Friday, June 19, 2009

Banks- too big to manage?

Governments the world over have rescued banks that are too big to fail- Citibank and Bank of America in the US, RBS and Lloyd's in UK. One fall out is that regulators and central banks are actively contemplating measures to prevent banks from growing beyond a certain size, FT reports.

This is what the incoming head of the Swiss National Bank has to say:
“A size restriction would of course be a major intervention in an institution’s corporate strategy,” Hildebrand, the central bank’s current vice-chairman, observed with masterful understatement. “Naturally the SNB is aware that there are advantages to size. [But] in the case of the large international banks, the empirical evidence would seem to suggest that these institutions have long exceeded the size needed to make full use of these advantages.”
But what would be that size? How do you operrationalise this concept? I haven't seen any concrete ideas on this. I guess one parameter could be the recapitalisation cost as a percentage of GDP in the event the bank fails. But this only leads on to another question: what percentage of GDP? There cannot be an absolute limit across all countries. Much would depend on an economy's fiscal situation. An economy where the fiscal situation is good could afford a failure that costs, say, 15% of GDP. Another- like India's- may not be able to afford even 5% of GDP.

But this creates a piquant situation. Larger economies can afford bigger banks. So can well managed economies. In other words, the size of the economy and the fiscal situation become determinants of competitive advantage based on size.

Should we worry? I don't think so. Because beyond a point, size ceases to confer any big advantage and, in fact, becomes a problem. In India, I would say that any bank with a balance sheet of around Rs 150-200,000 crore has the requisite size to take on competition. For the regulator, the problem is: too big to fail. For bank managers, the focus should be: too big to manage.

That's why I am not enthused by talk of SBI merging with all its associate banks. Is SBI getting the most out of its current size? Does it have the necessary depth and breadth of management at its current size? If not, HRD and systems should be focus, not simply getting bigger.

1 comment:

K.R.Srivarahan said...

It is unfortunate but true that growth sometimes becomes the only strategic focus of an organisation. Is there something like the optimal size for a commercial bank? Intuitively one may say that the optimal size will be a function of internal constraints / facilitators and external factors. Reducing this to a regression analysis will be a theoretician's delight.
In our country, debate about optimal size has been waxing and waning. For example. in early 1970s, private banks tended to avoid the deposit threshold of Rs.50 crore fearing that crossing that limit would attract nationalisation. (e.g.the then Vysya Bank Ltd.)
Banking reforms post-Narasimham committee reports emboldened bank managers to feel "the bigger,the merrier". The Basel norms which are implemented more rigidly in India have changed the mindset of risk managers in banks. They are now confident that tier-1 and tier-2 capitals are both steroid and antibiotic promoting growth and preventing contagion.Unfortunately, they are also a diuretic creating unforeseen liquidity problems. A few years back, Mr.P.Chidambaram tried to encourage the "merge and grow" culture hoping that growth per se will take care of many banking ills. The following story gives a taste of discussions of those years.

Obviously, the final word is not yet said.