Friday, March 12, 2010

The joys of central planning

When central planners take the outcome away from the self-organising system of the market economy, we often get strange outcomes. At the end of June 2009, 32 foreign banks were in India with 293 branches. In addition, 43 foreign banks were in India through `representative offices'. (Source: RBI Annual Report. Hat tip: Radhika Pandey).

In a news item today, I saw Domino's say that they have 300 branches in India and will go up to roughly 500 in three years. With RBI giving out permissions for all foreign banks (put together) to open 18 branches in India a year, this means we'll soon have more outlets of Domino's in India than all foreign banks put together.

34 comments:

  1. Failure of domino's won't cause a systemic failure , failure of one of the large foreign banks .....I wonder :)

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  2. @ Anonymous - Oh I don't know about that... It'd cause a SYSTEMATIC failure of my daily diet :P

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  3. Could you please clarify why you call this a 'strange outcome'?

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  4. And Domino's will start distribution services for credit cards and other financial products (for which they have no barrier to entry except NBFC categorization)

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  5. Mr. Shah,
    Foreign banks have limited access to India for security reasons.

    Considering how much influence the banking system in the U.S. has over its own government's policies (which has recently become very evident), how can India, a much smaller economy, not be anything but cautious?

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  6. This blatant promotion of things foreign makes me feel sick all the way down to my foreign branded under wear and socks. Made in India, but still foreign brand.

    What was that thing about the colour of the cat....

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  7. Hmm, international airlines like Air France have experienced worrisome plane crashes. So they should be banned from flying in India? Or maybe the ban should extend to planes made by Airbus?

    Toyota has had a spate of safety problems - so cars by Toyota should be banned from India?

    It is only in a police state that a policeman's job is easy.

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  8. 1)Ohh...I never thought banking is as easy as baking pizzas..!!
    2)I liked your articles (I've been following your blog for 2 Years)..agreed with your insightful views in different measures..but this post is really tough to digest..equating banking to baking..phew..!!
    3)With all the major international banks in soup post-LB debacle, you still wants to give them a free run in India? I agree their operational procedures are more efficient than local banks..but do they have the necessary prudence to run a bank (considering bank being a very important in financial system)..?!

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  9. I should better get back to finance 101. From the comments it seems that only the collapse of large foreign banks would cause systemic problems. Collapse of large Indian banks is manageable?

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  10. Let's not jump to the other extreme.

    My position is that neither Domino's nor Nirula's nor SBI or Global Trust Bank or Citibank should have a free run.

    My position is that Domino's and Nirula's should both be subject to the identical Health-Safety-Environment regulations.

    Similarly, my position is that whether it's SBI or GTB or Citibank, banking is a tricky and troublesome thing, and that we need high quality banking regulation.

    The focus should be on building a high quality banking regulator. Banning stuff is just wrong.

    Airplanes and aviation need safety regulation. The solution is not to have a xenophobic hostility towards foreign planes or airlines. The solution is to have the identical safety requirements for all planes and airlines. The safety requirements have nothing to do with nationality of ownership or the location of the HQ.

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  11. what..?.having some babu called the Health regulator is somehow part of the market mechanism?.in a market, it is the consumer who regulates and not some statute-book thumping safari-suited baboo.

    the presence of the RBI itself implies that money (supply) and interest rates are centrally planned.so whats the big surprise that they are in favor of micromanaging foreign banks? what else should one expect?
    i dont see you calling for an end to central planning in money itself?
    or are you from the monetarist ,psuedo free market school of thought?

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  12. how many foreign banks are "allowed" in developed countries each year? Even ICICI Bank once complained that there are "other entry barriers" created in Western countries to our banks. IF we had a crisis like US, we cant print money the way US has done - US enjoys the benefit of reserve currency of the world - which we don't. In the event of a crisis of similar proportions and an equivalent bailout, I dont know to what depths the Rupee would have shrunk. Let's not fool ourselves.

