There is much talk these days around consolidation in public sector banks (PSBs). There are good reasons for fewer and bigger PSBs. Larger PSBs can support the corporate sector better in overseas acquisitions, bigger banks are less susceptible to being taken over by outsiders (if government ever ceded control) and large synergies are available in mergers that could alleviate capital requirements. In India, moreover, there is a certain jingoist thrill in being able to say that we have a few banks that are globally significant.
But there could not be a worse time for this talk. When bank portfolios are uniformly strained, as they are today, mergers can accentuate the strains. A bank merger is never easy but when both banks have strained balance sheets, it can lead to a collapse. Mergers eat up a lot of top management time — IT systems, organisation structures, risk systems, exposure limits, and product portfolios need to be aligned. Branches need to be rationalised, customers need to be informed, brands need to be reestablished and people have to be placed in jobs. At a time when PSBs need a razor focus on cleaning up credit portfolios, mergers will be very distracting and will bring the sector to a halt.
In fact, Indian banking operates under three disparate regulatory policy regimes creating the PSB industry, the private bank industry and the foreign bank industry. These industries have had different freedoms, incentives and constraints in respect to branch licensing, compensation, regulatory prescriptions, M&A and capital raising. PSBs are also overseen by the dreaded Central Vigilance Commission and the Central Bureau of Investigation. The constraints that PSBs operate under, therefore, are well known and require them to address three specific challenges — recapitalisation (to deal with NPAs, Basel requirements and for growth of their balance sheet), governance autonomy (from Parliament — for strategic moves like acquisition, the vigilance apparatus, and the ministry for CEO and board appointments), and HR autonomy (in recruitment and compensation). In the current structure, none of this works. The recent attempts to address their plight (Indradhanush), while useful in themselves, have not come close to addressing the core issues.
The current talk of consolidation provides an opportunity to address these issues once and for all. The approach I suggest can clean up the mess, release capital, and create five large, structurally unconstrained government-promoted banks that do not require any parliamentary permissions. How?
I believe the government should promote five new banks under the RBI guidelines for new private banks. The RBI guidelines stipulate that promoters can own no more than a 40 per cent stake at the time of launch, which needs to come down to 15 per cent in 12
years. No other shareholder can hold more than a 5 per cent stake. The government could even seek an exception from the RBI and ask to be allowed not to reduce its stake below 26 per cent. The five banks should be promoted in five different cities — Chennai, Bangalore, Mumbai, New Delhi and Kolkata. Consolidation would occur by getting all the public sector banks located in the same city (in the case of Bangalore, the state) to transfer all their good assets and liabilities to the single new bank promoted in that city over a period of three years. So, for example, in Mumbai, the good assets and liabilities of
Central Bank, Dena Bank, Union Bank, Bank of Baroda, Bank of India and IDBI Bank across the country should be transferred to the newly promoted Mumbai Bank and so on for each of the new banks. However, government capital should not be transferred. An equitable scheme for minority shareholders in the new banks would be required. Just the structure of the new banks promoted by government would allow them a much higher price to book than the less than 0.5 per cent that PSBs currently enjoy. These five new banks would enjoy all the freedom of the new private sector banks with the government just being the promoter of these banks. They would have full HR autonomy, they would not be under the CBI or the CVC, and they would each have independent boards akin to say an Axis Bank. They would raise capital from the market. They would start out on new technology and would look to digitise bank operations from the start. They would have fewer branches and would use partnerships and alternative channels (mobile) a lot more. The State Bank of India (SBI) could be allowed to carry on as it is but at some point the government should reduce its holding below 51 per cent to provide a similar freedom to its staff.
The existing PSBs could be provided the minimum additional capital necessary for basic ongoing business and essentially to work out their impaired assets. It is not even important to close these banks down after three years but they will become a small SUUTI type rump (the impaired assets company of UTI) that will fade away. The big bulk of their senior officers would retire in three years and their employees under 55 would get very favourable consideration in the new bank, where the bank assets are transferred, on the new terms of employment. We should recall that Axis Bank started with a bulk of their employees coming from the SBI and SBBJ.
What a move like this does is that in three years’ time, we will have five large banks, with government as the single-largest shareholder, but without any of the constraints of the present PSBs. No permissions are required to do this, no debates in parliament and in one stroke we clean up the entire sector, make the banks bigger and allow the rump to be worked out over the next three to five years. The consolidation discussion provides the required fillip. It will be a lasting legacy the Modi government could leave India — a robust, large and clean banking system.