ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Concentration, Competition and Soundness of the Banking System in India

The banking sector in India has journeyed through multiple structural and policy changes in the post-liberalisation period. The most recent of these changes includes the merger and consolidation of public sector banks. In light of these changes, this paper examines certain important aspects of concentration, competition and soundness of banks in India. It reviews both competition–stability as well as competition–fragility perspectives. Based on a threshold derived, it supports recent attempts at consolidation among public sector banks and upheld these attempts as prudent. The threshold level of market share estimated in the paper may provide guidance for any future endeavours on the consolidation of banks.

Views expressed in the paper are those of the author and not those of the Reserve Bank of India. Results and findings have been formed on the basis of data available in the public domain. The author is thankful to an anonymous referee for valuable comments. This paper is a modified and updated version of a paper of the same title published as an RBI Working Paper in March 2022.

The Indian banking sector has been witnessing a wide range of policy-induced reforms and structural changes since the early 1990s. The recent spate of consolidation of public sector banks (PSBs) started with the merger of a few associate banks of the State Bank of India (SBI) and another PSB with SBI in April 2017. Exactly two years later, two more PSBs were amalgamated with the Bank of Baroda. In April 2020, the Government of India (GoI) consolidated 10 PSBs into four and termed it a mega consolidation, expecting it to enhance the competitiveness of the PSBs and stimulate banking activity in the country (GoI 2020). Consequently, the number of PSBs went down from 27 in March 2017 to 12 in April 2020. The new steps towards the consolidation of PSBs were in line with the Narasimham Committee report (1991) to create a few but strong banks that can compete at the national as well as the international level (Das 2019). The need for research to determine the ideal size of a bank in a country was earlier emphasised by Gandhi (2016).

The Group of Ten (IMF 2001), BIS (2001) and the International Monetary Fund (Mathieson and Schnasi 2001) have discussed aspects regarding the increase in the size of banks. Public policy and theoretical views on the link between consolidation and fragility in the banking system are not uniform (Beck et al 2005). The Organisation for Economic Co-operation and Development (OECD 2010) underlined the importance of an ideal size for financial establishments to evade systemic crises emanating from too-big-to-fail entities. It is observed from OECD (2010) that consolidation–stability or consolidation–fragility and competition–stability or competition–fragility theories in the banking system are widely debated hypotheses. While the consolidation (competition) stability theories favour higher consolidation (competition) in the market for greater stability of the banking system, the consolidation (competition) fragility hypotheses believe in the destabilising impact of higher consolidation (competition) on the banking system. An investigation for an inverse U-shaped relationship between market share/power and soundness of banks has assumed importance to identify the optimum level of concentration and competition (Cuestas et al 2017). Pietro Calice and Leone Leonida (2018) found that with an increase in concentration, the soundness of banks improved when concentration was at a low level, but fragility increased with a higher level of concentration.

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Updated On : 10th Dec, 2023
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