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  13. Foreign is always good. That's one thing Indians should never forget and we get reminded of this every day, especially by our intellectual class that is busy hobnobbing with their international counterparts.

    Never is the question asked if they are always good or if they can be bad.

    Eastern Europe has had a very poor experience with international banks setting up shop there. The international banks came in and scooped up the local banks. Then they went on to serve only the cream of the industry there. So multinationals and the larger firms get credit while everyone else suffers.

    Then there is the question of national security risk. There are many barriers for operation of foreign banks in developed countries. With the Icesave fiasco, it is clear that deregulation and allowing foreign banks into even developed countries is risky. China continues to refuse to allow "innovative" financial firms from developed countries to invest there. Japan also restricts foreign financial firms.

    Identical requirements does not address the power of capital and simple political pressure that international firms can bring in. Once they enter, they will get the rules changed in their favour. So, its not a nice clear picture as you portray.

    Finally, the last thing we want is more Lehman-style accounting practices and CDSs to gamble away whatever little we have.

    Stop shilling for foreign interests. They are themselves rethinking all that they believed in. I have never understood Indian obsession with older ideas. It's like we live in the past and don't want to learn from any new events.

    PS: I don't know if its a matter of celebration to have more Dominos outlets. Perhaps we will have our own "health care debate" in a few decades.

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  14. Foreign is always good. That's one thing Indians should never forget
    and we get reminded of this every day, especially by our intellectual
    class that is busy hobnobbing with their international counterparts.


    Sarcasm isn't going to win arguments. Focus on the ideas, and win arguments in the space of ideas. By attributing motives to me, you don't win the argument.

    I ordinarily delete comments which engage in such personal attacks. You are warned.

    Eastern Europe has had a very poor experience with international banks
    setting up shop there. The international banks came in and scooped up
    the local banks. Then they went on to serve only the cream of the
    industry there. So multinationals and the larger firms get credit while
    everyone else suffers.


    Two points. First, see this report from the European Bank of Reconstruction and Development, where the statistical evidence shows different: it shows that countries with more foreign banking did a bit better.

    Second, this is not the essence of the question. Of course more international integration is bad at a time of international crisis. E.g. more trade integration hurts in a global downturn. The counterfactual you have to ask yourself is: If East Europe had done Indian-style banking policy in 1989, would their GDP have been worse today? I believe it would. Foreign banks have jumpstarted their banking system and enabled their high growth.

    Then there is the question of national security risk. There are many
    barriers for operation of foreign banks in developed countries. With
    the Icesave fiasco, it is clear that deregulation and allowing foreign
    banks into even developed countries is risky.


    Nobody is advocating `mindless opening up'. I fear all banks equally! Banking regulation is hard! All I am saying is that xenophobia is no substitute for careful sophisticated thinking in banking regulation. It is an easy short cut to fall back to. All of us should refuse to legitimise this short cut because it delivers neither growth nor stability.

    China continues to refuse
    to allow "innovative" financial firms from developed countries to
    invest there. Japan also restricts foreign financial firms.


    These countries are hardly models of high quality economic policy in these things.

    Identical requirements does not address the power of capital and simple
    political pressure that international firms can bring in. Once they
    enter, they will get the rules changed in their favour. So, its not a
    nice clear picture as you portray.


    You think PSU banks are an easier kettle of fish? I disagree. Citibank is a far easier problem in the Indian landscape than PSU banks are. The really nasty politics in Indian banking is the political power of PSU banks. We need more counterweights to that influence.

    Finally, the last thing we want is more Lehman-style accounting
    practices and CDSs to gamble away whatever little we have.


    Again, nobody is advocating mindlessness in banking regulation. And, there are plenty of mistakes being made in domestic banking regulation, for which there is no excuse either.

    If your aviation safety rules are bad, then planes will crash, and this has nothing to do with whether the planes are foreign or the airlines are foreign.

    Xenophobia is a convenient sounding shortcut and it buys us nothing by way of safety. Mistakes in our rules will give us difficulties with domestic banks. And if our rules are good, then foreign banks will work out fine.

