Almost three decades after the M Narasimham Committee first recommended a redrawing of India’s banking landscape, the NDA government on Friday announced a big and bold step to consolidate state-owned banks. According to the mega merger plan unveiled by the finance minister, Nirmala Sitharaman, Oriental Bank of Commerce and United Bank of India will be merged with Punjab National Bank, making it the second largest bank in the country, while the south-based Canara Bank and Syndicate Bank will become one entity which will make it the third largest local lender, besides an amalgamation of Andhra Bank and Corporation Bank with Union Bank of India and Allahabad Bank with Indian Bank. This comes on top of the merger of associate banks of the SBI with the parent bank, and that of Vijaya Bank and Dena Bank with Bank of Baroda during the Narendra Modi government’s first term, thus pruning the number of government banks to a dozen.
A consolidation offers the promise of economies of scale, leveraging of pooled resources, manpower, brands, better utilisation of branch networks and increased efficiencies. Supplementing these will be the government’s decision to infuse capital separately into many of these banks and game-changing reforms such as the insolvency law and the asset quality review of lenders. In the near term, this will certainly benefit the largest shareholder, the government, more, with fewer banks to focus on and to assign capital. But the question is whether creating bigger banks will necessarily lead to the emergence of stronger entities. The biggest potential risk in such a consolidation blueprint is the swelling of more systematically important or too-big-to-fail entities and the systemic challenges they pose as the IL&FS blow-out showed. Manpower rationalisation and cultural fit will also be issues. Overcoming political resistance, and that of bank unions, may also not be easy. The process of integration will be difficult, consuming a lot of political and managerial energies.
The success of this ambitious plan to shrink the number of banks in India will hinge on a much stronger and more independent central bank with an enhanced capability to supervise these banks and ensure financial stability. It will also mean further bolstering the RBI’s capital buffers. The government’s move on Friday comes at the right time, with the NPA or bad loans problem appearing to have bottomed out. But India’s banking reforms will be complete only when the next set of governance reforms show in board driven and professionally run banks, which are free to operate without policy constraints or hounding by probe agencies and when the government reduces its equity. That should be the next milestone.