Siddhant Kohli

A lot of debate in financial circles has recently been focused around the privatization of nationalized banks and merging of smaller banks into bigger ones.

Mr. Rajan and Mr. Jaitley have time and again reiterated the need for not more but bigger banks to spur the next stage of financial development in India. Their argument being that banks with larger balance sheets, cash reserves and lending capacity shall be the only ones capable of financing larger defense and public projects, invigorating large-scale private investment in the public sector. Currently, funding for these projects is procured from a consortium of banks who come together to create a corpus large enough for the project, with no single bank capable of handling the exposure alone.

While the rationale seems sound on the face of it, the concept of ‘banks too big to fail’ has been tried earlier. However, it failed miserably in the US, leading to the financial crisis in 2008. The government had systematically allowed or caused the merger of several small banks which ultimately led to the creation of the big 4, the ones that were the cause of the crash in the first place.

Giving greater monetary control to a smaller number of banks created a high stakes game of greater potential rewards with exponentially greater risk, in case these banks erred.

Replicating this model in India may give rise to the same conditions. As the government continues to reduce regulations in the interest of ‘ease of doing business’ while continuing to interfere in the creation and merger of financial institutions, it would result in an odd dichotomy: of private institutions being created by the government. These banks would have the size only governmental bodies are known to have while functioning with the motive associated more with private entities, a course that is bound to be unstable at some point. Of course, if the private sector reached a point similar to that on its own volition, without interference from the government, the situation would be different; since the size achieved would be organic, not political.

Who serves the poor?

The second issue in the question of larger banks is one that affects the rural sector. The rural sector is substantially undeserved, with most rural banks being cooperatives existing only at district levels and the like, providing micro loans and basic financial services to a part of the population who have no documents or access to the formal institutionalized banking sector. If the government reviews its focus from these small banks to larger ones, and even redirects capital infusions to them, the goal of financial inclusion will be compromised at some point. Naturally, these massive banks will not focus on financial services to the poor, leading to a dearth in micro loans, zero balance accounts and smaller bank branches which cater to small account holders.

In a country still very much poor and illiterate, perhaps the answer does lie in more banks and not larger banks.

This article was originally published on The Spontaneous Order.

Siddhant Kohli is currently a third year student of law looking to further a career in International litigation. He is interested in travelling, reading, and golf.

Posted by The Indian Economist