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  15. Stop shilling for foreign interests. They are themselves rethinking all that they believed in. I have never understood Indian obsession with older ideas. It's like we live in the past and don't want to learn from any new events.

    Let's focus on the ideas, and go easy on the abuse, please?

    PS: I don't know if its a matter of celebration to have more Dominos outlets. Perhaps we will have our own "health care debate" in a few
    decades.


    I don't eat at either Nirula's or Domino's. I'm only refusing the claim that xenophobia is a substitute for Health-Safety-Environment regulation. We are killing ourselves plenty with chicken tandoori.

    The more we get away from xenophobia, and understand problems for what they are, the more progress we will make. If the problem is high salt content in commercial food, we must address that problem. As long as we think there is an easy short cut ("ban foreign companies") we lose out on competition and new ideas, and we don't get the core job done (of getting salt content down).

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  16. "China continues to refuse
    to allow "innovative" financial firms from developed countries to
    invest there. Japan also restricts foreign financial firms. "

    China as a good example for banking? Really?! Even the Chinese communist party would be amused. And, what about the Japanese financial crisis of the 90s? It did not take foreign banks for that crisis to occur.

    Financial crises are not associated with foreign banks only - there are just so many things wrong with that thought! There also seems to be a bias/feeling that Indians are more prudent and we won't have our own Indian banks messing things up.

    An annoying outcome of xenophobia.. is that bureaucracy/politics can play to it and create a suboptimal outcome/crisis elsewhere.

    Indian banks (private and public) are pathetic with customer service. Even the web sites suck. I would love to see some foreign banks iff it improves the situation. The rules can be as strict as you like.

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  17. Apologies for what was construed as abuse. I don't know you and I shouldn't have cast aspersions or motives on you. But I have seen instances where people who are held in high esteem in the media are extremely corrupt privately.

    Again, my sincere apologies.

    About your EBRD report, there is evidence both ways. Yes, foreign bank and foreign capital can act as stablizers for the economy. But you did not address my point of credit for small businesses and the like. There are studies that show that whenever foreign banks take over, credit for small businesses dry up. We have to make sure what our developmental priorities are. Is it to get more and more multinationals in our country while marginalizing capital-starved local entrepreneurs or let a hundred neighourhood panwallah to innovate and build our country? I would choose the latter.

    In fact to put a point that favours yours, subprime credit was extended to retail consumers. An example of an American "innovation" making its way into Eastern European countries. The effect, at its worst, has been of the Latvian economy contracting by about 20%. I think China does look much better in comparison.

    Yes, China and Japan are good examples. China pulled up hundreds of millions of people from utter poverty in the middle class. We have yet to achieve anything near that. Eastern European countries are certainly not be emulated. They are never coming to any good especially not that country with a GDP that shrunk by 20% in two years.

    China is going slow on its development of its financial industry (which is argued to be much less developed than ours). But perhaps that go-slow process is better than allowing foreign interests to influence our politics. You are right about the influence of PSUs though you overestimate it. Most of them are pawns in the hands of some politicians. Why not have more local private competitors? If I am not wrong, the RBI has indicated that it will hand out more licences in the future.

    I understand that financial crises are not due to foreign banks alone but we have enough crooks in our own country to go around. We don't need to import more. The RBI has been hailed all over the world for running prudent policy where everyone else faltered.

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  18. Apologies for the long comments.

    Sadly, I do end up eating Dominos pizza at least once a week. I used to love Nirula's but the last time I was there in Delhi, the place looked shabby and poorly run. I will definitely have a health care debate of my own in the coming years. My comment was more in a lighter vein though I understand that it didn't fit with my tone earlier. I wasn't implying anything about you. Neither do I want Dominos to be banned. Though an ownership structure that allows Indian retail investors to share into the good management, technology and culture would be nice. Floating it in NSE might be great.

    Service culture is great in the US but most Brits have told me that its comparatively lacking in the UK. So there is a cultural aspect there. I did find the Dominos India people nice though quite uneven in their manners. I am not sure if a good service culture will ever translate into India.

