Are bigger banks better? Check out what should be the top priority

Updated: August 24, 2016 7:09:08 AM

The bigger a bank becomes, the greater is the tendency to leverage technology to automate processes

Indian rupee vs US dollarThe concept of creating big banks through mergers to reap economies of scale has been in circulation for quite some time. (Reuters)

During the last two years, various initiatives taken by the government have helped the country become the fastest growing major economy. While creation of physical infrastructure has featured prominently in the entire scheme of things, the banks, especially the public sector banks (PSBs)—main source of debt for infrastructure projects— are reeling under stressed assets and, thus, are severely constrained in terms of taking fresh exposure in infrastructure projects. Until and unless the PSBs are de-stressed, this can become a major stumbling block for the economy.

The concept of creating big banks through mergers to reap economies of scale has been in circulation for quite some time. Certain quarters perceive such a move to enhance the capital efficiency of the merged entity, rationalise the cost of operation, improve recovery of NPAs and also allow better bargaining power in terms of raising capital from external markets. At the first edition of Gyan Sangam, the bankers’ retreat organised by ministry of finance, in January 2015, the government officials floated the idea of bank consolidation which banking chiefs turned down unanimously. However, at the second Gyan Sangam held in March this year, the discussion was no longer on the need for consolidation, but on how to consolidate. Government made its intent clear for PSB mergers which has been followed up with the approval of merging six PSBs with SBI.

A move like that will certainly push up the global ranking of SBI among the largest banks of the world. But will it augur well for India? Did we act in haste in a matter of national importance? The government would have done well to wait for some more time and indulge in more research before going ahead with such a decision.

What seems to have been inadvertently overlooked is how the creation of bigger players can adversely impact the service delivery and take the focus away from the customers, especially the medium, small and micro customers. Experience from the banking sector shows that the bigger a bank becomes, its processes become more mechanical and it is the connect with the customer that gets neglected. It is for this very reason that entities like NBFCs and MFIs exist as commercial banking leaves a huge void and is unable to cater to the credit needs of the vast multitudes.

In this context, it is worth appreciating the difference in nature of the banking sectors in Europe and the US. Europe has mostly large banks and thus, when the banking sector faced a systemic crisis, economic growth plunged as credit intermediation suffered largely. On the contrary, in the US, many small banks and non-banks exist alongside the big banks. As a result, even when the big banks suffered during the global financial crisis, the US economy did not come to a standstill as the smaller banks carried on with their job. Thus, US has been able to cope with the crisis better than Europe. In India, too, although the commercial banking sector’s ability to lend has got constrained, its adverse impact on the economy is getting cushioned by the NBFCs and MFIs.

PM’s call for promoting entrepreneurship is spot on as that holds the key towards unlocking India’s true potential, creating new employment and generating wealth. Not all entrepreneurial ventures are urban start-ups. Majority of such ventures are from the grassroots level at the villages and non-urban centres. More than just funds, these entrepreneurs need mentoring and hand-holding. To enable that, nurturing a human interface in our banking system is imperative. The bigger a bank becomes, the greater is the tendency to leverage technology to automate processes. Therefore, the decision to create fewer but larger PSBs can do a major disservice to the cause of promoting entrepreneurship. This is something we simply cannot afford at this juncture when our economy is poised for a take-off. It is also worth noting that private banks will not be too keen to cater to the credit needs of entrepreneurs. It is the PSBs which will need to take the lead on this front.

Government should have ideally carried out an evaluation for a worst-case scenario, i.e, how creation of such banking behemoths can impact the economy in case of any future financial crisis. The 2008 global financial crisis is still fresh in our memory and we have already seen how the so-called big banks in the US, which are said to be ‘Too Big To Fail’ and account for a lion’s share of banking assets, created a systemic risk. When the financial crisis broke out, the problems not only remained restricted to the US, but also spread to other continents due to the interconnectedness of global capital, thanks to modern technology. Taking a lesson from that episode, we should have tested our preparedness in before taking such a giant step.

From that perspective, it seems that our present banking system with 27 PSBs and a mix of other banks is better off for the time being. We must not forget that, in India, the PSBs already hold nearly three-fourths of the total banking assets. Thus, reducing the number of players can only increase the concentration risk. If the merged entity comes under a financial crisis, it can pose a serious systemic risk making the entire economy vulnerable.

In our efforts to reap economies of scale in the banking system, we cannot afford to expose ourselves to bigger risks in the future. Our priority for the time being should not be creation of bigger banks, but making our banks better. The focus should be on how to capitalise our banks well, how to resolve the stressed assets problem and how to make our banking systems and processes robust so that the operational efficiency and flexibility of the banking system improves. Of course, that does not rule out possibilities of bank mergers in the future. We should be open to the idea of mergers, but we must ensure that the merged entities complement each other well to ensure that the merged entity does not become too big to pose any concentration risk. But that can be taken up at a later date and on a case-by-case basis.

The author is Sunil Kanoria, president, ASSOCHAM. Views are personal

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