During her keynote address at the 74th annual general meeting of the Indian Banks’ Association (IBA), Nirmala Sitharaman, the union finance and corporate affairs minister, said that India needed four or five more banks of the size of the State Bank of India (SBI) in order to scale up banking and meet the changing requirements of the economy and industry. “The way in which the economy is shifting to a different plane altogether, the way in which industry is adapting, so many new challenges keep arising. To address these challenges, we need not just more, but bigger banks”, said the union finance minister.
Road to Big Bank: Mega Merger of Public Sector Banks
In August 2019, more than fifty years after the nationalisation of banks, the union finance minister announced the amalgamation of ten public sector banks (PSBs) into four big banks. With the amalgamation taking place now, the total number of PSBs in the country came down to 12 from 27. These amalgamations were meant to enable the creation of digitally-driven consolidated banks with global heft and business synergies. The union cabinet approved the mega consolidation of PSBs to come into effect from April 1, 2020.
The mega consolidation of the PSBs included:
- Oriental Bank of Commerce and United Bank of India were merged with Punjab National Bank. The merged entity became the second largest PSB, after SBI, with business of Rs 17.94 lakh crore. It will also have the second largest branch network in the country.
- The amalgamation of Syndicate Bank with Canara Bank created the fourth largest PSB with business of Rs 15.20 lakh crore with the third largest branch network in the country.
- The merger of Andhra Bank and Corporation Bank into Union Bank of India created the fifth largest PSB with business of Rs 14.59 lakh crore with the fourth largest branch network in the country.
- The amalgamation of Allahabad Bank into Indian Bank made the merged entity the seventh largest PSB with business of Rs 8.07 lakh crore.
Why Big Banks are Needed
The mega merger plan focuses on creating banks of scale which would enable India to meet its aspiration of becoming a US $ 5 trillion gross domestic product (GDP) economy. Such an economy will have modern industries, emerging entrepreneurs, and a transformative technological ecosystem.
Modern banking facilities need to be commensurate with the needs of the transforming the economy. Now, if our banks continue to remain small, they cannot fund the needs of an aspiring economy. This is because of the way banking is structured: prudential banking norms require that banks do not take too much of a risk on a single company or a single entity. Banks take risks proportionate to size. Therefore, as the economy grows significantly in the next few years, banks would need to keep pace.
Over the last few years, our economy has grown steadily, and banking reforms have also been initiated steadily, but now is the time for a transformative change. Consolidation of PSBs into larger entities (big banks) is among the steps needed for such a transformative change in the Indian banking industry.
Moreover, banks need to have sufficient financial heft to invest in, say, technology upgradation for better customer service, to have better customer connect, and to have better ability to detect fraud. All of these will require investments. The bigger the bank, the more ability it will have to undertake those investments as well as to standardise processes in a larger set of entities.
Ultimately, to grow to a US $ 5 trillion economy, the country needs strong capital-based banks.
Merits of Big Banks
Banks perform the key role of intermediation, i.e., they take savings from the public and make these available for investments. For any economic growth to happen, credit (equity) and capital (debt) both are crucial. In the past, when an entrepreneur wanted to set up a large project, he would have to knock at the doors of several banks, which then used to form a consortium of lenders. The formation of big banks through consolidation of existing PSBs will help in unlocking potential.
Big banks will have a scale advantage comparable to global banks. This will allow them to compete effectively in India and globally. Greater scale and synergy, achieved through consolidation of banks, would lead to cost benefits which would enable these larger entities to enhance their competitiveness and positively impact the banking system in the country. Big banks, with their scale and financial heft, will be able to support larger ticket-size lending and have competitive operations by virtue of greater financial capacity.
Bank consolidation will not merely increase the size, but also enable the adoption of best practices and technologies across the amalgamating banks as well as access to a wider talent pool and a larger database. The big banks will, thus, be able to improve their cost efficiency and risk management, besides boosting the goal of financial inclusion through wider reach.
In addition to the above, big banks will have enhanced risk appetite. This would enable them to undertake big lending and support the credit requirements for large projects in the country.
Concerns Associated with Big Banks
It has been suggested by financial experts that the focus of the government should be on improving the efficiency of PSBs rather than increasing their size through mergers. With economic growth, the banking sector will gain size over time as per the needs of the economy.
As suggested by banking experts, what is more suited for banks is to follow consortium approach (wherein a number of banks lend simultaneously to large businesses rather than a big bank lending a large sum) while lending to large businesses. This would not only enable better due diligence, but also help banks reduce concentration risk in lending (according to Basel Committee, it refers to the exposure with the potential to produce losses large enough to threaten a financial institution’s health or its ability to maintain its core functions).
Moreover, big banks can create systemic risks (according to Investopedia, it refers to the possibility that an event at the company level could trigger severe instability or collapse an entire industry or economy).
Big banks may become too big to fail, making it difficult for the banking regulator to intervene when these get into trouble. When banks are not very big, it is easier for the banking regulator or the government to intervene and tame the crisis.
Big banks may not be able to adapt quickly to rapid changes happening in the area of financial technology, as compared to smaller banks.
Thus, the focus of the government should be on providing an enabling environment for the banks to reform themselves and perform efficiently.
Conclusion
While the driving reasons for amalgamation of PSBs was to create scale, these mergers have not been able to do so significantly. Even with the latest set of mergers of PSBs, the book of SBI is much bigger than the next three largest banks put together. In spite of that, the move of consolidating a large number of regional PSBs is commendable, given its intent to create banks of scale. However, it will be worth watching how these banks will benefit the economy, especially in a rapidly changing technological and financial landscape. Unless the government pays attention to improving the efficiency of PSBs by providing an enabling atmosphere for them to work in, big banks will work no better than the existent small PSBs.
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