    Again, my sincere apologies for my ugly tone. Nothing justifies it. This was my first time commenting here.

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  19. duh- the anonymouse cites 'security' reasons for banning foreign banks. hullo?.we already surrendered that away while accepting the dollar reserve currency standard.if the govt had any guts or real concern over security,it would go on a neutral commodity standard unilaterally and not suck up to the federal reserves whims.

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  20. "Is it to get more and more multinationals in our country while marginalizing capital-starved local entrepreneurs or let a hundred neighourhood panwallah to innovate and build our country?"

    If you make that blanket statement, how about we start by pushing out the IT, Pharma MNCs from the country first? Your argument may have relatively more merit when restricted to the finance industry (and maybe defense, etc). But, it should be explicit coz its not clear if you hate MNCs on a universal basis. And, by the way its not a zero sum game. MNCs have a ready pool of knowledge and innovation to be tapped with mutual benefit. I don't understand how or why one would be against that, specially when that has been one of the bases of Indian growth in the past decade.

    "An example of an American "innovation" making its way into Eastern European countries."

    For every bad example (and I can give you more - American military imperialism has been as devastating) of innovation there are many good examples of American innovation (computers, internet, medicine, etc, etc).

    "China pulled up hundreds of millions of people from utter poverty in the middle class. We have yet to achieve anything near that."

    Yes, there is much to like about Chinese economic progress in certain areas but I thought we were talking about Chinese banking? I didn't realize that good economic numbers automatically implies a good banking system - I thought that was a flaw in thinking in the OECD countries through the 2000s and one would not repeat that mistake. The open economies of OECD have had quite a bit to do with China's progress as well. Additionally, a couple of reads on finance in China:
    China Defaulting Loans Soar, Insolvency Lawyer Says
    Blog by Michael Pettis

    "Why not have more local private competitors?"

    My personal experience has not been good with ICICI or HDFC bank. They are a step above the PSUs but still very, very poor by international standards. And, sad to say it has gotten worse in the last 3-4 years.

    "The RBI has been hailed all over the world for running prudent policy where everyone else faltered."

    Perhaps, and while the truth might be more nuanced, so what?
    Anything they do now is beyond debate because they got it right once? And, who's talking about policy? I thought we were talking about the identity of market participants and not prudence of policy.

    Sorry, I don't see the world quite as black or white (atleast not on examples alone) but in shades of grey. And, willing to be corrected - no problem.

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  21. mpettis doesn't like China. I wonder why the Chinese let him stay in their country and bad-mouth them. Pettis wants China to stop "overinvesting", perhaps so that it can stunt its own development while investing its surplus in debt-ridden America. He repeatedly brings up Japan as an example but never discusses the effect of the Plaza Accord.

    I don't hate MNCs. We have a lot to learn from them. It's not fun or even useful to reinvent the wheel when they already have a lot of knowledge and it can be readily transferred to India. But the majority of the fruit of our growth should stay within India. We shouldn't become sharecroppers in our own land. With the financial crisis, that threat is much diminished but still real. In fact, cash-rich China and its corporations could be a new threat.

    I broadly agree with Mr Shah. But I disagree that foreign entities deserve same treatment as local entities. Every sovereign nation has the right to discriminate and it should because there are advantages to providing support to local entities. The Multilateral Agreement on Investment (MAI) has been opposed and rightly so.

    Mr Shah calls for radical change. On the other end of the spectrum, there are others who want to go backwards in time. I prefer a much more slower and measured approach than Mr Shah. All of us have a place in the debate though I am not a public figure and I wish there were public figures who represented my point of view. The officials in the RBI seem to be closest. The government seem to be more on the radical side with its austerity measures and budget-balancing at a time of global contraction and huge potential for future domestic growth. Ideology can be blinding.

    I guess I am going way off-topic.

    PS: I agree that tandoori chicken is just as lethal as a pizza maybe more so.

