Illustration: Jayachandran/Mint
Illustration: Jayachandran/Mint

The risks of creating giant banks

The merger of SBI with its associate banks runs counter to 2008's lessons

The cult of behemoth banks has lost many followers since the global financial crisis. The lending institutions that were once considered exemplars of financial synergy are now looked upon as epicentres of systemic risk.

Finance minister Arun Jaitley has decided to push for the creation of a new banking giant by merging the State Bank of India with its associate banks. The stock markets have already been told about this. The merger move comes at a time when the most important issue facing Indian banks—and the Indian economy—is the growing pile of bad loans with the baking system. The quarterly financial results announced by Punjab National Bank this week were particularly shocking.

The quest to create an Indian bank that will be in the league of global giants is an old one. It has been talked about since the 1991 economic reforms, a time when the world looked in awe at the Japanese banking giants. Their sheer size emboldened them to turn on the lending spigots during the boom years for the Japanese economy. They eventually had to be bailed out by taxpayers after years of capital erosion.

Four of the five biggest global banks in terms of assets are now Chinese. Few see them as paragons of financial stability. Their government has used them as fiscal tools to keep the growth engine running in times of trouble. The 2008 Chinese stimulus was a classic example of this. There is good reason to believe that the large Chinese banks are far weaker than what the official numbers say. Ireland was perhaps the most extreme example. It encouraged the growth of banks that overwhelmed the entire economy in 2008 after their bets went wrong.

The US too has seen that large banks are not necessarily efficient banks. The political power of these lenders has prevented the Barack Obama administration from moving ahead with suggestions by former central banker Paul Volcker to limit their size. The provision in the Dodd-Frank Act to break up the big US banks has also been put in cold storage.

The bailout of the US lending giants eventually proved to be a profitable deal for US taxpayers—but not all such taxpayer put options work for those who are putting up the bailout money.

India right now needs more banking competition rather than more banking consolidation. In other words, it needs more banks rather than fewer banks. This does not mean that there should be a fetish about small-scale lending operations, but to know that large banks are not necessarily better banks.

The merged State Bank of India is likely to be five times larger than its nearest competitor in terms of balance sheet size. We wonder how the competition regulator will look at this forced merger, given the fact that one bank will now dominate the Indian banking landscape. Or is the government planning to create other lending institutions which will match its might?

The Reserve Bank of India has already become more sensitive about the need to give special regulatory attention to banks that could be sources of systemic risk or financial conglomerates that can send shocks to other parts of the financial system. The creation of banking giants through mergers should raise the bar as far as its regulatory abilities go.

India is right now seeing the creation of new banks that could add to variety in the domestic financial system. These new banks should make the Indian loan market more competitive. The decision to merge the large public sector banks does exactly the opposite. It will likely reduce competition—and without any major efficiency gains to the economy as a whole.

The cult of size is always an attractive one. But the enthusiasm to create massive banks through mergers needs to be tempered with scepticism. The global experience since 2008 is especially important in this context.

Is bank consolidation a good idea? Tell us at views@livemint.com

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