India needs more efficient financial entities
Finance Minister Nirmala Sitharaman said last week 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. It is not clear if the government is again considering the option of merging some of the remaining PSBs. In the last round of mergers, for instance, Oriental Bank of Commerce and United Bank of India were merged with Punjab National Bank, while Union Bank of India took Corporation Bank and Andhra Bank into its fold. Besides, Allahabad Bank was absorbed by Indian Bank. But these mergers have not created scale of any significance. As things stand now, SBI’s book is bigger than the next three largest banks put together.
It is perhaps the aspiration of the government to have very large banks, but it’s not obvious how they will benefit the economy in a rapidly changing technological and financial landscape. Banks will grow in size with a growing economy, and some will grow faster than the others, but India is unlikely to have four or five banks of SBI’s size over the next several years. However, this is unlikely to affect the flow of credit. In terms of large lending to businesses, it is better to follow the consortium approach, which not only enables greater due diligence but also reduces concentration risk. The government’s thinking perhaps 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. Infrastructure projects typically have long gestation, which creates an asset-liability mismatch for banks, irrespective of size. 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.
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. Further, since rapid changes are happening in the area of financial technology, it may not be easy for large banks to adapt quickly. Thus, the focus should be on improving efficiency rather than increasing size through mergers as was done with PSBs. In this context, it is worth noting that the finance minister had talked about privatisation of two PSBs in the Union Budget. There has not been much movement on this front, though the government is reported to have started consultation with the Reserve Bank of India. The government would do well to speed up the process. It should, however, strictly avoid another round of mergers among PSBs with the pretence of creating scale. Since there has been virtually no movement on reforms in the way PSBs function, large banks would create bigger problems for the government. The banking sector, in general, will gain size with economic growth over time, and the objective of the State should be to provide an enabling environment with effective regulation.