Comparison of Indian and American Banking System - Case Study Example

Abstract

This paper explains the relevant foundation of American banking system and regulations that guided it, starting from passing of legislations such as Glass-stealgall Act and Mcfadeen Act, several decades ago. The Indian banking system, being comparatively new, evolved after 1950s. This paper compares both systems while highlighting the difference in daily business activities of banks in these two countries.

Introduction

While India became independent in 1947, the prevailing banking system at that time followed imperial structures that were present in Great Britain. Thereafter Indian banking system aimed at achieving financial inclusion by providing minimum banking facilities to huge rural masses. The political leaders of India visualized this exercise as being in direction of making India economically independent. On the other hand, banking system in USA has been prevalent in the current form since last more than a century. The Federal Reserve System, which is mandated by law to regulate the banking industry in America, has worked all through towards incorporating necessary economic and banking reforms through regulatory measures. With sufficient regulatory structures in place, American banking system is mature and resilient.

However, the historical economic depression of 1930s along with small recessionary periods following this crisis has alerted Federal Reserve System to make changes in banking regulations that can address the possible errors. Accordingly, it formulated regulations and guidelines for operation of foreign banks in the country, while drafting Acts such as Glass-Steagall Act and McFadeen Act for regulating domestic banking operations. These regulations are currently guiding domestic as well as foreign banking operations in U.S.A.

Federal Regulatory framework for foreign banks

According to American federal regulations, foreign banks can operate in United States by opening a representative office, a branch or an agency. In addition, foreign banks can establish an investment company in the state of New York. The commercial banking operations can also be a subsidiary company being chartered under state or federal law. While in certain sates such as Texas, foreign banks are not allowed to open a branch office or agency, establishing the representative office is the only option left for foreign banks in these areas. In addition, state law of California requires that representative office procure a license from Superintendent of Banking before starting any operations there. In any case, representative offices cannot conduct any banking operation in America.

While federal law does not allow for issuance of license to open branches or agency offices by foreign banks, several states permit such banking operations within the respective state. These include California, Washington, Illinois, New York, Georgia, Oregon, Hawaii, Alaska Utah, Missouri and Massachusetts. The state-chartered subsidiary level of operations is allowed in New York, Illinois and Massachusetts where foreign banks can establish a branch to conduct all commercial banking operations. Among other states, only California allows acceptance of selected foreign source deposits provided the concerned foreign bank receive a written approval to this affect from Banking Superintendent.

Due to several strict restrictions and non-lucrative business prospectus in other states, foreign banks prefer concentrating their banking activities mainly in New York, Illinois and California. Foreign banks find good business in these states because New York, Los Angles, Chicago and San Francisco are important international trade-financial centers. In addition, these states are benefited in the form of getting reciprocity operational licenses in other countries for their banks, subject to such agreements. However, the establishment of foreign bank branches is limited to ‘one’ only as domestic banks in the state are permitted to open a single branch only.

In addition to above, different states have specific regulations that aim to protect depositors of foreign banks in these states.

However, foreign bank operations have certain advantages in USA over the domestic banking operations. While McFadden Act does not permit state and national member banks to open branches outside the home state, foreign banks are not subject to such restrictions as they are not eligible for getting Federal Reserve System membership. This takes them, technically, out of McFadden Act obligations. Moreover, American foreign law, instead of state or federal law, determines the eligibility of foreign banks concerning their opening of branches in USA. In addition, the Bank Holding Company Act of 1956 (BHCA) along with its amendments does not define foreign bank agencies and branches as “bank” subsidiaries. Thus, multi-state banking prohibitions, as applicable to domestic banks under BHCA do not apply to foreign bank branches.

