Context

Finance minister announced  the merger of public sector banks.

Challenges with the merger – short term

• It is coming in the wake of growth sinking to a six-year low and thus a needless distraction.

• In the short-term, the mergers will contribute nothing towards a turnaround of the economy. 

• The administrative and logistic challenges of mergers will divert the mind space of bank management away from managing the NPAs and aggressive lending.

Long term view on mergers – positives

• Large banks will entail cost advantages by way of economies of scale, such as centralised back-office processing, elimination of branch overlap, eliminating redundancies in administrative infrastructure, better manpower planning, optimum funds management, and savings in IT and other fixed costs. 

• Large banks will also be able to finance large projects on their own while staying within the prudential lending norms.

Long term view on mergers – drawbacks

• Organic mergers of banks motivated purely by business considerations lead to efficiency gains, arranged marriages of this kind are debatable.

• They can become too big to fail.

1. The financial sector is all interconnected and a risk in any part of the system is a risk to the entire system.

2. If a large bank were to fail, it could bring down the whole financial sector with it, as experienced by Lehman Brothers in 2008, which triggered the global financial crisis.

3. RBI identified systemically important financial institutions and subjected them to higher capital requirements and more stringent regulation. Eg., SBI

• The knowledge that a nation will be forced to rescue it encourages irresponsible behavior by big banks.

PSBs – a background

• Banks were nationalised 50 years ago in a different era, in a different context. 

• In the event, PSBs rendered commendable service to the nation by deepening bank penetration into the hinterland and implementing a variety of anti-poverty programs. 

• Of the many factors responsible for India moving from low income to low middle income, financial intermediation by PSBs has a place in that list.

Do we still need PSBs? 

• The financial sector is wide and deep enough to take care of financial intermediation without the government at the steering wheel.

• Today’s economic slowdown is due to both cyclical and structural factors. RBI has cut rates and the government has announced a few measures like frontloading expenditures and slashing some taxes. 

• We will become a $5-trillion economy not by growing at our current potential growth rate but by raising it. That requires structural reforms. 

CONCLUSION

If the government gives up its majority stake in PSBs, it will go a long way in pushing us into a $5-trillion economy.