The global financial crisis has changed the narrative on big banks. The cult of size has lost its resonance. Banking behemoths were considered to be paragons of synergistic efficiency not too long ago. Now they are seen as epicentres of systemic risk.
Yet, Union finance minister P. Chidambaram has said he wants more large banks in the country. He recently pointed out that no Indian bank is among the biggest 20 banks in the world, while three Chinese banks feature in the list.
The quest to have fewer but larger Indian banks has been a long one, going back to the reforms of 1991. That was also the time when Japanese banks straddled the universe. They expanded aggressively in the 1980s by exploiting a high domestic saving rate, increasing international trade and a booming stock market. At the height of the Japanese bubble economy in the late-1980s, the 10 biggest banks in the world were Japanese.
Once the bubble went pop, Japanese banks saw capital erosion because of growing bad loans and a collapse in the stock market. Tokyo had to infuse trillions of yen of public funds to bolster bank capital.
More recently, at the end of another bubble, the failure of a few large banks pushed Iceland towards national bankruptcy. Ireland had to knock at the doors of the European Central Bank and the International Monetary Fund (IMF), seeking financial assistance when there was distress among its large banks in 2010.
These experiences suggest that as banks get ambitious, they tend to lend aggressively and diversify into risky businesses such as investment banking. But when the tide shifts, these actions begin to hurt the entire economy.
In recognition of the risks that larger banks pose, US President Barack Obama decided to give bank regulators the power to limit the size of the largest banks in his country, and the scope of their risk-taking activities. He publicly endorsed the Volcker Rule in January 2010 to put limits on bank size and prohibit commercial banks from trading for their own accounts. Subsequently, the Consumer Protection Act (or the Dodd-Frank Act) was signed into federal law in July 2010; it proposed a break-up of large banks which had become “too big to fail” to minimize the risks they pose to the economy.
What India needs right now are more nimble banks to fund economic growth and to drive financial inclusion. Banking mergers in the quest for size are not exactly a crying need.