While considering this as an advantageous opportunity, several foreign banks have established many branches in states such as California, New York and Illinois. These banks have opened branches in other states while operating as an established subsidiary in one state. (Welsh, 1975)

Basic banking operations in India are slow

According to Chaze (2004), it takes two days for the local checks clearance in places such as Bombay, which is the financial hub of India. Clearing checks for other locations may take as long as 15 days. However, that was before 2004. In order to streamline and fast track the Indian banking operations, the country’s central bank, Reserve Bank of India successfully tested a pilot project in 2004 that involved inter-banking transactions settlement in real time on a gross basis through computerized on-line operations. Initially this system called, “Real Time Gross Settlement” (RTGS) involved four banks along with their corporate customers. In addition, RTGS covered the treasury operations and all inter-banking settlements. This enabled the clearance of checks through on-line operations. Later on, RTGS system was set to cover all banks as well as primary dealers along with customer fund transfers. However, many experts had doubts about efficient working of RTGS, as inter and intra-bank connectivity remained a major concern for Indian banking operations in 2004. However, Chaze apprehends that the new system will result in decreasing profits for many foreign banks such as Citibank, which already has IT systems and all modern processes, as per the situation that prevailed in 2004. (Chaze, 2004). As several years have passed by, investigating into the working of RTGS system, currently, may be necessary.

Regulations governing Indian banking system

The focus of Indian banks has remained, since decades, to achieve financial freedom for the country as India got political independence from British rule in 1947. Accordingly, the Indian banking regulatory measures remain directed to embark upon a program of financial inclusion in the country, with banks being able to operate in almost 73000 hamlets and villages of the country. While this makes it mandatory for all banks to open branches for mobilization of small deposits in these areas, the aim remains to release small farmers from clutches of traditional moneylenders. Accordingly, Indian banking industry has focused strongly on social banking strategies.

However, the expanding global financial transactions have also influenced Indian banking system with the need to formulate regulatory procedures that can help in maintaining economic resilience. Indian banks have witnessed such resilience during recent financial crisis, when major economies around the globe went into recession. According to an evaluation of commercial banks by Committee on Financial Sector Assessment (CFSA), the strength of Indian banks is associated with greater credit expansion, lesser non-performing assets and robust balance sheets. While CFSA conducted stress tests for risks associated with liquidity, market and credit, these tests reveal that Indian banks have the capacity to absorb shocks arising from any major change in conditions related to these factors.

Regulatory procedures in Indian banking system are focused on achieving long-term growth and economic stability. According to a research study by Federation of Indian Chambers of Commerce and Industry (FICCI), last few decades witnessed major positive changes in Indian banks’ business profile as it included non-traditional activities such as mutual funds, merchant banking and several new financial products. The research study results further reveal that banks are stressing on different parameters such as cost reduction, innovation and technological up-gradation as well as customization for bringing profitable growth in their retail operations.(FICCI, 2010)

However, Indian banks have started with a clean slate, very recently, when compared to operation of banks in United States. As financial inclusion and economic freedom for vast Indian population remains the aim of Indian banking system, they may not be at par with American banks in terms of commercial banking activities. Nevertheless, with current rapid globalization of financial operations, Indian banking is taking help of available advanced technology to speed up their activities with adequate statutory regulations.

A simple comparison of Indian banks vs. American banks

• While Indian Banks work on Saturdays, American banks generally are closed for half a day on these days. In addition, many non-government banks in India such as ICICI bank work from 8 AM to 8 PM on weekdays.
• On-line funds transfer with Indian banks is free, while US banks charge for this operation.
• Services offered by US banks are better than those offered by Indian banks. However, several non-government Indian banks such as HDFC and ICICI have introduced priority-banking activity for selected clientele, which offers personalized service to such customers.
• Indian banks restrict cash withdrawals through ATM to INR 20000 to 25000, while the limit for such withdrawals in USA is USD 500.
• Indian banks offer credit cards to customers based on their income, while American banks offer this facility based on credit history of the customer.(Dantam, 2007)

US federal restrictions on non-banking activities

The 1933 Banking Act, called Glass-steagall Act provided for differentiating commercial and investment banking operations in U.S.A. According to this Act, domestic banks in USA cannot engage in both, the investment as well as commercial banking operations, simultaneously. In addition, the member banks at state and national level are prohibited to have relation with any investment banking concern. However, foreign banks operating in USA can engage in investment banking activities as per their home country regulations. In this direction, several foreign banks in USA invested in an American dealer, as these operations were deemed part of their international financing and banking services.

