Two things become clear. One, India is still an ‘unbanked’ country. Two, by global standards, even the biggest of Indian banks are minnows in a business where size means clout and where geographical boundaries are blurring. Even by Indian standards, most of the banking sector is disadvantaged by size: the top 25 banks — of which, 18 are owned by the government — account for about 85 per cent of banking assets.

Such fragmentation is a matter of concern, more so approaching 2009 — the date set by the Reserve Bank of India (RBI) to relax operational norms for foreign banks. The sweep, nature and timeline of those changes haven’t been articulated yet, but as and when foreign banks are allowed unrestricted access, or even something approaching that, they could muscle out the smaller banks with their large capital base.

For instance, total assets of HSBC Holdings, the biggest global bank with a presence in India, are about thrice the assets of all Indian banks put together. Says Bhaskar Ghosh, managing director, IndusInd Bank: “Consolidation is required. No Indian bank can grow organically to reach a significant size, so it’s a good idea to merge and form some international-sized banks.” A parallel is the experience of non-banking finance companies (NBFCs), who, unable to compete with banks on costs and marketing, lost their business of home loans and car loans to them.

Squeezed by size and competition, a similar fate could await banks that are small or are uncompetitive, where there’s a lot of duplication of products and services without any value-addition to the customer. The set of public sector banks, which account for 75 per cent of banking assets, are ripe for mergers and acquisitions, and hold the key for any meaningful change in the dynamics of the banking sector.

Barring SBI, there’s not much to distinguish one public sector bank from another. It’s common to find 10 public sector banks in an area, all offering an identical banking proposition. Says Ghosh: “Indian customers will be served better if a large number of those become big entities, where cost can be shrunk without losing the product base.” Consolidation will lead to more efficient use of resources — branches, ATMs, employees, technology — enabling them to offer cheaper banking services.

Compared to their smaller peers, big banks can allocate more towards technology, the benefits of which are being able to service more customers and reach the desired economies of scale. In some of the new, large private sector banks, as much as 75 per cent of banking transactions are now conducted through the automated route (ATMs, Internet banking and call centres), compared to 20 per cent about four years ago.

The common consensus among banking sector experts is that M&As are desirable, even inevitable. But since the Left doesn’t think the same way, the sense of urgency is missing in the set of banks that need it the most: public sector banks. Since any merger moves are likely to be scuttled by employee unions and the Left, the best public sector banks are able to do today is form loose alliances of the kind struck by Corporation Bank,

Indian Bank and Oriental Bank of Commerce, which agreed to, among other things, rationalise branch network, and share IT and treasury resources.

Private banks are having to grapple with survival issues of their own. Being financial intermediaries that mobilise public savings and lend them onwards, banks have a fiduciary responsibility. Hence, the ownership pattern of banks is considered crucial to protecting the interests of depositors. As some of the private sector banks are community-based or promoter-driven, their shareholding pattern is concentrated in the hands of a few, which raises the possibility of misappropriation of funds.

If their stakes are to be reduced, some of the smaller banks will necessarily have to merge among themselves. Compared to public sector banks, there’s less overlap between private banks, as they have different business models and cater to different segments, but that also creates its own shortcomings. Says Shailendra Bhandari, managing director, Centurion Bank of Punjab: “They have different strengths. So, they know how to do SME, but they don’t know retail. They know how to do deposits, but not processing. There’s a need for them to come together.”

That apart, the RBI has also mandated a net worth of at least Rs 300 crore for banks. Some of the smaller banks with a lower net worth will be forced to become bigger and find ways to raise more capital. In a short period of time till 2009, it will be difficult for banks to grow organically, hence they are left with no option but to merge.

The RBI has paved the way over the next few years for banks to grow bigger, whether by themselves or through M&As. Says Ghosh: “There’s an understanding that big banks need to get bigger, as they are still not there internationally. Lower down too, mergers have to happen.”

The basic business of banking borrowing through deposits and lending through credit can only be profitable if costs are contained, which is best achieved by size. If Indian banks are to compete in an open environment, they have no choice but strive for size with efficiency.

‘Consolidation will happen’

Shailendra Bhandari MD, Centurion Bank of Punjab

On the need for M&As. Mergers are necessary. We have a lot of banks, but we don't have scale. Our largest bank, SBI, is ranked 84 in the world. Since there are many public sector banks, mergers will make sense. In the private sector, apart from three or four large banks, most don't have a national presence. Most of them, in fact, have limited strengths. So, for instance, they know how to do SME, but not retail. There's a need for them to come together, and learn and use the skills of different banks.

On when it will happen. The RBI is saying foreign banks can't do anything to local banks till 2009, which gives the latter a chance to get together. It wants promoters to reduce their stakes and raise more capital. Some attempted mergers landed in court. In India, non-economical, illogical reasons slow down mergers. That said, there's an understanding that even big banks need to get bigger to compete internationally. So, consolidation will happen.