India’s merger debate: Bigger banks or better banks?

Another round of public sector bank mergers is on the horizon, with policymakers again signalling ambition to create “world-class” institutions. Apparently, bigger banks are presumed to be stronger, more resilient, and more globally relevant. Yet India’s economic structure raises doubts about whether size alone can deliver competitiveness or resilience.

India’s share of global merchandise exports remains below 2%, hindered by its relatively weak manufacturing base. Consequently, export finance represents less than 2% of total bank credit, significantly lower than in peer economies. Capital controls exist. Indian PSBs, thus, perforce, remain focused on mobilising deposits, lending domestically, and supporting rural development. Together, they run about 85,000 branches and employ hundreds of thousands of staff. What exactly is the challenge that merged banks will handle better than the current survivors?

The last restructuring in 2019-20 reduced the number of PSBs from 27 to 12. The integration of technology, HR, and branches was painful, with regional and personal connections often blunted or lost. Asset quality improvements were driven more by write-offs – amounting to over Rs 12 lakh crore in the past decade – than recoveries under the Insolvency Code. But what did size achieve? Five private banks – HDFC, ICICI, Axis, Kotak, and IndusInd – often collectively exceed Rs 20 lakh crore in market capitalisation, surpassing all PSBs combined, indicating that profitability, technology, and partnerships are more important than scale. Merging balance sheets without changing business models risks adding complexity, not global reach.

Globally, the contrast is stark. SBI’s assets are approximately $800 billion; the next four PSBs each hold between $180 billion and $210 billion. China’s ICBC alone has $6.9 trillion. JP Morgan Chase has $4 trillion, while Bank of America, Citigroup, and Wells Fargo each manage $2-3 trillion. Britain’s HSBC, Barclays, Lloyds, and NatWest all exceed $1 trillion. Even if India merged all PSBs, they would still be smaller than a single Chinese bank. Yet size alone does not make banks competitive. China’s lenders expanded because they were tied to national objectives, including financing exports and promoting the yuan. US and UK banks thrive in open capital markets, while India lacks these structural advantages.

The real issue is risk concentration. India has only about 135 scheduled commercial banks – including 12 public sector, 21 private, and 44 foreign banks – along with 28 regional rural banks and approximately 1,800 cooperative banks, implying that systemic risk is concentrated in a small set of institutions. This magnifies shocks, as seen in the NPA crisis. Other countries take a different view. The US has more than 4,400 FDIC-insured banks and 4,500 credit unions. The EU counts nearly 4,800 credit institutions. China has 4,000 rural and city commercial banks. Crises will always occur, and banks will be impacted; however, if they are large in number and varied in type, the shocks are more manageable.

India’s PSBs also carry unusually large branch networks. In the US, though JP Morgan and Wells Fargo have approximately 4,000-5,000 branches, banks with several hundred branches are considered large. European banks, such as Rabobank or Credit Agricole, operate as networks of smaller, community-focused, semi-autonomous banks. China’s giants avoid agricultural, priority, and microfinance lending. India’s unilinear PSB networks, staffed by undifferentiated cadres, risk anonymity and poor service quality. Customers often perceive PSBs as weaker on service and personal connect than private banks, a systemic issue rather than an institutional one.

Global turbulence has intensified, and risks are multiplying – from cyber threats to digital fraud to trade and climate-related conflicts. Other countries keep modernising regulators. The US spreads oversight across multiple agencies, such as the Federal Reserve, FDIC, OCC, and CFPB. The UK follows the “twin peaks” model: the Prudential Regulation Authority, under the Bank of England, for safety and soundness, and the independent Financial Conduct Authority for consumer and market conduct.

In the EU, the European Banking Authority harmonises rules through the “single rulebook” while national supervisors and the European Central Bank oversee banks. China has been continuously making regulatory setup changes, most recently in 2023, when it established the National Financial Regulatory Administration.

RBI, by contrast, still combines monetary policy, banking supervision, foreign exchange management, and payments regulation. Uniqueness should not excuse inertia. Insufficient investments in enhancing regulatory capability may create more problems than those faced in other countries, which continue to update their supervisory frameworks. Strong banks are necessary, but strong regulators are essential.

India’s PSB system does not lack scale or ambition; it lacks agility, which stems from a lack of operational independence and inadequate human resource reforms. Granting increased independence will require greater policy confidence in regulatory strength, warranting continual enhancements to regulatory capability lest India’s lenders fall victim to the newer risks, just as IndusInd Bank reminds us. As Clemenceau warned, “Generals always prepare to fight the last war, not the next.’’

(The writer is the former chairman of the Export Import Bank of India is a banker with a theory of everything.)

Disclaimer: The views expressed above are the author's own. They do not necessarily reflect the views of DH.