Accordingly, many choices are available for any foreign bank in USA to maintain its presence in commercial banking as well as making investments. A foreign bank can obtain license to operate a branch in the country, while acquiring the controlling interest in any U. S. dealer or broker company, as doing so will not come under the purview of 1933 Banking Act. As they are not members of Federal Reserve System, the regulations under this Act do not apply to them. However, this may not be the case when any foreign bank has controlling interest in any of the chartered, federal or state, bank in USA.(welsh, 1975)

American banking system is well established and mature, as the Federal Reserve System is more than a century old. The 1933 Banking Act that regulates the current system is around 70 years old. On the other hand, Indian banking system is just growing. As India got its political independence during 1947, the priority of Indian banking system remained in achieving the financial inclusion that could make banking operations accessible to poor rural people residing in remote villages. Economic independence for India meant liberating this large section of society from the clutches of traditional moneylenders. Hence, Commercial banking activities in India are just gearing up to meet the global requirements.

Financial crisis of 2008

Although Federal Reserve System regulations were in place, American financial institutions could not escape the economic recession experienced during 19th and 20th century. As credit squeeze and bankruptcy followed these financial setbacks, the economy went into depression during subsequent periods. The recent financial crisis of 2007-2008 resulted in bankruptcy of many financial institutions and banks. While American economy was struggling to revive from the recession caused by dotcom crash, the overconfidence in housing boom resulted in bursting of economic bubble, as lenders of housing loans were lured to sell risky mortgages on higher rates of interest. Housing properties being over-priced by almost 70 percent, these prices crashed drastically after peaking out in 2006. As financial institutions could not recover the loans, the whole cycle of economy went into major recession, which also badly affected global economies.

Subsequent to this crisis, American government took over Fannie Mae and Freddie Mac, which were major home financiers in the country, after they became insolvent. While WaMu - the largest loan and savings institution- failed, the major insurance company AIG experienced near failure as it had taken heavy risks on mortgage market. Lehman Bothers, the large investment bank also went into bankruptcy.

Timely action by Federal Reserve helped in economic revival

The Federal Bank being the government central bank of USA, it has the responsibility to ensure the safety of country’s financial system. Accordingly, Fed helped financial institutions with emergency loans, when normal funds were not available. However, such lending program had the backing of good collateral, which resulted in full repayment of such loans. While Fed had used government funds, American taxpayers’ money, it generated an interest of almost $20 billion that went to American Treasury. Although the emergency lending programs of Fed along with other steps taken by U.S. treasury helped in stemming the financial crisis, the economic recovery was slow. While aftershocks of this recession are still visible, around the world, American economy has not fully recovered until now. The scale and nature of unemployment has shattered American economy badly, as millions of Americans remain out of job even today.

The action of Federal Reserve has proved effective for the economic revival that saw banking and financial institutions regaining their confidence. At the same time, Fed has aimed at keeping inflation under control while generating maximum employment. With dipping oil prices, inflation is less than expected, but Fed and government policies need to do more in the direction of solving the unemployment crisis. The government’s action during and aftermath of 2008 crisis did help in stimulating American economy through increased spending while reducing the taxes. (Williams, 2012)

Conclusion

While Indian banking system has picked up pace since it launched on-line banking operations, coupled with RTGS, it needs to pursue vigorous banking reforms to remain competitive in global banking activities. Reserve Bank of India being the country’s central bank has tried to assist member banking and financial institutions by providing guidelines concerning interest rates, among others.

American banking system has faced severe setback as financial crisis of 2007-2008 severely crippled it. However, with timely action from Federal Reserve System many banks in the country are getting back to normal. The regulatory structures in the system have resulted in maintaining the robust health of American financial institutions and banks.