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  22. Surprising, isn't it. Communist China allows dissenting folks in their country whereas someone in democratic India wonder why they allow it?!

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  23. All ye anonymi and others reading and writing here: It is very interesting to have a vigorous debate on these interesting questions. Let's just focus on rigorous debate with logic and evidence, and we'll all find this forum more useful.

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  24. Interesting discussion. One comment that is made more than once is that entry of foreign banks reduces credit availability to poorer sections of the populace. I find that hard to believe unless some truly distortionary effects were in play where there studies were carried out. For example, if the by far dominant part of the financial sector is foreign and is capacity limited or cost limited to primarily serve only a sub-segment of the populace (the more profitable one given the capacity limitation), I can see that happen. However, even in that case, unless policies exist to stifle growth in other segments, I see capacity expanding over time and gradually services moving twoards the lower ends of the pyramid. Thus, I would be curious to know what the conditions were.

    In India instead, I think the existing structure is capacity limited (PSBs can only serve so many people). Lets say we have foreign banks coming in and taking over the high end credit disbursal. Now, firms which will compete with these firms including the public sector banks and lose will have no choice but to go to the other segments. That coupled with existing PSbs who can serve segments beyond a purely profit based goal should only be good for India.

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  25. On the subject of serving poor people, two stories are instructive: telecom and airlines.

    With each of these, there was an erstwhile socialist approach, where entry barriers against private & foreign were maintained under the excuse that only a public sector monopoly would serve poor people. As an example, when my father started CMIE in 1976, it took him six years to get a phone at the office. In 2001, when I flew to Delhi to start my new job at MOF, I got a mobile phone on the same evening that I landed (and this was as a private citizen, not as an MOF staffperson).

    To make analogies with finance, if we remove entry barriers in banking, that will drive competition and force some players to work on serving poor people. I would guess (based on the experience of telecom and airlines) that the firms who will (in the end) serve poor people will be private firms, because the kind of focus and intensity that is required to drive down the cost per transaction is not easily found in the public sector.

    As another example, Sergio Schmukler did a talk at the 6th NIPFP DEA Conference about SME financing worldwide. He finds that foreign banks and big private commercial banks dominate this space, not the public sector banks.

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  26. Strange outcome? It makes perfect sense..bank failures can have a domino effect!!

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  27. Mr Shah, how much time did you need to get a phone as an MOF staff member? :) (I am only joking)

    You come up with analogies again.

    I came upon this curious tendency of MNC banks to service only multinationals and big local firms in an Economist article about a decade ago. Things have changed a bit since. But overall, almost all literature accepts that bank lending to SMEs and locals in general did decline once a local bank was bought up by a foreing entity. But then, as you surmised, they slowly move into serving the other sections. But most literature seems to combine lending to SMEs and consumers. I think these are two different beasts. Lending to consumers has definitely been crazy, especially in Eastern European countries, with disastrous consequences for everyone involved.

    Here is the marketing material from the one organization that actively tries to pry open third world financial markets for Wall Street and the evidence is mixed at best:
    http://info.worldbank.org/etools/docs/library/154927/financeforum2002/pdf/martinez_financeforgrowth.ppt

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  28. haha! Thanks for the laugh! Didn't expect that at all. It's such a sad comment on the ministry.

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  29. 1.There are enough entry barriers for even new Indian entrants into Banking its only logical foreign banks would have more of them.
    2.Capital is a competitive advantage in banking and Banks from developed world have plenty of it and can abuse this to corner Indian marketshare.
    3.Banking is the lifeblood of any economy so its logical that the regulator should proceed with caution.Remember WMDs. Also, any problems in the operations of most of the non banking sectors is localised while Banking as we have experienced can have drastic butterfly effects.
    4.The track record of Foreign Banks and even Indian private banks in serving 'aam Admi' and Micro and Small Enterprise has not been encouraging.That is poor business and poor PR for making a case for loosening the regulations.
    5.Banks from geographies like Switzerland do add to the policy muddle and the value that they add might be less than what they take away.This vitiates the atmosphere for all 'them foreign banks'.
    6.Its likely that foreign Banks are more at ease in making good use of places like Mauritus, further increasing the anxiety of RBI.OTOH this might be good for globalising Indian corporates.

