It is not just the pink papers reporting that foreign financial entities (GE Money, Goldman Sachs and Merrill Lynch to name a few) are showing interest in Indian banking sector, but the concerned authorities in the country also seem to be encouraging the same.

Reserve Bank of India's twin-phased roadmap for facilitating entry of foreign banks into India seems to be a step towards fulfilling the key objectives of competition, consolidation and convergence in the sector. But what is it that is enticing the foreign entities to the Indian shores? Here, we try to reason the same.

Fragmented market

Twenty seven PSU banks, 25 private banks, 30 foreign banks and a host of cooperative and regional rural banks do not in any sense implicate that India, as a country, is under-banked. However, a comparison of the total credit outlay (consumer credit as a  per cent to GDP) with some of the smaller economies suggest otherwise.

Source: CRISIL

Consumer credit accounts for a meagre 28.6 per cent of the country's GDP and the buoyancy in the economy offers sufficient scope for it to grow. Although corporate credit has shown some signs of revival over the past few quarters, it has been the 'retail credit' segment that has accelerated the non-food credit growth. As economy progresses, demand for credit from this segment will continue to surge.

Despite the fact that the 'banking behemoths' have catered to a substantial portion of the demand, it is pertinent to note that they account for only half of the total pie and there is a reasonable room left for others to cash in.

The fact that the top 8 banks account for barely 54 per cent of the market share suggests that several smaller players occupy the remaining 46 per cent.

It is here that the foreign players see the 'opportunity'. Although the smaller players together account for a reasonable share, most of them are undercapitalised, on a standalone basis.

The need to cater to the burgeoning credit demand also calls for additional capital requirement, for which their foreign counterparts can come to the rescue of the smaller Indian banks.

Also, since the new foreign players will not be allowed to expand freely, the ones taking the subsidiary route for expansion will not be subjected to rural branch norms (25 per cent of branches to be set up in rural areas) as well as priority sector lending requirement (35 per cent). They can thus concentrate their focus on the lucrative urban markets.

Demand for non-food credit, from retail and corporate segments alike, is set to witness an uptrend given the economic and demographic changes in the country. The smaller banks (occupying 46 per cent of market share) have neither the resources nor the ability to raise the same, to cater to the incremental demand. Foreign banks will thus capitalise on this opportunity, by either picking up stake in the smaller entities or setting up subsidiaries, thereby eating into the market share.

The government mandation of fulfilling the minimum priority sector credit (of which 18 per cent is food credit) has forced the domestic banks to cater to this segment despite the low profitability and vulnerability of asset quality. Particularly, it is the PSU banks that stand to be the 'scapegoat' in the regard. However, their foreign counterparts (new entrants) have the respite of being exempted from this and will thus not be looking at this 'not so credible' option.

Except SBI, no other banking entity in the country has a sizeable portion of market share of the total low cost deposits. Exemption from setting up branches in the rural areas will also enable the foreign entities to raise low cost deposits from the urban areas by consolidating the shares of several smaller players.