Consolidation in Indian banking sector to gain prominence

In the Indian banking sector consolidation is likely to gain prominence in the near future. Despite the liberalization process, state- owned banks dominate the industry, accounting for three- quarter of bank assets. The consolidation process in recent years has primarily been confined to a few mergers in the private sector segment, although some recent consolidation in the state- owned segment is evident as well.

These mergers have been based on the need to attain a meaningful driven largely by synergies and location and business specific comiementarities. Efforts have been initiated to iron out the legal impediments inherent in the consolidation process. As the bottom lines of domestic banks come under increasing pressure and the options for organic growth exhaust themselves banks in India will need to explore ways for inorganic expansion. This, in turns, is likely to unleash the forces of consolidation in Indian banking.

However there are two caveats. First, any process of consolidation must come out of a felt need for merger rather than as an imposition from outside. The synergic benefits must be felt by the entities themselves. The process of consolidation that is driven by flat is much less likely to be successful, particularly if the decision by flat is accompanied by restrictions on the normal avenues for reducing costs in the merged entity. Thus, any meaningful consolidation among the public sector banks must be driven by commercial motivation by individual banks with the government and the regulatory playing at best a facilitating role.

Second, the process of consolidation does not mean that small or medium sized banks will have no future. Many of the Indian banks are of appropriate size in relation to the Indian situation. Actual experience shows that small and medium sized banks even in advanced countries have been able to survive and remain profitable. These banks have survived along with very large financial conglomerates. Small banks may be the more natural lenders to small business.

(Excerpts from speech of Dr C Rangarajan, Chairman of the Economic Advisory Council and former Governor, RBI at Global Banking Conference, 12th Sept 2007)

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