
Gross Advances
CRAR
Capital to Assets
India
1.0
2.3
13.0
6.4
Brazil
1.1
4.3
18.5
9.2
Mexico
1.2
3.8
15.2
9.1
Russia
0.5
7.6
18.5
13.6
China
1.0
1.8
12.0
5.4
USA
0.2
3.8
13.5
10.1
UK
-0.5
1.6
12.9
4.4
Japan
0.2
1.7
13.4
3.6
France
0.4
2.8
10.4
4.2
UAE
2.2
2.5
16.2
10.6
Banking Performance Indicators for India
(Per cent)
Year
Return on
Assets
Return on
Equity
Gross NPA
ratio
Net NPA
ratio
CRAR
Credit
growth
2006-07
0.9
13.2
2.5
1.0
12.3
30.6
2007-08
1.0
12.5
2.3
1.0
13.0
25.0
2008-09
1.0
13.3
2.3
1.1
13.2
21.2
Bank group-wise Performance Indicators for India
(Per cent)
Number of
banks
Gross NPA to Gross
Advances
Credit growth
Growth in credit
to priority sectors
Return on assets
2009
2008
2009
2008
2009
2008
2009
2008
2009
Public sector
banks
27
2.7
2.0
24.8
25.7
16.9
17.9
0.8
0.9
Private sector
banks
22
2.4
2.8
24.9
10.9
12.9
15.9
1.0
1.0
New private
sector banks
7
1.6
3.1
26.3
9.8
-
-
1.0
1.0
Old private
sector banks
15
3.1
2.4
20.2
15.8
-
-
0.9
0.9
Foreign banks
31
1.4
4.0
27.5
2.6
32.9
10.4
1.8
1.6
Concerns about the Banking Sector
Bank group
Percentage of off-balance
sheet exposures to total
liabilities
2008
2009
Public sector banks
61.3
50.6
New private sector banks
309.8
204.2
Old private sector banks
57.1
50.3
Foreign banks
2804.3
1570.0
All banks
335.1
203.6
Concerns about the Banking Sector
Bank group
Lending to Sensitive Sectors
(real estate, commodities and capital markets)
as percentage of total advances
2008
2009
Public sector banks
17.5
16.3
New private sector banks
34.5
30.7
Old private sector banks
19.7
19.8
Foreign banks
26.6
30.5
All banks
27.6
11.2
Developmental Impact of Banking
Liberalisation



Large number of closure of rural bank branches –
30,524 in 2000 to 28,281 in 2008
Growing shift away of banking from rural to
metropolitan areas and from backward to relatively
more developed regions
Decline in the access to banking for socioeconomically deprived sections (backward tribes
and other social groups, and women)
Developmental Impact of Banking Liberalisation
Share in credit
Share in deposits
2008
2008
2000
2008
Rural bank branches
(28,281 centres)
10.5
7.5
14.6
9.3
Metropolitan bank
branches (33 centres)
60.0
68.1
42.6
57.1
Conclusions



Crisis has raised questions about the very process of
financial liberalisation.
Further talks during the Doha round on financial
services liberalisation need to be kept on hold.
Similar to regulatory reforms being thought of in
BCBS, there is need to strengthen prudential
regulatory space within GATS.
Conclusions




Developing countries including India need to adopt a
conservative
approach
towards
further
domestic
liberalisation of the financial system.
Developing countries need to lay thrust on supply-driven
approach to banking (developmental banking).
Developed and developing countries need to strengthen
macro-prudential regulations of financial system and adopt
a counter-cyclical approach to prudential regulations.
Developed and developing countries need to expand the
scope of regulations to the entire financial system minimising
the scope of regulatory arbitrage.