In India, there is
increasing talk of merging smaller banks to create a behemoth that
will take on larger global players and fund big infrastructure projects.
Finance Minister Arun Jaitley has already set the ball rolling for bigger banks
by getting state-owned State Bank of India to absorb its smaller
associates.Contrast this with the narrative in the US, where President Donald
Trump said over the weekend that he is thinking of breaking up the giant Wall
Street banks.While a straightforward comparison cannot be made between big
banks in the two countries, both models deliver a strong underlying message.
Let’s look at the US first.
In the interview with Bloomberg,
Trump spoke of reviving a Depression-era legislation called the Glass-Stegall
law. It essentially involves splitting banks into two categories – consumer and
investment banking. The first is a deposit-taking entity backed by taxpayers
and shareholders that primarily provides loans to businesses and consumers. The
other banks fall under the category of investment banks and insurers that trade
and underwrite securities and create or focus on other complex instruments.
Many experts believe it was the latter –
trading and investing – that led to the financial meltdown in 2008, which
impacted not only the US but global markets too.
During his election campaign, Trump called for
a “21st century” version of the 1933 Glass-Steagall law. The logic behind
the law is to prevent tax payer money from flowing into speculative operations
from normal banking.
While Trump’s interview momentarily impacted
banking stocks, they soon recovered and moved higher on hopes that the
sum-of-part valuation will be higher than the current value of these banks.
However, not many are optimistic on Trump’s
proposals and feel it would be difficult to implement. The biggest hurdle will
be the banks themselves, which are too big to be disturbed. The banking
industry has dismissed the idea as not feasible and one that would have a
seismic effect on the banking system and impact jobs as well as lending
activity.
In India, the rationale for the merger was to
prevent the smaller banks from being crushed under the weight of their toxic
assets. Banks here have small trading books as compared to the overall size of
the bank. Thus, the threat of tax payers and shareholders money moving to
riskier capital markets assets is ruled out. In India, lending itself is a
risky business with weak laws that prevent recovery from defaulters.
The primary reason that India wants to make
big banks and the US wants to break them is the same: preventing the ills of
the banking system from spilling over to the economy.
However, the US experience shows us these
banks become too big to manage. In fact, most of the top financial and economic
roles in US governments have gone to representatives of these banks who ensure
their interests are taken care of.
However, It is highly unlikely that the US’
big banks, which fund Wall Street and a substantial portion of global markets,
will be allowed to be broken up by the forces that hold the purse strings.
In India, the reality is the exact opposite.
Banks are used to meet the government’s social commitments which are at times
not financially feasible. Political pressure is used to fund company expansion
plans and undertake restructuring that serves little purpose. Since they are
nationalised banks, the government cannot be seen failing them.
Both
nations need to look at Japan and the historic failure of its big banks. The
country has yet to recover from the failure of its big banks at the start of
the 1990s. Its economy has shrunk and at 234 percent, the government debt to
Gross Domestic Product is the highest in the world. This fact should be enough
to deter the Indian government from creating a monster that can take the
economy down with it.
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