A private bank failure in the first decade of this century and timely intervention by the RBI in the second decade to prevent two likely collapses, have marked India’s contemporary private banking space. In two of these instances, the public sector/government came to the aid of the tottering banks, brought down by the malfeasance of the owners and poor governance practices.

As banking is ultimately anchored on trust, more than on ratios of capital adequacy and liquidity, the sovereign is the go-to guarantor in times of stress. This has been proven internationally too. The former Bank of England Governor Mervin King said famously that “banks are global in life but national in death”.

When banks fail, discussion also centres around the issue of oversight and what went wrong in supervision. India’s banking regulator has the institutional integrity to analyse the recent cases to make sure that “ex-ante” action is taken, as part of micro-prudential regulation/oversight.

In regulatory supervision, the number of entities to be overseen is also material to quality. In the public sector, thanks to the concerted efforts of the Union Government, the number of banks has been reduced from 27 in 2017 to just 12. Except four, they are all large banks now.

Little relevance

There is neither existential nor commercial relevance for tiny banks in the “universal banking” space in the country.

On the other hand, the systemic risks posed by the tiny “universal” banks is high because they are licensed to undertake “all” banking activities .

The resultant risks outweigh the benefits. Though there are no prescribed norms for what could be a minimum mass, given the size of our economy, a total business (deposits and advances) of, say, ₹5-lakh crore would be a desirable norm. Anything smaller and they are better off being local area/regional banks with a restricted licence.

In 1991 itself, this was the prescription of the second Narasimham Committee . It recommended that there could be three or four large banks, including SBI, as India’s international banks, eight to ten national banks with a network of branches across the country and the rest as regional banks with operations limited to a region. The strategic disinvestment policy of the present government is also broadly aligned with this objective.

Based on this logic, the public sector space has seen mergers. There are at least three benefits which have flowed from the government’s bank consolidation exercise.

RBI studies, on the basis of financial efficiency parameters, “confirm that banking mergers in India have been, on an average, beneficial to the banking sector as the financial performance and efficiency of acquirers improved post-merger. The results are valid for both public and private sector banks” (Snehal S Herwadkar, Shubham Gupta and Vaishnavi Chavan, RBI occasional paper, December 2022)

As owners of capital, the government’s focus on performance monitoring and evaluation has improved vastly. Which owner would deploy capital mindlessly in competing entities who squabble for the same business?

Most importantly, supervision pressure and costs on RBI have likely eased as the number of universal banks has dropped and concomitantly the quality and bandwidth of supervision, improved. (Supervision costs incurred by RBI is an unexplored area and many regulators are now considering imposing costs on the regulated entities.)

Now let us turn to old private sector banks. They have been around for more than 75 years, older than our republic. They cannot complain about lack of opportunities for growth as the ownership was entirely private. All of them are licensed as “universal” banks — they can conduct all the activities that the much bigger national banks do, including infra credit and forex/NRI business.

There are 10 of them now. Their individual business ranged from ₹21,000 crore to about ₹3-lakh crore as at end-2022 — the largest of them has business more or less equal to the smallest government-owned bank.

More significantly, their individual market cap ranges from less than ₹1,000 crore to about ₹28,000 crore. To gain control of the largest of them, it would take only about ₹15,000 crore, if there were no regulatory restrictions. Most of the other banks can be bought over at even lower sums.

While four of these 10 banks are from Kerala, three are from Tamil Nadu, two from Maharashtra and one from Karnataka. (A private bank based out of Srinagar has been not reckoned in this group). All of them have a niche relevance and well-entrenched regional business connections, being good local banks. At the national level, they are irrelevant by size and Too Small To Survive (TSTS) as “universal” banks. And what they have not been able to achieve in 75 years or more, they cannot be expected to cover in the near future. Hence the options are clear: become “niche” players as local area banks by focusing on the regional economy or consolidate/merge to continue as “universal” banks with a minimum critical mass.

Given the present system of licensing (where it is “universal” or “small finance” and there is no provision for local area banks) there is need to either enforce/induce consolidation among the old private sector banks or between them and the new private sector banks.

For any reason, if any of them totters, public money will have to flow to support them and the regulator will have to go to their rescue.

The lessons from private bank failures here as well as recent ones abroad, the efforts required for supervision/regulatory oversight of these tiny entities, the benefits arising out of consolidation, the low level of business they have built up and the systemic risk posed by these banks as they do “universal” banking call out for either a “morally-suaded” or a voluntary consolidation, in public interest.

The writer is a commentator on banking and finance

comment COMMENT NOW