It is the only body skilled enough to check anticompetitive practices but it has no role in facilitating the banking consolidation process
One must compliment Palaniappan Chidambaram to be able to rise above narrow considerations and support the jurisdiction of the Competition Commission of India (CCI) as the sole body to review mergers in not only banking, but all sectors. Thus, he has promoted the integrity of the economic governance system, which is imperative for the success of economic reforms.
All countries empower the competition regulator to oversee competition issues in all regulated sectors, including banks, purely because of their skills. The only exception vis-à-vis banking mergers is Turkey, but there, too, the central bank has to use the competition law to review mergers. A variation of this exists in the US, where the Federal Reserve and a few big state banking regulators oversee banking mergers, but the Antitrust Division of the Department of Justice can also intervene to check the competition angle.
In many countries wherever competition issues arise in regulated sectors, including mergers, the competition agency has to mandatorily consult the sector regulator. The proposed Competition Amendment Bill cleared by the Union Cabinet on October 4, 2012, has provided for such a coordinated approach. The process itself has a chequered history, which is relevant to the discourse. To begin with, the proposed Banking Regulation Amendment Bill, which is pending before Parliament, ousted the CCI’s jurisdiction on mergers. When the proposal on the Competition Amendment Bill came up before the Cabinet sometime in July, then Finance Minister Pranab Mukherjee sought blanket exemption for banks. Mukherjee’s position was echoed by Kapil Sibal – the communications minister – who wanted an exemption for telecom mergers because the Department of Telecom has its own merger guidelines. Chidambaram, then home minister, opposed it, and the matter was conveniently referred to a Group of Ministers (GoM) headed by Mukherjee. After Mukherjee became president, Chidambaram was appointed the chairman of the GOM and also as the new finance minister. He continued with his earlier stand in the GoM and the Cabinet, fortuitously, did not change the tune.
In order to address the overlap and conflict issues among our regulators and competition agency, the amendment Bill makes it mandatory for mutual consultation on all such issues. This paradigm has also been captured in the proposed National Competition Policy (and the Planning Commission’s National Manufacturing Plan), which will now go before the Cabinet for adoption.
We have faced many such conflicting situations in which there are ambiguities in our laws that create parallel jurisdictions for different regulators. They end up creating unpredictable legal environments, a lawyer’s paradise but an investor’s nightmare. Clearly, the law ministry sleeps and promotes such incoherent ambiguities, while the line ministries push their own versions, tinged by coalition politics, ignorance and dichotomies. The latest row is on the draft notification issued by the Central Electricity Regulatory Commission (CERC) on competition issues in the electricity sector in August, 2012. It is empowered to do so under the Electricity Act, 2003.
Mind you, all regulatory laws are required to promote competition, but it is only the CCI that is empowered to check anticompetitive practices in the whole economy. Even our courts have not been able to appreciate this fine distinction. In the case of a complaint against an aviation fuel cartel, the Delhi High Court erroneously stayed the proceedings before the CCI on grounds that the Petroleum and Natural Gas Regulatory Board (PNGRB) is the authorised body. Under its own law, the PNGRB is required to promote competition and consumer interest, but not check anticompetitive practices. But the PNGRB does not have any competition regulations.
Why was the CERC sleeping when it could have and should have drafted the competition regulations long ago? Since the recent debate on banking mergers, CERC realised that it, too, should flex its muscles. In any event, once Parliament clears the Competition Amendment Bill and the Banking Regulations Amendment Bill, ambiguities in other laws will also need sorting out.
Partner | National Leader - Global Financial Services, Ernst & Young
“Risk management practices and financial strength are more crucial to the sustainability of the sector. So, the commission should perhaps rely on RBI’s approval framework
In a free or competitive market economy, the prices of goods and services should be determined by demand and supply. The Competition Commission of India (CCI) was established to prevent practices having adverse effect on competition, to promote and sustain competition in markets, to protect consumers’ interests and to ensure freedom of trade carried on by other participants in markets. Any monopolistic or restrictive trade practice aimed at controlling supply or prices would be detrimental to the overall economy by reducing the economic efficiency leading to externalities and costs. Given the current regulatory framework and powers of the Reserve Bank of India (RBI), is there a role for CCI in the banking consolidation process?
Our banking system comprises 86 scheduled commercial banks, 82 regional rural banks, 1,645 urban cooperative banks (53 scheduled cooperative banks) and 95,765 rural cooperative banks. The business in terms of assets is dominated by scheduled commercial banks. Unlike manufacturing or other services, a critical aspect in the banking and financial industry is risk management and financial stability of the entities. The stringent regulatory and compliance requirements on capital adequacy and risk management practices lend to the stability of the banking system.
For financial products and service providers, the size of their balance sheets lends them financial stability and economies of scale. At any given instance there may be a variety of risks that are carried in the banks’ balance sheets. Larger the size, the better able a bank is to hedge and disperse the concentration as well as other risks within the portfolio. Size also provides banks with the ability to tide over unfavourable business cycles. The prolonged period of high interest rates over the last couple of years has adversely affected many sectors as well as economic growth. The banking sector, though facing a deteriorating asset quality, has been able to absorb the shock with steady return on assets and increase in operating income.
Size also allows banks to cross-subsidise products and pricing. Social banking has been one of the thrust areas in recent years and given the fact that financial inclusion in the country is around 50 per cent, the size of banks will be the key in the expansion of banking services. Banking regulations require banks to keep aside about 28 per cent of funds in cash reserve ratio and statutory liquidity ratio. Any bank without size and a business model focused on financial inclusion will struggle to stay afloat. The costs of social banking have been prohibitive for banks due to lack of branches and distribution infrastructure. Even with effective leverage of technology, the small size of financial inclusion portfolios makes it difficult to generate profits.
The experience in other geographies shows that a pyramid structure has evolved over time through consolidation and amalgamations. It is based not just on size but also on the customer segments serviced. For example, in China the four large banks have approximately 50 per cent market share and in Australia the big four banks control 77 per cent of the market. Experience in many other geographies shows a similar trend. Meanwhile, the Indian banking industry is highly fragmented with the largest bank along with its associates having a market share of about 23 per cent, the second and the third-largest banks have 5.7 per cent and five per cent share respectively. Importantly, the size of Indian banks is pale in comparison to global banks. Though on some levels it might be felt that fragmentation would drive competition and better pricing and service for customers, smaller sizes have excluded banks from achieving economies of scale.
Another aspect to consider is whether consolidation would lead to monopolistic and unfair trade practices. The industry follows a base rate system for pricing that takes into account the cost of funds, operational costs and margins to arrive at a price. The high level of transparency and grievance redressal mechanism precludes unfair trade practices.
The industry may, in effect, benefit from consolidation, given the current fragmented state, helping improve economies of scale and ability to cross-subsidise products and pricing. Additionally, appropriate risk management practices and financial strength are more crucial to the sustainability of the sector. Considering these factors, the commission may perhaps rely on RBI’s approval framework.