Tuesday, September 27, 2005
Are small banks viable? ---------------------- An intense debate is now on,in ourcountry,regarding the desirability of allowing smallbanks (either in the private sector or in the publicsector)to continue as independent entities.The FinanceMinister,Mr.P.Chidambaram,has been advising the banksto aim at the 3-Cs,namely Consolidation,Competitionand Convergence. The basic premise of those arguing for the mergerof small banks with large banks is that small banksper se are not potentially viable.It is contended thatmargins/spreads in banking business keep narrowing andtherefore banking has become a "volumes game".Only thebig players can survive;smaller banks have either tobecome big (organically or through mergers) or go outof scene. The counter-argument is that sustainability ofbanking business depends on efficiency andgovernance;size is not the deciding factor.Banks havegone under not because they were small,but becausethey were ill-governed.The Barings Bank,by no means asmall bank,collapsed because its systems were leakyand the camouflage of one person (Nick Leeson) wasenough to undo a banking behemoth.Nearer home,GTB bitthe dust owing to gross irregularities inmanagement.New Bank of India and Nedungadi Bank losttheir identity on account of lack of good governance. Banking Leviathans:There is always some inherentmerit and some innate demerit in size.Big banks likeState Bank of India and ICICI Bank are certainly ableto take advantage of economies of scale,garner low-cost deposits and offer low-interest creditproducts.They can easily afford to put in placeeffective risk management systems and therebyavoid,atleast theoretically,accumulation of distressedloans.Some large banks are alert enough to securitiseand sell their potentially non-performing assets wellin advance.It is another debate altogether whetherthese are desirable or sharp practices. Size,however,is not a guarantee against judgementalerrors.Empirical evidence suggests that the proportionof contaminated assets among larger loans ishigher.The advantage of large-sized banks is that theycan weather the shocks of large loan losses with lessstrain than the smaller banks.In this context,it isinteresting to note that "small versus big banks"debate is taking place in many countries now.Forexample,Judy Wasylycia-Leis,an MP belonging to the NewDemocratic Party of Canada has written to Canada'sMinister of Finance,in a letter dt.12th August,2005 asfollows: "We do not believe that large size ofbanks-resulting from bank mergers-improves oureconomy.Few benefit from Canadian banks such as CIBClosing billions on unproven investments such asEnron,yet permitting more Enron activities abroad isthe central goal of current merger talks." This may bean ideologically loaded statement,but this also showsthat bigness is not a panacea. Small banks,on the other hand,ensure 'financialinclusion'.They take care of financial needs of manysmall customers who may get marginalised by largerbanks.Social desirability of this aspect is alsostressed by Federal Reserve Bank of Chicago in their2004 annual report.To quote:"On a dollar-for-dollarbasis,community banks make nearly three times as manysmall business loans as the typical large bankingcompany,and they rely more than twice as much on smalldeposit accounts for funding.These are long-runeconomic relationships-community banks do not sell-offthe loans they make to local businesses,and theyconsider their depositors to be permanentcustomers,not just sources of funds." Size is crucial especially in capital-intensiveindustries.Surprisingly,despite the much talked-aboutBasel norms,banking is not equity -intensive.Publicdeposits which are basically debts for the banks ,aretypically more than ten times as much as the ownedfunds of banks.With such a high leverage,bigger banksobviously pose a much higher systemic risk.Hence,sizecan be counter-productive.Needless to say,we must laymore emphasis on prudent management of banks than onsize of banks.