Will RBI be a better judge for banking mergers?

Business Standard, May 09, 2012

By Pradeep S Mehta

As a prudential regulator, the central bank cannot step into the shoes of the Competition Commission of India. What is needed is more cooperation between the two authorities

Ever since the Competition Commission of India (CCI) started taking baby steps to regulate the jungle of competition abuses in the country, and some very successful cases, many started howling for an exemption from its bite. The latest one is from banking circles asking for an exemption from CCI’s remit to review mergers under the Competition Act, 2002, in that sector. Other strong contenders include the Department of Telecommunications seeking an exemption for the telecom sector. These moves are tragic and will affect the integrity of our economic governance system, and should be discouraged as strongly as the demand being made for exemptions.

In the case of giving the Reserve Bank of India (RBI) power to review mergers in the banking sector, let me argue thus. The banking sector’s stability is critical for the whole economy and we have learnt bitter lessons from the regulatory failures in the mecca of capitalism: the US. Second, there are too many banks in the public sector in India that need to be consolidated. However, these are two different issues and should not be confused. In Brazil, the central bank reviews all banking mergers from the angle of financial stability, but only when the competition authority refers the matter to the bank after it carries out its own due diligence.

It has been argued that CCI does not have the expertise to regulate mergers and acquisitions (M&As) in the banking sector, and that it is still young. Recent experience shows that CCI has been efficient, and has also cleared a takeover by HSBC of RBS’s retail business in India, a deal worth $1.8 billion. It did not refer the matter to RBI since there was no need and later even RBI may clear the merger with come conditionalities in line with our international rights and obligations. In some other cases, CCI has consulted sector regulators like in telecom and electricity because it felt that their opinion was germane to merger cases.

RBI is a prudential regulator of banks, while CCI is a competition regulator for the whole economy, including the financial sector. Prudential regulation requires laying out and enforcing rules that limit risk-taking of banks, ensuring safety of depositors’ funds, stability of the financial sector and other public policy requirements. Thus, regulation of M&As by RBI would be determined by such benchmarks. Competition regulation of M&As in the banking sector, on the other hand, is a different matter. The review will take into account whether such a merger can lead to an “appreciable adverse effect” on competition. For illustration, it will seek to ensure that banks compete among themselves for customers by offering the best terms and interest rates for both deposits and borrowings. While CCI is not a prudential regulator, RBI is not a competition regulator, though both are required to promote competition and consumer interest.

Competition in the banking sector helps the economy hugely and, in India, we can see its benefits after deregulation.

Studies have found a negative relationship between an increase in the level of concentration and savings deposit rates, and a positive relationship between an increase in concentration and an increase in interest rates and accompanying conditionalities. The recent move by RBI to allow portability of bank accounts is a step forward to expose banks to competition since they currently have an incentive to extract more rents from customers owing to switching costs once they are dominant.

However, central banks normally abhor intense competition among banks so as to ensure stability in the sector and depositor security. Competition can lead to high risk-taking as banks fight for customers, thereby compromising on security; hence, there would be a trade-off with financial stability. It is, therefore, important that both authorities are given space to exercise their mandates in the banking sector.

The International Competition Network (ICN), the global association of competition authorities, calls for application of general competition rules to the banking sector by competition authorities in parallel to the rules enforced by the central bank. This practice is also followed by almost all countries with competition laws, save for a few, but qualified, exceptions. There is only one significant exception, that is, Turkey.

In Turkey, the competition law is not applicable to the banking sector, but only if the total assets of the banks to be subjected to merger does not exceed 20 per cent of the market share. In Italy, although the competition law applies to the banking sector, it is applied by the central bank. The situation in the US is unique. Although banking mergers are exempted from competition laws, once the relevant agency (there are four of them, which includes the Federal Reserve) has approved a merger, the Anti-Trust Division of Department of Justice can file a suit within 30 days to block the transaction. If such a suit is filed, the parties are barred from consummating the merger until a federal district court conducts a review of the transaction.

In the case of failing banks, unquestionably, the mergers are allowed swiftly as in the case of Global Trust Bank in India that was taken over by the Oriental Bank of Commerce in 2004. There can also be a one-time exception from competition rules allowed in specific cases like in the UK in 2009 when Halifax Bank of Scotland was merged with Lloyds TSB after the earlier turned turtle following the financial crisis.

There is room, therefore, for both CCI and RBI in the banking sector, and the economy stands to benefit if both are allowed to exercise their powers. Genuine concerns such as the effects of delays from CCI in making decisions, especially in case of forced mergers, should not be used as justification for total but rather conditional exemptions. Just like in other countries, CCI can handle M&As in the sector with no delays only if there is cooperation between RBI and CCI. The sooner the two regulators sit down and work out a cooperation agreement the better for the whole economy, and one hopes that this call for exemptions will not be a basis for an adverse relationship between the two.

The author is secretary general, CUTS International.

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