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  30. Why not have more local private competitors? If I am not wrong, the RBI has indicated that it will hand out more licences in the future.

    AFAIK, it is only the FM who said, in his budget speech that more banking licenses will be issued. The MoF / RBI (2 sides of the same coin?), since then, have been adding caveats to the same - all through the press ofcourse and without any official notification. Please refer -
    http://economictimes.indiatimes.com/news/news-by-industry/banking/finance/banking/Industry-groups-unlikely-to-get-banking-licences/articleshow/5736568.cms

    In the context of the above discussion in the comments section on the bad influence of MNCs.. guess we should assume that the MoF extends "bad influence" logic to the majority of the Indian private sector too.

    So where does that leave us - PSUs, some pvt sector banks who are happy that they are a "cut above the rest" and well established NBFCs like SREI, Shriram, Magna etc to fight for the next round of licenses. Please tell who among these is not politically well-connected and will not try to change the rules to meet their convenience? IMO, as long as there is no transparency in terms of entry criteria, at least for Indian private sector, political pulls and fancies will lead you to a license.

    People talk about the telecom success story - but remember DoT / TRAI / TDSAT / God knows who else did have their share of mis-steps and mishaps. But they tried to move forward.. incrementally improving. SEBI has faltered. But things have moved ahead. To everyones benefit.
    Frankly, that is what we need from the RBI. If we were to go back to the late 1990s / early 2000 we would hear the same kind of stuff on banking sector deregulation - references to other countries / how bad MNCs are / how bad industrial houses are etc. Have we been able to develop any incremental data on this in the Indian context? Please let me know, because it looks like we have stood still - no steps so no mis-steps!

    Ref to a post that had something to the following effect. Have over d- Politicians control PSU banks. They simply dance to their political masters

    The former FM was a big votary of banking sector consolidation - Going to the extent of actually identifying which bank should acquire / merge with which other bank. Did anything happen? Let us not get into whether the FM's approach was correct or not.. but just the fact that he tried for a couple of years and still things did not fructify? Are PSUs really so powerless?

    Finally I have enjoyed reading this whole discussion with the wide variety of views. Initially it started off on a personality attacking note, but then developed into a relatively sober discussion. Thanks to Ajai and all the commenters.

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  31. Mukund,

    I share your weary sense that this stuff is hard. There are no quick fixes.

    I feel confident on the broad approach: remove entry barriers for foreign banks, remove entry barriers for domestic banks. But there will be air pockets along the way.

    E.g. when we look back at the private bank entry from 1993 onwards, quite a few of them faltered. But on the other hand, we can also say that as a net result of all that drama, we ended up with a neat set of private banks who have added value in the ecosystem.

    It seems very reasonable to go up from a cap on 18 branches a year for all foreign banks to a more sensible number like 360 branches a year for all foreign banks (i.e. 20x bigger). It seems very reasonable to have entry by 10-20 new private banks every year.

    There will undoubtedly be difficulties along the way -- but that is better than the stasis of a graveyard. It is better to try, and learn, and make progress in the end, rather than sit tight and refuse to try. A lot of learning will happen along the way. As with TRAI etc. we are holding institutions today which did not exist at the time the reforms began. If we had staunchly insisted that there should be no change then all those developments would not have taken place.

    I am quite sympathetic to the RBI position on not wanting firms who have other non-financial business interests to run banks. With Indian-style governance, we can easily get ourselves in a mess. I'm also not impressed at many of the NBFCs. Fit and proper is undoubtedly an issue. But it is quite feasible to get 10-20 new banks every year while having all these constraints in place.

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  32. i think it great to see such foreign banks investing in India.

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  33. you have shown good report regarding the effectiveness in Indian financial system.

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