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Large banks more efficient, scope for more mergers in the sector: RBI study

The RBI analysis suggests that PSBs scored relatively better than other bank groups.

Large banks tended to be more efficient than small banks as they could reap the benefits of economies of scale, providing an additional rationale for recent mergers and further avenues of consolidation in the banking sector, a Reserve Bank of India study has said.

"It may also be the case that small banks have limited business operations," the study said. "Our results point to larger banks being labour cost efficient relative to their smaller counterparts as the former can reap the benefits of economies of scale. This finding provides an additional rationale for recent mergers of banks, both amongst PSU banks and private banks and suggests that further avenues of consolidation in the banking sphere may be explored," the RBI study on 'Labour Cost Efficiency of Indian Banks' has said.

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Larger banks can reap benefits of economies of scale

The central bank says larger banks are labour cost efficient relative to their smaller counterparts as the former can reap the benefits of economies of scale. The RBI report's finding provides an additional rationale for recent mergers of banks, both amongst PSU banks and private banks and suggests that further avenues of consolidation in the banking sphere. There's scope for more consolidation in the sector after the recent mergers of Dena Bank and Vijaya Bank with Bank of Baroda, Capital First merger with IDFC Bank and Indiabulls Housing Finance merger with Lakshmi Vilas Bank.

It said public sector banks (PSBs) turn out to be more efficient than private sector peers, reflecting deceleration in employment growth as also cost cutting through innovative techniques. "Furthermore, large banks are found to be more efficient than small banks as they can reap economies of scale," it said.

The number of large banks were 39 and 42 in 2005 and 2018, respectively, while for small banks the numbers corresponded to 37 and 42. In all the years, large banks were found to be more efficient than small banks. "Among large banks, PSBs initially had most number of banks with efficiency score of 1. After 2009, however, foreign banks had the largest number of banks on the efficiency frontier. In the case of small banks, foreign banks consistently remained the most efficient bank group throughout the period of study. This result is consistent with the results for bank-group wise analysis, which showed that foreign banks remain the most efficient banks amongst all the bank groups," it said.

"Our findings show that during the period 2005-2018 the labour cost efficiency of Indian banks moderated across all bank groups. The deterioration was especially marked during 2011-2016-a period that was characterized by severe stress in the banking sector – an exogenous factor not controlled by the labour cost dynamic," the RBI study said.

The RBI analysis suggests that PSBs scored relatively better than other bank groups. This has important policy implications as it demonstrates that labour cost efficiencies can be augmented by rationalising work processes. "This opens up the avenue of rationalisation in work flow by harnessing new technologies. In this context, payments banks, which are expected to leverage technology, could offer a laboratory experiment and it would be interesting to study their labour cost efficiency once data becomes available," it said.

With 144,952 branches of 159 scheduled commercial banks (SCBs) catering to the needs of about 1.3 billion people, the Indian banking system is one of the largest in the world. Over the years, its business model has remained primarily brick-and-mortar based although in recent years, the spread of digital modes of transaction has increased significantly, the RBI said.

This transformation has become pronounced since 2015 when the number of bank branches began to decelerate. "As a corollary, employment growth in the banking sector has also decelerated, which is in line with the international trend. Paradoxically, the per employee output of the banking system in terms of deposits, loans and advances, investments and non-interest income has increased during the period, suggesting that labour cost efficiency of the banking system has improved," the RBI study said.