PUBLIC SECTOR BANKS CONSOLIDATION & MERGER
The IMF’s Global Financial Stability Report released in April made a strong case for bank consolidation, particularly in Europe. It argued that banks whose business models are no longer viable following the financial crisis held some 15 per cent of bank assets in advanced economies. Already, an ongoing global readjustment to the new regulatory structure — including the TLAC requirements (total loss-absorbing capacity requirements for global systemically important banks), the Dodd-Frank Act compliance, the Vickers Commission reforms and the Likanen group reforms — has forced banks in the US, the UK and the EU to rearrange businesses and move towards consolidation.
In this context, bank consolidation in the NPA-ridden Indian banking sector appears to make imminent sense. The idea is evidently not new. Way back in 1991, when India was faced with a forex crisis, the Narasimham Committee Report had recommended a three-tier banking structure through the establishment of three large banks with international presence, eight to ten national banks and a group of regional and local banks. In his Budget speech for 2016-17, the finance minister has spelled out the road map for consolidation of Public Sector Banks.
The state Bank of India, the largest Public Sector Bank of India has started the process of merging five of its subsidiaries namely the State Banks of Bikaner and Jaipur, Hyderabad, Mysore, Patiala and Travancore; and the Bhartiya Mahila Bank with itself.
Advantages of Consolidation
The biggest advantage of merger and consolidation is the realization of benefits of scale. Merger and consolidation of public sector banks will increase their asset size and hence the capacity to finance larger projects. To take the example of SBI, it will enter the list of top 50 global banks and could become one of the anchor banks to finance large projects like the Dedicated Freight Corridor, renewable energy projects etc. thereby reducing the dependency on foreign lenders or a consortium of multiple banks.
Further, there is an assumption that larger banks are less risky than smaller ones due to more diversified portfolio and hence earn a higher credit rating.
Merger and Consolidation will lead to risk diversification and reduce duplication as most of the banks target same clients with almost similar products.
The move will consolidate resources and infrastructure of the banks thereby reducing the cost of operations, human resources, technology etc. It will also reduce costs of inter-banking transactions.
Merger will allow banks to rationalize their bank branches and services and reduce branch overlapping. This will allow them to reach out to the unbanked areas in a cost effective manner.
A consolidated banking structure, according to Fitch Ratings, would be “a positive development” in the long term for the banking system and that consolidation coupled with higher capital needs and governance reforms “would position the banking system better in support of a more open and higher-growth economy”.
One of the foremost challenges in this process of banking consolidation is the existing NPAs. Without injecting sufficient capital, the process of merger and consolidation could lead to rerouting the problem of NPAs to the new consolidated bank thereby harming its future prospects. The merger of Global Trust Bank with Oriental Bank of Commerce in 2004 is an example of this.
Mergers and consolidation will affect the Banking Competition in the economy. As per some experts India needs more banking competition than consolidation to improve the banking services in the country.
Existence of excessively large banks may also create significant moral hazard costs for the entire system. A failure of a very large bank may have systemic implications and therefore, there is a perception that large banks may be bailed out during stress periods.
Finally, the process is to face considerable challenges from potential opposition from employee unions due to concerns like relocation and retrenchment due to rationalization of branches or impact on promotion prospects due to curtailment of seniority. This could hamper merger efforts and drive up costs. For example, SBI estimates that its merger with the associate banks will cost up to Rs.3 crore due to differences in employee pension schemes.
While the long term benefits of the consolidation process outweigh the short term concerns, the Bank Consolidation and Merger is still a tricky issue and should be taken on a case by case basis instead of being made a general policy. It is only to be applied to right banks and in a rightly planned manner and with proper safeguards.
Also, the acquiring bank should not dominate the smaller banks. Instead good practices of both should be combined and the focus should be on synergizing the efforts of all stakeholders towards evolving a healthy banking structure.
Finally, the merger process should not only be guided by the notion that big healthy banks have to acquire small weaker banks. Other models of merger like banks with diverse regional presence etc. should be considered. For instance, merge an eastern India-focused bank with one that has strength in the south to create fewer banks with a wider network.