Will a merger of banks lead to ‘too big to fail’?

Need for large-sized banks to compete at the global stage, since India’s global economic clout is increasing

The Union Cabinet recently approved the merger of the State Bank of Bikaner & Jaipur, State Bank of Travancore, State Bank of Patiala, State Bank of Mysore, State Bank of Hyderabad as well as Bharatiya Mahila Bank with the State Bank of India. If the merger gets off the ground well within the set timeline, much synergetic benefit can be gained out of it. However, it is a mammoth task for the government, looking at the overall bank size, interconnection and complexity involved, and dealing with the various political unions of respective banks.

The discussion on merger in the Indian banking industry is not a new concept. In fact, the State Bank of India itself is a product of mergers of the Presidency Banks. Since the early 1990s, financial sector reforms have talked about consolidation of the banking sector. In 1991, the Narasimham Committee report suggested the need for large-sized banks for international presence. There are various pro and cons against consolidation; however, consolidation of commercial banks with established synergies will lead to more benefits than detriments.

Public sector banks in India own a disproportionately large share of the total banking industry—they hold about 74% of banking assets, compared to 26% in the UK and 32% in Germany. The objectives of financial inclusion and broadening the geographical reach of banking can be achieved only with the merger of large pubic sector banks and leveraging on their expertise.

One must recall that Indian banks have stayed strong during financial crises. In fact, in some of the recent crises, the concept of “too big to fail” was tossed; big financial institutions, anyway, are so large and so interconnected that their failure would be disastrous to the greater economic system, and therefore they must be supported by the government when they face potential failure. At the same time, a few economists, including Paul Krugman, are of the view that economies of scale in banks and in other businesses are worth preserving, so long as they are well regulated in proportion to their economic clout, and therefore the “too big to fail” status can be acceptable.

There is indeed a requirement of a larger number of banks in India; nonetheless, there is also a need for largesized banks to compete at the global stage, especially in today’s times when India’s economic clout is increasing across the world.

In the Indian context, a “too big to fail” bank would be less risky than a small bank, especially because such a large bank would have a wide, diversified portfolio, resulting in less volatility in its ear ning. As a result, such a large bank would command higher credit rating compared to smaller banks.

Another major advantage of a mega-merger would be compressed transaction costs and reducing the risks associated with financing of small businesses, which may be high for small banks. Large, consolidated banks can mitigate costs better and penetrate through lending into these sectors, thus financial inclusion in true wisdom can be achieved.

In addition, this will augment geographical diversification and penetration into new markets. In today’s digital age, such a consolidation will also shrink the common cost that goes into technology; such a cost can be applied homogeneously in the merged entities. However, while monitoring, caution should be observed on skewing consolidated portfolio towards higher risk-return investment, which may be damaging to the economy.

One must also keep in mind that each merged organisation would have various employee schemes, all of which need to be streamlined. However, it might have cost implications in the long run. Therefore, diplomatic skills and care are needed to overcome strong unions in the merged entities.

A merger, clearly, is not going to be a cakewalk for any governmental financial institution. However, once it is formalised, it would prove be a winwin situation for both the employees and the organisation. The author is a senior executive in a leading bank. Views are personal