On Friday, Finance Minister Nirmala Sitharaman announced the government’s decision to merge 10 state-owned banks to create four large entities or lenders. Under the plan, Oriental Bank of Commerce and United Bank of India will be merged with Punjab National Bank; Canara Bank with Syndicate Bank; Andhra Bank and Corporation Bank with Mumbai-based Union Bank of India; and Allahabad Bank with Indian Bank. That will mean a consolidation of banks in India from 27 before 2017, to 12 after the merger goes through. What are the upside and downside of this move?
How does consolidation help?
For years, expert committees starting from the M Narasimham Committee have recommended that India should have fewer but bigger and better-managed banks to ensure optimal use of capital, efficiency of operations, wider reach and greater profitability. The logic is that rather than having several of its own banks competing for the same pie (in terms of deposits or loans) in the same narrow geographies, leading to each one incurring costs, it would make sense to have large-sized banks. This may be true especially in India’s bigger cities and towns. It has also been argued that such an entity will then be able to respond better to emerging market trends or shifts and compete more with private banks. The Finance Minister has said that the proposed big banks would be able to compete globally and improve their operational efficiency once they lower their cost of lending and improve lending. But none of India’s banks including the largest, SBI, figures in the list of the top 50 global banks. So that may be a long way away.
How does it help the government?
For over decades starting from 1992, the government as the biggest shareholder of over 25 banks had to provide capital for them. To grow and lend more, the banks often need a higher amount of capital to set aside also for loans that could go bad. With the government not willing to lower its equity holdings and with a large slice of the capital being set aside to cover for bad loans, which have swelled over the last few years, the burden of infusing capital rests on the majority shareholder. This means marking a large amount of money almost every year during the last few years in the Budget for many banks at a time when there is a huge demand for funds for education, health and other programmes. By reducing the number of banks to a manageable count, the government must be hoping that the demands for such capital infusion will be lower progressively with increased efficiencies and with more well capitalised banks. It will also help that the government can focus now on fewer banks than in the past.
On what rationale were the banks for the new mergers chosen?
The Finance Minister has said the government chose these banks on the basis of ensuring that there is no disruption in banking services and that these banks benefited from higher current and savings accounts (CASA) and greater reach. In the past, the government and the RBI had discussed potential mergers taking into account banks that operated in a particular geographical region or had strengths in such regions. During Raghuram Rajan’s tenure as RBI Governor, one proposal discussed was to merge all PSU banks headquartered in the East which were inherently weak. In the currently proposed mergers, this argument may apply mainly to the Bengalaru-based Canara Bank and Syndicate Bank. In the PNB-led merger, Oriental Bank is also a Delhi-based lender, while the strengths of midsized banks such as Andhra Bank and Corporation Bank in the South may complement Union Bank that has a stronger presence in the West and elsewhere. For Indian Bank, a conservative bank and one of the few to have reported profits earlier when many other banks were hurting, the high CASA of Allahabad Bank is bound to help. That will imply cheaper source of funds.
What are the potential downsides of such a merger?
Smooth integration of operations always poses a risk, especially with the prospect of resistance from staff and unions in the entities being merged. There are issues like cultural fit, redeployment of staff, and fewer career opportunities for many in a merged entity. Another concern could be deterioration of services and disruption in the near term as the merger process gets under way. It could also reflect in fewer options for customers; an easing of the personal touch which many of the midsize and smaller banks have. The swelling of combined bad loans with some of these mergers is also an issue.
Yet another worry is the possible creation of what is known as systematically important institutions, or those too big to fail, leading to the prospect of bailouts in the future, which could hurt the government and financial stability. But a bigger challenge will be in ensuring that there is no disruption in activity, especially lending, because of the proposed mergers at a time when banks have been loath to lend. Whether this will lead to a further slowdown in lending for a while is another concern.
What do these mergers signal for the Reserve Bank of India?
The RBI keeps monitoring large institutions whose potential failure can impact other institutions or banks and the financial sector, and which could have a contagion effect and erode confidence in other banks. A case in point is the recent instance of IL&FS Group, which defaulted on repayments hitting many lenders and investors. The creation of more large-sized banks will mean the RBI will have to improve its supervisory and monitoring processes to address increased risks.
What has the global experience on bank mergers been?
It seems mixed with some studies indicating that only 50 per cent have succeeded. Integration and cultural fit have been issues.
Can consolidation alone make a difference to the state of Indian banks?
No. Governance of these banks has been an major issue, which has dragged down many. The government has spelt out some measures to address that while indicating that more steps could be in the offing. Former RBI Governor Y V Reddy, in his D T Lakdawala memorial lecture, had said the idea that consolidation of banks will solve the problem of public sector banks is not correct. According to him, if the problem is structural and of governance, it does not matter whether the banks are large or small.