The government has merged some relatively strong banks with some relatively weak ones, to create some large banks, with capital adequacy, ratio of gross non-performing assets to total assets, and provisioning all reasonably adequate. However, reducing the number of public sector banks to 12 from 27 in 2017 reduces competition in providing credit, in an economy where the share of bank lending to GDP, taking out lending to the government, is about 50%. The saving grace is that the RBI has licensed a number of regional banks, small finance banks, payment banks and have a policy of bank licences on tap, so that competition could go up, if market conditions warrant it. So, potentially, competition in banking could go up, even as actual competition comes down.

The consolidation of public sector banks into 12 now, from 27 just two years ago, is a significant change. Even more significant would be the governance reforms, making the banks board-run and making the remuneration of bankers market-linked — it is difficult to imagine that once the risk officer’s salary is market-linked, other senior bankers’ renumeration would not be similarly market-linked. Here, instead of leaving the structure of bankers’ compensation to individual banks’ boards, it would be useful for the government to give some broad guidelines. Ideally, there should be a decent, upfront sum of compensation, a more liberal component linked to medium-term performance and the most generous component linked to longer-term performance, subject to clawback.

Among the 100 largest banks of the world, India has just one entity, SBI, coming in at the 55th position. PNB could now come close to entering the list. Where size matters is when it comes to Indian companies making largescale acquisitions abroad. When Tata acquired Corus or Jaguar-Landrover, the group had to rely on foreign banks. For large acquisitions, that picture will not change, but for smaller ones, Indian banks could suffice to finance such expansion, even within their exposure limits for a single group. Large banks are necessary for the efficient functioning of a large economy.

At the same time, large banks carry greater risk, that of being too big to fail. If a bank feels that it is systemically important and the government would not allow it to fail, it could take riskier lending decisions. That is, of course, theory: right now, banks are too scared to lend even modest sums.

One significant area of reform that should have accompanied the creation of large banks is to guard against such moral hazard: a separate capital structure and resolution procedure for large banks. The largest banks of the world, deemed systemically important, are required to have loss-absorbing capital significantly higher than that of the minnows. Where is such regulation in India, now that we are creating banking behemoths? And suppose one of these banks do fail, how is its resolution going to be carried out? The Modi government chickened out of proceeding with the Financial Resolution and Deposit Insurance Bill in its first term. India needs such a law in place, especially now that we have created large vulnerability with large banks.

Yet another reform that must be carried out without delay is to remove the shackles on the payment banks that have stunted their operations, and licence yet more banks, without compromising on the fit-and-proper eligibility norms for bank promoters. Some well-functioning NBFCs have been inhibited from converting into banks because of eligibility norms that require them to forgo their most lucrative lines of NBFC lending.

Fintech is another sector that the government loves to claim to promote. True, the RBI is creating a regulatory sandbox for fintech firms. But the regulations that exist now are too stringent to allow their growth. The saving grace, from a fintech perspective, is that they have untrammelled access to personal data harvested from mobile phones that download an indiscriminate number of apps, each of which calls for an expansive set of data access permissions that few have the patience to read through before granting,

The bond market reforms remain a work in rudimentary progress, the banking sector sees potentially reduced competition amongst banks that are large enough to take government protection for granted and so could be tempted to take more risk than is healthy and are free from any requirement to mobilise added loss-absorbing capacity by way of capital buffers, and are bereft any systematic resolution procedure.