The issue of having big banks has come back to the discussion table. The Indian banking system has a unique model where there are differentiated banks serving specific purposes.
Hence besides the commercial banks which are virtual universal banks, there are small finance banks, payments banks, and the cooperative banking system. There are evidently benefits from such a structure.
Case for big banks
With the aura of going global pervading economic thinking there are arguments being made for having big banks. First, there is the reputation issue. Today it has become axiomatic to be at the top — whether it is GDP or banks given the economic power that vests with India in the global space. Therefore, being a part of the top 100 or top 500 is an aspiration, and here size of banks matters. A globally integrated economy necessitates large banks.
Second, with big banks, there is scope for taking larger exposures. This is because large banks have a bigger balance sheet which is supported by capital. As lending is linked with capital, intuitively more capital allows larger exposures. This becomes pertinent when infrastructure is involved where banks are taking the lead.
Third, the RBI recently relaxed the large exposure norms and allowed for funding of M&A activity. This means that larger banks would be able to work in this business segment more effectively than smaller ones. Given the pace of M&A activity in the country, financing it will potentially be big business for banks in future.
Fourth, larger banks tend to have the wherewithal to invest more in innovation and compete in global markets. As we talk of globalization of the rupee, our banks need to be at the forefront, and it is the larger ones which can follow this path.
Further, in a digitally-oriented banking system, big banks will find it easier to invest in technology. AI, which will be an integral part of banking in future, is an area which requires substantial investment on an ongoing basis.
Therefore, there are compelling reasons to have larger Indian banks. In fact, the concept of banks being financial supermarkets fits into this canvas where a large bank offers all financial products through subsidiary outfits under one umbrella.
The downsides
Interestingly, there are also arguments which support the status quo.
First, size in the global context is notional. This is so because given the exchange rate and conversion to dollars for comparison purposes Indian banks will always be lower down the pecking order. In fact, if size of banks were reckoned based on purchasing power parity, we would feature in this list already as GDP in PPP is almost 4.5 times GDP in nominal terms.
Second, having a few large banks will mean increasing risk in the system due to the large exposures taken. The ‘too big to fail’ hypothesis is often put forward here as any fissure can have major repercussions for the financial system. Rescuing a small or medium size bank is less complicated than a large bank. Therefore, having such banks would mean creating such monoliths and then putting them under the scanner under the systemically important banks regulation. This can be countered, however, with stronger regulations in the system.
Third, given the asset-liability profile of banks, they may not be suitable for infrastructure lending. Deposits are typically for three years, and funding infra for 10-15 years creates continuous mismatches. Efforts are being made to deepen the bond market and create new long-term lending institutions, which could be more effective alternatives. But the counter argument here is that this takes time to develop based on experience and hence banks must perforce do the main work here.
Fourth, given that infra lending involving long tenures cannot be eschewed, the consortium approach is already there which ensures that all the eggs are not put in a single basket. This has worked well for us and hence creating new big banks to replace such lending is not necessary.
Fifth having large and fewer banks would automatically lead to the creation of an oligopolistic structure which may not be desirable. For example, a company seeking a large sized loan may not have much of a choice if there are just 3-4 banks. Reduction in competition could lead to mispricing of capital. Customers will also have fewer choices of banks.
An analogy is often drawn with the aviation sector where customers do not really have an option when flights are delayed or flights cancelled with no compensation. Here too it is counter argued that a strong regulatory structure should be in place to ensure that this does not happen.
Tough choices
So whether or not to create big banks is a hard decision to make given the arguments for and against them.
The Indian experiment with bank mergers among PSU banks has been an unequivocal success. This has sparked the debate once again.
Our need to ramp up growth will entail an investment level of 35 per cent of GDP. . Financing this will be the challenge. While foreign capital can support such investment, the primary driver will be domestic institutions. The corporate bond market needs further development to cover corporates with lower ratings. The government has already furthered the idea of special financial institutions targeting infrastructure. Until these structures develop, the onus will be on banks to finance growth.
Capital requirements of banks tend to rise as credit growth averages 15 per cent a year. Incremental capital required would be around ₹5 lakh crore by 2030, increasing to ₹38 lakh crore by 2045 when the nation would be on the threshold of being a developed nation. Therefore, on balance there may be merit in pitching for more big banks.
Given the healthy state of the banking system, this is perhaps the right time to debate on the issue of big banks.
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