The big bank idea

Synopsis: India needs more efficient financial entities. Amalgamation of PSBs to create bigger banks, is not the ideal way forward.

Introduction

Recently, Finance Minister, said that India needed four or five banks of State Bank of India’s (SBI’s) size to serve the growing and changing needs in the post-pandemic world.

The minister further argued that one of the driving reasons for amalgamations in public sector banks (PSBs), which happened before the pandemic, was to create scale.

But analysis of recent mergers point out that mergers have not created scale of any significance.

Why increasing the scale of banks will not aid infrastructure financing?

The government’s rationality could be that large banks will help finance India’s infrastructure needs more easily. But the fact is that banks are often reluctant to lend to infrastructure projects because of their basic nature of business. They typically have a long gestation period, which creates an asset-liability mismatch for banks.

Further, the government is setting up a development finance institution to cater to the infrastructure sector.

Additionally, longer-term debt should ideally be raised from the bond market and can be financed by insurance and pension funds.

Why government should not aim at increasing the scale of banks through mergers?

Firstly, at a broader level, large banks can create systemic risks and some will become too big to fail. It is relatively easier for the banking regulator or the government to intervene when banks in trouble are not very big. Since there has been virtually no movement on reforms in the way PSBs function, large banks would create bigger problems for the government.

Secondly, since rapid changes are happening in the area of financial technology, it may not be easy for large banks to adapt quickly.

What is the way forward?

The focus should be on improving efficiency rather than increasing size through mergers as was done with PSBs. Here, privatisation of PSBs is an option.

In terms of large lending to businesses, it is better to follow the consortium approach. It not only enables greater due diligence but also reduces concentration risk.

The objective of the State should be to provide an enabling environment with effective regulation. If provided, the banking sector, in general, will gain size with economic growth over time.

Source: This post is based on the article “The big bank idea” published in Business Standard on 30th Sep 2021.