That the banking sector needs to be made more responsive to the needs of the economy goes without saying. In this context, attention deserves to be paid to the directive issued by the high-level group on the services sector, constituted by the Planning Commission, to pursue the unimplemented recommendations of the two Narasimhan Committees?including the reduction in regulatory pre-emption of bank liabilities, phasing out of directed credit, and reform of public sector banks. The government, one hopes, will get cracking on all these straight away. Of equal relevance is the committees? take on the need for bank consolidation and scaling up of operations. The high-level group has endorsed the Narasimhan Committee?s vision of a banking sector composed of three or four large Indian banks of international standing, eight to ten national banks engaged in universal banking with branch networks across the country, several local banks in specific regions, and many other regional rural banks. This should be treated with caution, however, since force-fitting the industry into such a neatly tabulated structure would require top-down moves that could amount to micro-management. Instead, the M&A instincts of banks should be allowed to flourish within a framework of bank autonomy. In fact, the eventual aims of consolidation will be better achieved if the branch licensing system is done away with, and the industry is allowed to shape itself to market needs in whichever way business logic dictates.
Liberal licensing, as experience in developed markets shows, makes space for market-driven consolidation. The US banking sector, for example, saw the number of banks almost halve from around 14,000 in the mid-1980s over two decades, even as the number of branches almost doubled to 77,000 during the period. By contrast, in India, the number of commercial banks shrank by only about one-fifth to 222, while the number of branches rose marginally to 69,471 during that period. Today, the US boasts one commercial bank for every 4,485 people?about one-fourth the number served by each commercial bank in India. Of course, for Indian banking to extend its reach, marginal transaction costs must be brought down. But why let the branch licensing policy hamper the effort? That?s a relic. Get rid of it.