Mumbai: A new report from a research division of the Reserve Bank of India, or RBI, has raised concerns about consolidation in the banking industry and warned that creating “mega banks” could lead to increased operational risks, contagion risks and systemic risks.
The report on currency and finance for 2006-08, released on Thursday, said the introduction of Basel II norms could prompt small banks to merge with bigger players to maintain capital adequacy. But, consolidation among large banks, in particular, would raise competition and moral hazard concerns, that is, “too big to fail”.
The Basel II guidelines require banks to set aside higher capital according to the risk weightage of borrowers.
Leading the pack: According to the Reserve Bank study, the State Bank group was the most efficient among all banks in 2006-07. Harikrishna Katragadda / Mint
“The increased presence of foreign banks, by intensifying competition, could accelerate the consolidation process that is under way,” the report said. “While this may be the positive outcome, it may, at the same time, also raise the risk of concentration.”
It said mergers among large banks could undermine competition. However, “Competition can be enhanced if mergers take place among the smaller and weaker banks in order to compete with the larger banks.”
The report also found that the State Bank group—consisting of State Bank of India and its seven associate banks—was the most efficient among all banks for the 2006-07 financial year, followed by new private sector banks, nationalized banks, foreign banks and old private sector banks.
During that period, the group had an efficiency level of 0.85 on cost basis, 0.95 on technical basis and 0.89 on allocative basis, with the maximum being 1.0, the study said.
The cost efficiency level of new private sector banks was 0.83, while that for nationalized banks was 0.80, foreign banks 0.66 and old private sector banks 0.59.
“With regard to relatively low efficiency levels observed in the case of foreign bank group, it may be noted that it is quite a heterogeneous group with efficiency levels varying from as low as 0.37 to the maximum level of 1,” it said adding that the least efficient ones, which constituted not more than 20% of the total, were also the ones with very small size and limited operations.
The overall efficiency level of foreign banks, excluding the outliers, however, was almost 1.0 in 2006-07. Of the 28 foreign banks in India, nine had an efficiency score of 1.0.
Among the 28 public sector banks, the efficiency range was 0.8-1.0, with five—three from the State Bank group—getting 1.0. Three new private sector banks, out of six, received a 1.0, but no old private sector bank got the maximum score.
According to the report, the government’s 51% holding in public sector banks can become an issue hampering their growth if the government is not able to provide adequate capital for expansion.
“The issue of state ownership needs to be weighed against the changed operating environment and whether public sector banks can continue to expand without being constrained by capital,” it said.
With the introduction of Basel II norms, the capital requirement for banks could go up by 1.0-1.5 percentage points, prompting public sector banks to raise additional capital. Although in the near term, public sector banks are adequately capitalized, in the medium- to long-run, banks may need to raise additional capital from the market.
According to the report, only six state-run banks have sufficient headroom to raise capital as the government shareholding in these banks was significantly above the minimum requirement of 51%.
Anita Bhoir contributed to this story.