BEWARE OF BANK CONSOLIDATION

An article written by Sri T.T. Ram Mohan, Faculty, IIM, Ahmedabad in The Economic Times dated 17.09.2009 on bank consolidation in India has been republished in AIBOC's Common Bond Magazine for the month of November 2009.

As the article is informative and analytical, we are reproducing here the same along with a link to November 2009 issue of Common Bond Magazine.
“One outcome of the present global crisis is that large banking monsters have come to be feared. That is why the recent death anniversary of Lehman Brothers drew a barrage of comment. And Lehman wasn’t even a bank, it was an investment bank. We worry now not just about large banks but about ‘systemically large’ financial institutions.
Economist Joseph Stiglitz and many others want banks to be limited either in size or in scope. Stiglitz wrote recently, “We need to break up the too-big-to- fail banks; there is no evidence that these behemoths deliver societal benefits that are commensurate with the costs they have imposed on others.”
Stiglitz’s views are echoed by several others, including Henry Kaufmann, a much respected figure on Wall Street. It’s a different matter that Mr Kaufmann has woken up to the dangers of bigness rather late in the day: he happened to be on the board of Lehman Brothers. In contrast, here. in India, there is a revival of the clamour for bank consolidation. The Chairman of SBI, Mr. 0 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.
Can Indian banks get a lot bigger quickly? Should they do so? Do we need bigger banks at a time when others want their banks to shrink? In the first place, Mr Bhatt’s suggestions do not appear feasible, given the present sizes of Indian banks. Yes, we can have banks bigger than SBI by merging SBI with its subsidiaries or with other banks.
But having two or three banks bigger than SBI or half a dozen banks the size of SBI is almost impossible. To get just one more bank the size of SBI, we would have to merge the four biggest public sector banks (PSBs) after SBI. Mergers of private banks with PSBs are difficult to contemplate and even these will not produce banks bigger than SBI. That apart, the arguments typically made for bank consolidation in India lack Substance:
Indian banks are much smaller than global giants: True. In 2007, SBI was not even one-tenth the size of the tenth largest bank in the world. But this also means that no amount of consolidation will give Indian banks a global size in the foreseeable future.
Bigger size is needed for scale economies: Yes, scale economies are useful. But beyond a certain size, the benefits of scale taper off and tend to be offset by growing complexity. Internationally, studies have shown that a size of around $20 billion is optimal. India’s top ten banks meet this size requirement.
Our banks need to be bigger in order to meet the needs of large corporates. Why should one bank meet the needs of any large corporate on its own? From the point of view of risk management, consortium financing is preferable. Some large requirements of corporates, such as overseas finance, cannot be met by Indian banks, however large they may become.
There is too much competition in the Indian market: Concentration in the banking market works to the detriment of customers. Fragmentation is bad for banks. You need to strike a balance. A good way to see where a banking system stands is to compare the share of the top five banks in assets. In India, the figure is 44%, which comes somewhere in between the 60% for France and 30% for the United States. Not only are the arguments for bank consolidation not persuasive, there are a number of compelling arguments against bank consolidation.
First, large banks are harder to manage and create greater disruption when they fail. That Indian banks are smaller in absolute terms than globe giants is no comfort. When it comes to systemic risk, the relevant measure is balance sheet size relative to GDP.
Secondly, merger is required where the potential for profit growth is limited. This is emphatically not true of the Indian market. In a normal year, one can expect commercial credit to grow at 20-25%, with a net interest margin of around 2.5%. Not many markets in the world can boast of a similar potential.
Thirdly, mergers make huge demands on HRD capabilities. This is precisely the weak spot for PSBs. Most PSBs face a decimation of their top management in the next three to five years. So this would be quite the wrong time to attempt consolidation. Instead, PSBs should concentrate on delivering better performance at their present sizes. If you cannot get the most out of assets of Rs.250,000 crore, you are unlikely to do better with Rs.500,000 crore of assets. As India returns to a growth rate of 8% and sustains it over a decade, our banks will attain a globally respectable size. There is no need to leapfrog the process through consolidation. The motto for Indian banks should be one that applies universally: don’t grow too big for your boots.”
Source: http://aiboc.org/New_circulars/b-nov-29a.pdf