The whys and hows of bank consolidation in India

Maidavolu Narasimham, 80, the 13th governor of the Reserve Bank of India (RBI), must be a happy man in Hyderabad today. What he had ideated in a seminal report on banking reforms more than two decades ago may finally see the light of day. At least, recent media reports suggest that. His report in 1991 recommended merger of public sector banks to make them stronger. It had envisaged a three-tier banking structure with three large banks with international presence at the top, eight to 10 national banks at tier two, and a large number of regional and local banks at the bottom.

Ever since the Narasimham report made this recommendation, there have been several rounds of discussions on mergers and consolidation of banks in India at periodic intervals. While the objective has, all along, been building scale and strengthening the risk-taking ability, the trigger for the latest round of discussion is the pile of bad assets under which some of the state-owned banks are likely to get buried.

A recent PTI report, citing an unnamed government official, said the government is working on a consolidation plan for public sector banks, in order to create a three-tier structure that will have three to four global-sized banks and reduce the number of state-owned lenders to about 12 from 21. According to the report, some “region-centric” banks like Punjab and Sind Bank and Andhra Bank will continue as independent entities, while some medium-sized lenders will also co-exist.

A TV channel even explained graphically the new banking structure. It seems that Oriental Bank of Commerce, Allahabad Bank, Corporation Bank and Indian Bank will be merged with Punjab National Bank; Union Bank will absorb IDBI Bank Ltd, Central Bank and Dena Bank; Syndicate Bank, Indian Overseas Bank and Uco Bank will be merged with Canara Bank; and Bank of India will grow by merging Andhra Bank, Bank of Maharashtra and Vijaya Bank with itself. The list does not mention Bank of Baroda playing any role in the new structure even as some reports suggest that the government wants the large banks themselves to explore the idea and it is up to them how they want to go about it. Finally, media reports also say that the government think tank NITI Aayog and a few other global consulting firms are examining the possibility of consolidation of these banks and the NITI Aayog will set the road map for this exercise.

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I am not sure of the authenticity of these reports, but one thing for sure is that both finance minister Arun Jaitley and Reserve Bank governor Urjit Patel are in favour of consolidation in public sector banks, which roughly account for 70% of the industry but are fast losing their market share. If, indeed, the government and RBI want to go ahead with the plan, they can do so as any merger between two public sector banking entities takes place under an Act that stipulates that two banks can initiate merger talks, but the scheme of the merger must be finalized by the government in consultation with the central bank and it must be placed in Parliament, which reserves the right to modify or reject the scheme. In case of a merger between a public sector bank and a private bank too, parliamentary approval is a must. Section 44A of Banking Regulation Act 1949 lays down the norms for voluntary mergers and “forced” mergers are done under Section 45 of the Act.

It may not be easy to arrive at the swap ratio as rights of minority shareholders—the government stake in these banks varies between 85.23% in United Bank of India and 58.38% in Oriental Bank of Commerce—have to be protected, but the government will not find it difficult to push through the mergers in Parliament. Since 1969, when Bank of Behar was merged with State Bank of India (SBI), and till Kotak Mahindra Bank Ltd took over ING Vysya Bank Ltd in 2015, most bank mergers have been an offshoot of the central bank’s efforts to protect the financial system and depositors’ money, and very few of them have been driven by the need for consolidation and growth. The only instance of a state-owned bank being merged with another was in 1993, when New Bank of India was merged with Punjab National Bank and this was not a voluntary merger.

Why do we need consolidation? Since financial stability is not threatened and depositors are not running the risk of losing money (as long as the banks have government backing), the logic for consolidation should be cutting cost and acquiring efficiency. In one press conference, Jaitley had said that weak banks will have to sell assets, reduce overheads and shut loss-making branches, among others. Patel had said in New York that consolidation of banks could entail sale of real estate where branches are redundant, as well as offering voluntary retirement schemes to manage headcount and adding younger, digital-savvy personnel. Technology may not be a big hurdle for mergers as most banks are working on a platform managed by the same vendor but the key to success of any merger will be large-scale shutting of branches in urban centres, reduction in staff strength and exploring the right business synergy and work culture. Despite automation, most Indian banks have gone for massive expansion of their branch networks in urban India, many of which will be redundant when some of them merge.

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Another critical point to ponder is—Do our relatively large banks have the ability to absorb weaker peers? Punjab National Bank, the largest among them with Rs7.21 trillion assets, has 12.53% gross NPAs (92% of its capital and reserves or net worth); Bank of Baroda (Rs6.95 trillion assets) has 10.46% gross NPAs (49.23% of net worth); Bank of India (Rs6.95 trillion) has 13.22% gross NPAs (90.42%); Canara Bank (Rs5.8 trillion) has 10.56% gross NPAs (76.55%) and Union Bank (Rs4.54 trillion) has 11.17% gross NPAs (88.02%). (Out of these, Canara Bank’s NPAs are of the June quarter and the rest relate to the March quarter.)

Yes, five SBI associate banks have been merged with their parent, catapulting the entity in the league of top 50 global banks in terms of assets, but even SBI has not been able to escape the pain of merging its associates with itself. Following the merger, its gross NPAs have jumped from Rs1.08 trillion to Rs1.79 trillion. In percentage terms, it rose from 7.23% of its advances to 9.04%. While its own net profit was Rs2,815 crore in the March quarter, the merged entity reported a loss of Rs3,300 crore. 

If this could happen to India’s largest lender following the merger of its own entities run by the same management, it’s anybody’s guess what will happen to a bank that takes the lead in the merger process, if it finds that the merged entities have not made the right disclosures and need massive fund infusion to take care of the bad assets. If we are serious about mergers among public sector banks, along with identifying business and geographical synergies, the quality of assets of the banks to be merged must be put under the scanner and the government should be ready to infuse fresh capital. In the process, if we find the health of some of the banks to be too bad, they must be allowed a painless death with their real estate, performing loans and deposits being sold to others and employees being redeployed in other banks or given a severance package. Ideally, the consolidation process starts after these banks are nursed back to health but if we are in a hurry, then the experiment should start with one bank and be taken forward after a few years only if it succeeds.

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Indeed, bank consolidation is the flavour of the season, but one should not lose sight of the fact that India needs more banks. RBI should continue to give licences to more small banks as well as universal banks along with the experiment on consolidation. The Narasimham committee had spoken about a large number of regional and local banks at the lowest tier of banking structure.

Tamal Bandyopadhyay, consulting editor at Mint, is adviser to Bandhan Bank. He is also the author of A Bank for the Buck, Sahara: The Untold Story and Bandhan: The Making of a Bank.

His Twitter handle is @tamalbandyo. Respond to this column at [email protected]

First Published: Mon, Jul 24 2017. 07 47 AM IST