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RBI sees little relation between scale & efficiency
September, 10th 2010

The Reserve Bank of India has warned against scale, saying its studies have shown that relationship between scale and efficiency or performance was ambiguous.

The central bank's observations could mark a departure of strategy in terms of policy. A few years earlier, the finance ministry had indicated that while it would not force banks to merge, it would bless proposals for mergers put forth by banks themselves. Although several banks announced their ambitions to acquire smaller banks, there have not been any merger of healthy banks other than that of SBI and its associates.

Speaking at a FICCI banking summit, RBI deputy governor Subir Gokarn said in the Indian context, no discussion about the banking sector reform is complete without reference to consolidation, which is generally taken to mean a merger between two relatively small banks or between a large, supposedly strong one and a smaller, supposedly weak one. "While it is perhaps tempting to see the achievement of scale as the silver bullet for competitiveness, both domestic and global evidence do not make an unambiguous case for it," he said.

The deputy governor also highlighted RBI's concerns of a trade-off between objective of scale and the need to maintain a competitive industry structure. He said while in an ideal world, competition would drive banks to focus on areas of competence and achieve scale, in reality that the market is highly segmented and raises the prospect of scale-deterring competition in some segments while leading others to underservices. "From a policy perspective, this is not a desirable outcome," he said.

According to Mr Gokarn, large banks can become extremely vulnerable if their expansion strategies have been based on taking on a complex array of risks. "In the Indian context, there is substantial evidence, some of it produced by my colleagues in their research activity, that there is no unambiguous relationship between scale and efficiency or performance," said Mr Gokarn.

"A simple comparison of the five largest banks in China and India suggests that while the former are many times the size of the latter, in terms of their balance sheets, this does not apparently lead to a significant difference in efficiency and performance indicators," he said. According to the deputy governor, there are questions over the uni-dimensional approach to competitiveness taken by banks. He pointed out that while scale may matter, it is not by itself enough to guarantee the desired outcome.

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