Barely six months before a review of norms for greater exposure to foreign banks, the Reserve Bank of India [Get Quote] on Thursday indicated that it will liberalise the guidelines only gradually.

While RBI is due to review the norms in April 2009, foreign banks are slowly giving up hopes of the regulator allowing them to buy stakes in the healthier and bigger Indian banks.

RBI, in the latest Report on Currency & Finance, said that it may need to revise the entry norms of foreign banks from April 2009 as part of its efforts to mitigate the risks of enhanced presence of these players in the country.

It said that the emergence of large banks, involving foreign shareholding, could have an impact on the businesses of smaller domestic banks and might result in a decline in lending to small enterprises, as in the case with several other economies.

It said that although an increase in presence of foreign banks - by intensifying competition - may accelerate the consolidation process of the Indian banking industry, it may increase the risk of concentration if mergers or acquisitions involve large banks. While reviewing the norms for foreign banks in India, RBI aims to reduce the impact of consolidation on existing domestic banks and the required supervisory and regulatory challenges in view of the sophisticated operations of these foreign banking groups and their involvement in complex and sophisticated products.

RBI said that the liberalised entry norms for foreign banks should not hamper the country's ongoing emphasis on financial inclusion, credit to agriculture and SMEs, and public policy on credit delivery, cost and allocation.

Although India has committed 12 branches of foreign banks in a year, it has been more liberal than the commitments. Between 2003 to October 2007, the central bank gave approval for 75 new foreign bank branches. However, during the second phase (April 2009 onwards), the challenges relating to co-ordination between home and host countries regulators would also be revisited.

On their part foreign banks have been complaining of RBI's reluctance to open new branches. "If you ask for 40 branches, you get permission to open two," said a senior executive at a foreign bank.

Besides creating more rooms for foreign banks, implementation of Basel II norms would also trigger further consolidation of the banking sector. Also, there could be changes in the ownership pattern of the public sector banks in the medium and long term, said the RBI report.

Despite a number of bank mergers and acquisitions, the Indian banking system has become less concentrated during the post-reform period. While some consolidation of the banking sector is necessary, the regulator will have to formulate policy to ensure that the consolidation does not undermine competition in the future, RBI added.