India is contemplating a major overhaul of its banking system: increasing the foreign investment cap in public sector banks (PSBs) beyond the existing 20%. The move, currently under discussion in the government, aims to help state-owned lenders build stronger balance sheets, attract foreign capital, and play a larger role in powering India’s economic transformation. With a guarantee that the government’s holding will not dip below 51%, the policy change would provide PSBs the flexibility to raise resources and prepare for global competitiveness.

Background: The Case for Reform

Currently, foreign direct investment (FDI) in PSBs is capped at 20%, with voting rights limited to 10%. Private banks, by contrast, can allow up to 74% foreign ownership. This limitation has restricted PSBs from raising foreign capital, even as their financial health has improved significantly in recent years.

Key indicators highlight this turnaround:

• Gross NPAs fell from 9.11% in March 2021 to 2.58% in March 2024.
• Net profits surged from ₹1.04 lakh crore to ₹1.78 lakh crore.
• Dividend payouts rose from ₹20,964 crore to ₹34,990 crore.

Despite these gains, PSBs face capital constraints that limit their ability to fund India’s growing credit demand, particularly for infrastructure and industrial expansion.

Growth Aspirations and Strategic Position

During the recent PSB Manthan conclave, Financial Services Secretary M. Nagaraju emphasised the need for PSBs to emerge as “champions of growth, innovation and leadership” for India’s path to Viksit Bharat 2047. He noted that banks must pursue global competitiveness, build resilience, and expand their influence in traditional industries as well as emerging sectors such as renewable energy and digital services.

By raising foreign investment caps, PSBs could strengthen their capital base, expand balance sheets, and enhance their capacity for large-ticket lending. In a country where the bank credit-to-GDP ratio remains relatively low, this is an opportunity for credit deepening and financial inclusion.

Safeguards for Public Ownership

Policymakers have stressed that liberalising foreign ownership will not dilute the public nature of PSBs. The government will retain a minimum 51% stake, ensuring management and strategic decision-making remain under its control.

Two potential guardrails are being discussed:

• Golden Share Mechanism: Allows the government to retain special rights, irrespective of its equity stake, to safeguard national interests.
• Board-Level Safeguards: Prevent foreign investors from dominating governance, even with higher shareholding.

This approach allows foreign investors to bring capital and expertise while maintaining government oversight.

Investor Appetite and Market Dynamics

Foreign investors are increasingly drawn to India’s growth opportunities, particularly in banking and infrastructure. With PSBs reporting improved balance sheets and profitability, they are seen as stable long-term bets.

The State Bank of India (SBI), the country’s largest bank by assets, already has close to 10% foreign shareholding. A liberalised investment regime could attract international funds to other PSBs, providing both capital and knowledge transfer in areas such as risk management, digital banking, and ESG compliance.

Challenges and Concerns

While the potential benefits are significant, the reform faces challenges:

• Governance Risks: Higher foreign ownership may complicate board relationships.
• Regulatory Sensitivity: Maintaining RBI compliance while avoiding undue influence.
• Political Sensitivity: PSBs remain symbols of state ownership; any dilution could provoke unions or political stakeholders.

Successful reform will require calibrated regulations and open dialogue with stakeholders.

FAQs

Q1. What is the current FDI cap in public sector banks?
It is 20%, with voting rights limited to 10%.

Q2. How much foreign investment is allowed in private banks?
Private banks can attract up to 74% foreign ownership.

Q3. Will the government lose control of PSBs after raising the limit?
No. The government will maintain at least 51% ownership, ensuring public control.

Q4. Why is this reform being considered now?
PSBs have stabilised financially, and India requires higher credit growth for infrastructure and long-term development. Foreign capital can help meet this demand.

Q5. What is the golden share mechanism?
It allows the government to retain decisive control over key issues, even if foreign investors hold larger stakes.

Conclusion

Raising foreign investment ceilings in PSBs is a major step toward aligning India’s banking sector with its growth ambitions. By balancing international capital inflows with public sector control, the government aims to position PSBs as strong, competitive players globally. If implemented cautiously, this reform could unlock new capital and propel India towards Viksit Bharat 2047, making PSBs drivers of both financial inclusion and economic growth.