Banks: scale matters | Photo credit: iStockphoto
Therefore, in addition to the commercial banks, which are almost universal banks, there are small finance banks, payment banks and the cooperative banking system. There are clearly advantages to such a structure.
A plea for big banks
With the aura of globally pervasive economic thinking, arguments are made for having big banks. First, there is the reputation problem. Nowadays, it has become a given to be at the top – be it in terms of GDP or banks, given the economic power that India has in the global space. That is why it is an ambition to be part of the top 100 or top 500, and here the size of the banks is important. A globally integrated economy requires large banks.
Secondly, there is room for greater risks at the large banks. This is because large banks have larger balance sheets backed by capital. Because lending is tied to capital, more capital intuitively allows for greater exposures. This becomes relevant when it comes to infrastructure where banks take the lead.
Third, the RBI has recently relaxed large exposure norms and allowed merger and acquisition financing. This means that larger banks could operate in this business segment more effectively than smaller ones. Given the pace of merger and acquisition activity in the country, financing it will potentially become a big business for banks in the future.
Fourth, larger banks typically have the resources to invest more in innovation and compete in global markets. When we talk about globalization of the rupee, our banks have to be at the forefront, and it is the bigger banks that can follow this path.
Furthermore, in a digitally oriented banking system, large banks will find it easier to invest in technology. AI, which will be an integral part of banking in the future, is an area that requires continued substantial investment.
Therefore, there are compelling reasons to have larger Indian banks. In fact, the concept that banks are financial supermarkets fits into this canvas in which a large bank offers all financial products through subsidiaries under one umbrella.
The disadvantages
Interestingly, there are also arguments that support the status quo.
First, size in the global context is fictional. This is because, given the exchange rate and conversion to dollars for comparison purposes, Indian banks will always be lower in the pecking order. If the size of banks were calculated on a purchasing power parity basis, we would already be in this list, as GDP in PPP is almost 4.5 times GDP in nominal terms.
Secondly, having a few large banks means that risk in the system increases because of the large risks taken. The ‘too big to fail’ hypothesis is often put forward here, because any rupture can have major consequences for the financial system. Saving a small or medium-sized bank is less complicated than saving a large bank. Therefore, having such banks would mean creating such monoliths and then bringing them under the scanner under systemically important banking regulation. However, this can be countered by stricter rules in the system.
Third, given the asset-liability profile, banks may not be suitable for infrastructure lending. Deposits typically have a term of three years, and infrastructure financing for ten to fifteen years creates constant mismatches. Efforts are underway to deepen the bond market and create new long-term lending institutions, which could be more effective alternatives. But the counterargument here is that it takes time to develop based on experience and that the banks must necessarily do the main work here.
Fourth, a consortium approach already exists as long-term infrastructure loans cannot be avoided, which ensures that not all eggs are put in one basket. This has worked well for us and therefore there is no need to create new large banks to replace such loans.
Fifth, having large and fewer banks would automatically lead to the creation of an oligopolistic structure, which may not be desirable. For example, a company looking for a large loan doesn’t have much choice if there are only three to four banks. Reduction of competition can lead to mispricing of capital. Customers will also have less choice with banks.
An analogy is often drawn with the airline industry, where customers don’t really have a choice when flights are delayed or flights are canceled without compensation. Again, it is countered that there needs to be a strong regulatory structure to ensure this does not happen.
Difficult choices
So it is a difficult decision whether or not to establish large banks, given the arguments for and against those banks.
India’s experiment with bank mergers between PSU banks has been an undeniable success. This has reignited the debate.
Our need to ramp up growth will require investment levels of 35 percent of GDP. . Financing this will be the challenge. While foreign capital can support such investments, domestic institutions will be the primary driver. The corporate bond market needs further development to cover companies with lower ratings. The government has already promoted the idea of special financial institutions focused on infrastructure. Until these structures develop, the onus will be on the banks to finance growth.
Banks’ capital requirements tend to rise as credit growth averages 15 percent per year. The required growth capital would be around ₹5 lakh crore by 2030, rising to ₹38 lakh crore by 2045, when the country would be on the cusp of becoming a developed country. On balance, it may therefore make sense to pitch to more major banks.
Given the healthy state of the banking system, this may be the right time to debate the issue of big banks.
The writer is Chief Economist of Bank of Baroda. Opinions are personal
Published on November 19, 2025
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