A Study on Bank Concentration using Herfindahl-HirschmanIndex in Indian Banking Sector

Abstract

Bank concentration refers to the dominance of a few large banks in the industry, where control becomes more centralized as larger banks expand while smaller ones diminish. Over time, two contrasting schools of thought have emerged regarding the relationship between bank concentration and stability. Proponents of the "Concentration-led Stability" theory argue that banking systems dominated by a few large banks are more efficient, as these institutions can better manage risk through diversified portfolios.  This study assesses bank concentration in the Indian banking sector using the Herfindahl-Hirschman Index (HHI) methodology. The findings reveal that bank concentration negatively impacts profitability, solvency, and efficiency—key components of the composite bank stability index—ultimately leading to a decline in overall banking stability. To mitigate the adverse effects of high bank concentration, policymakers should focus on maintaining profitability by improving returns on assets and equity, monitoring capital adequacy to ensure solvency, and enhancing efficiency by reducing unnecessary costs. Additionally, banks can leverage digitalization to lower operational costs and improve efficiency.  The study also finds that bank concentration, measured by total assets, deposits, and advances, negatively and significantly affects the solvency of commercial banks. However, concentration in terms of total assets and deposits has a positive and significant impact on liquidity, while concentration in advances has an insignificant effect.  Regarding sector-specific trends, public sector banks experienced negative growth in HHI values for total assets, deposits, and advances, with average HHI values below 0.15—indicating a low level of concentration during the study period. In contrast, private sector banks showed growth in HHI values across all concentration parameters, with average HHI values exceeding 0.15, suggesting a moderate level of concentration. Foreign banks, despite displaying negative growth in HHI values for all parameters, still maintained average HHI values above 0.15, indicating a moderate level of concentration as well.