1273637, Sanjay Verma , F2, Q. 30, Is Consolidation of Banks the way forward?

INTRODUCTION

Bank consolidation is the process by which one banking company takes over or merges with another. This convergence leads to a potential expansion for the consolidating banking institution. The issue of consolidation in the banking sector has assumed significance, considering the need for a few Indian banks to cater to global needs by becoming global players and the growing corporate and infrastructure funding needs. Taking into account the pros and cons of consolidation, it has to be borne in mind that while consolidation of commercial banks with established synergies and on the basis of voluntary initiatives is welcome, it cannot be imposed on banks. A measured approach is to be made both on consolidation and global presence even if attaining global size is not imminent.

DISCUSSION

The debate about consolidation in the Indian banking structure is not new. Starting from the age of Presidency Banks, the Indian banking sector has witnessed consolidation to enhance competitiveness. In fact, India’s largest bank, the State Bank of India, is a product of mergers of the Presidency Banks. There are, however, arguments both in favour and against consolidation. Consolidation can have several positivities but gives rise to certain concerns too.
The pros and cons of consolidation are discussed below.
Pros

·  Consolidation may facilitate geographical diversification and penetration towards new markets.
·  Big banks are usually expected to create standardised mass-market financial products. The merging banks may try and extend marketing reach and enhance their customer-base (Dymski, 2005).
·  The common criticism against consolidation is that it will have an adverse effect on supply of credit to small businesses, particularly, those which depend on bank credit, as consolidated big banks would deviate from practising relationship banking. But, there is recent evidence that reduced credit supply by the consolidating banks could be offset by increased credit supply by other incumbent banks in the same local market (Oxford Handbook, 2010b).
·  The transaction costs and risks associated with financing of small businesses may be high for small banks. Large and consolidated banks can mitigate the costs better and penetrate through lending into these sectors.

Cons

1. Consolidation may increase the market power of merged institutions and could result in neglect of local needs leading to reduction in credit supply to some category of borrowers, particularly small firms. The consolidated bank may rather cater to big ticket business, in the process adversely affecting financial inclusion.
2. Not all customers are treated in the same way by the big banks. There is empirical evidence [Dymski (1999)] that one consequence of the merger wave in US banking in 1990s has been that loan approvals for racial minorities and low income applicants have fallen and the extent of this decline was more severe for large banks.
3. The consolidating institutions are found to shift their portfolios towards higher risk-return investment (RCF, 2008).
4. Consolidation could also result in less competition through structure-conduct-performance-hypothesis giving fewer choices to the customer and arbitrary pricing of products.

CONCLUSION

According to me, consolidation of banks is the way forward as Larger banks may be more efficient and profitable than smaller ones and generate economies of scale and scope. Furthermore, the reorganisation of the merged bank can have a positive impact on its managerial efficiency. The efficiency gains may lead to lower cost of providing services and higher quality as the range of products and services provided by larger banks is supposedly wider than what is offered by smaller banks. Experience in some countries indicates cost efficiency could improve if more efficient banks acquire less efficient ones.