Debate on Big Banks and Indian Banking System

The discussion on the role and necessity of big banks in India has gained momentum in 2025. India’s banking system is unique with a mix of commercial banks, small finance banks, payments banks, and cooperative banks. The question is whether India should promote bigger banks or continue with a diversified banking model.

Context of Indian Banking Structure

India has a multi-tiered banking system. Commercial banks serve as universal banks. Small finance banks and payments banks cater to niche sectors. Cooperative banks serve local needs. This diversity supports financial inclusion and specialised services.

Arguments for Big Banks

Big banks can enhance India’s global economic stature. Large banks have bigger balance sheets and capital, enabling bigger loans. They can finance large infrastructure projects and mergers and acquisitions effectively. The Reserve Bank of India (RBI) has eased norms for large exposures, favouring big banks. Bigger banks can invest more in technology and innovation. They can lead the globalisation of the Indian rupee and adopt AI in banking operations.

Concerns Against Big Banks

Size alone may not reflect true strength due to currency conversions. Large banks pose systemic risks; their failure can destabilise the economy. Smaller banks are easier to manage and rescue. Infrastructure loans mismatch with typical deposit tenures, creating risks. The bond market and specialised institutions are being developed as alternatives. Consortium lending reduces risk by sharing large loans among banks. Fewer big banks may reduce competition, leading to higher costs and fewer choices for customers. This oligopolistic risk requires strong regulatory oversight.

Experience with Bank Mergers

Recent mergers of public sector banks have shown positive results. They improved efficiency and capital strength. This success fuels the debate on whether more mergers or creation of big banks is needed.

Financing India’s Growth

India aims to invest 35% of GDP to sustain growth. Domestic banks will be the primary source of funding. The corporate bond market needs to mature further. Special financial institutions for infrastructure are being promoted. Banks will continue to play a major role until alternatives mature. Credit growth of 15% annually means rising capital needs. Estimates suggest ₹5 lakh crore capital by 2030 and ₹38 lakh crore by 2045. This supports the case for bigger banks with stronger capital bases.

Regulatory and Market Implications

Big banks require robust regulation to prevent systemic risks. Competition must be maintained to protect consumers. Innovation and technology adoption will be critical to global competitiveness. The balance between scale and diversity is key to a resilient banking system.

Questions for UPSC:

1. Taking example of the Indian banking system, discuss the advantages and challenges of having a diversified banking structure versus a few large banks.
2. Examine the role of the Reserve Bank of India in regulating large exposures and mergers in the banking sector. How does this impact financial stability?
3. Analyse the importance of the corporate bond market and specialised financial institutions in financing infrastructure development in India. Discuss in the light of the limitations of bank lending.
4. Critically discuss the risks and benefits of banking sector consolidation. With suitable examples, explain how regulatory frameworks can mitigate systemic risks associated with large banks.

Answer Hints:

1. Taking example of the Indian banking system, discuss the advantages and challenges of having a diversified banking structure versus a few large banks.

1. Diversified structure promotes financial inclusion by catering to niche sectors (small finance, payments, cooperative banks).
2. Small and medium banks reduce systemic risk; easier to manage and rescue compared to large banks.
3. Large banks offer bigger balance sheets enabling large infrastructure and M&A financing.
4. Big banks can invest more in technology and innovation, supporting global competitiveness.
5. Consolidation may reduce competition, leading to oligopoly, higher costs, and fewer choices for customers.
6. Diversified system allows risk-sharing (e.g., consortium lending) and specialized services tailored to varied needs.

2. Examine the role of the Reserve Bank of India in regulating large exposures and mergers in the banking sector. How does this impact financial stability?

1. RBI relaxed large exposure norms to enable banks to fund bigger projects and M&A activities.
2. Regulation of systemically important banks (SIBs) ensures stronger oversight over large banks.
3. RBI’s merger guidelines aim to improve efficiency and capital strength of banks.
4. Stricter prudential norms reduce risk of contagion from failure of big banks.
5. Regulatory vigilance balances growth ambitions with containment of systemic risk.
6. Effective regulation supports stable credit growth and maintains depositor confidence.

3. Analyse the importance of the corporate bond market and specialised financial institutions in financing infrastructure development in India. Discuss in the light of the limitations of bank lending.

1. Bank deposits are short-term (typically ~3 years), mismatched with long-term infrastructure loans (10-15 years).
2. Corporate bond market offers long-term funding alternative, reducing asset-liability mismatch.
3. Specialised institutions focus on infrastructure financing, providing expertise and patient capital.
4. Development of bond markets and institutions is gradual; banks remain primary financiers currently.
5. Consortium lending by banks helps share large infrastructure loan risks.
6. Deepening bond markets will diversify financing sources and reduce pressure on banks.

4. Critically discuss the risks and benefits of banking sector consolidation. With suitable examples, explain how regulatory frameworks can mitigate systemic risks associated with large banks.

1. Benefits – Improved capital base, efficiency, ability to fund large projects, and invest in technology (e.g., PSU bank mergers in India).
2. Risks – ‘Too big to fail’ problem; failure of large banks can destabilize entire financial system.
3. Consolidation may reduce competition, leading to oligopolistic behavior and mispricing of credit.
4. Regulatory frameworks (SIB norms, higher capital requirements, stress testing) help contain systemic risk.
5. Strong supervision and resolution mechanisms ensure timely intervention and crisis management.
6. Examples – RBI’s oversight of merged PSU banks and large exposure norms limit excessive risk-taking.