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Do Foreign Banks Affect Market Power, Efficiency, or Stability in India?
An assessment of foreign bank ownership’s direct and indirect effects on market power, efficiency, and stability in Indian banking produces two main results. First, foreign banks have greater market power, lower marginal cost of the production of bank output, greater price–cost margin, and higher insolvency risk than domestic banks. Second, greater foreign bank presence increases market power, reduces marginal cost of the production of bank output, increases price–cost margin, and reduces inefficiency, insolvency risk and net non-performing loan ratio of an individual bank. The findings have implications for a policy decision on foreign bank presence.
The author is thankful to the anonymous referee for valuable comments that improved the paper.
The Indian banking sector comprises three types of commercial banks as major players: government-owned, domestic private, and foreign banks. These commercial banks operate on all India basis and cater to different banking needs of various sectors of the economy. Since mid-19th century, foreign banks have been operating in India through the branch mode. Various expert committees that promote structural changes in Indian banking allow more active foreign bank participation. For the branch mode of foreign banks, the Reserve Bank of India (RBI) issues a single class of banking licence for conducting all types of banking business, including retail, wholesale, forex, derivatives, and credit cards. Foreign banks see growth in universal banking, more specifically in trade finance, treasury banking, investment banking, and personal banking. Commenting on the role of foreign banks, Gandhi (2014) notes that
[t]he presence of foreign banks in India is seen to be one of the drivers to increase competition, promote efficiency of the local banking system and also for bringing in sophisticated financial services and risk management methodologies which can be adopted by the domestic banks.
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