Bank consolidation

There is a revival of talk about bank consolidation. The chairman of SBI, Mr O P Bhatt, wants Indian banks to grow bigger. Mr Bhatt has been quoted as saying: “The size of Indian banks is not good enough, we need to consolidate....Even SBI is not large enough to serve Indian corporates”. Mr Bhatt thinks there should be at least two to three banks bigger than SBI and half a dozen banks the size of SBI in the country.

I have been sceptical about bank consolidation in India for quite some time. I reiterated my doubts in my recent ET column, Beware of bank consolidation. Earlier, my concern was about the HRD issues: did management of Indian public sector banks (PSBs) have it in them to manage mergers? Making a success of mergers has been a challenge to top management even in advanced economies where there is freedom of hire and fire. In India, where this is difficult and so is closure of branches, I would reckon that mergers would stretch top management for several years. It would prove a major distraction from other tasks that need urgent attention.

Now, after the recent financial crisis, I have an additional concern: the systemic risk posed by largeness. Better, on balance, to have a number of small banks competing with each other instead of having a few 'systemically large' institutions- except where banks are so small as to lose out on scale economies. The larger the bank, the greater the difficulty in managing it. Moreover, consolidation can work to the detriment of the customer. Lastly, you have to make out a case for merger, saying: look, I have made the most out of my present size, I need to get larger in order to sustain earnings growth.

I doubt that many PSBs can make this case. They have failed to get the most out of their existing size. As for SBI itself, it is large as it is. It doesn't have to get larger by gobbling up its subsidiaries, many of which have done better than SBI.

Incidentally, I read in one paper that SBI's proposed merger with State Bank of India has been held up by the finance ministry because of concerns about the malign effects of consolidation.