The ‘Big Bank’ theory

This is going to be a merger like none other. We had 27 public sector banks (PSBs) in 2017. We have seen two mergers already in recent times – Vijaya Bank and Dena Bank merged into Bank of Baroda (BoB) in April, and the State Bank of India absorbed five of its associates and the Bharatiya Mahila Bank in 2017.

Now, six public sector banks will be merged with better performing banks, which are being called anchor banks. The upcoming mega mergers (or “consolidation,” as the ministry has called it) will reduce the number of PSU banks to 12.  Given the size of the banks, this will be a shakeout of a kind not attempted before, and in that sense bold or reckless, depending on which way you see the move. 

The idea of mergers emanates from the corporate world, and gradually the culture has arrived in the PSU sector. For perspective, it is said that eight out of 10 mergers are unsuccessful in producing any business benefit and shareholder value. But in this case, all are PSU banks, so culturally and sectorally, they come from similar if not the same stock, but within that they are diverse each has its own culture, history and standing. Officially, the objective for the mega merger exercise is the streamlining of operations, size and national footprint as well as strengthening banks’ risk appetite.

NPAs in focus

A study of the Non-Performing Assets (NPAs) of the 10 banks being merged into four shows that as many as nine have net non-performing assets (NPAs) ratio of over 5%. Only Indian Bank’s net NPA ratio is below 5%, at 3.75% as on March 31, 2019. United Bank of India (UBI) has the highest net NPA ratio of 8.67% as on March 31, with provision coverage ratio (PCR, or the ratio of provisioning to gross NPA, which indicates the extent of funds a bank has kept aside to cover losses; higher is better) of only 51.17%. As a result, the merged entity in this case, Punjab National Bank, will have a net NPA of 6.61% (against 6.55% pre- merger), and PCR of 59.59% (against 61.72% pre-merger). The health of UBI looks up; that of PNB goes down marginally.

The lowest NPA in this merger is of Oriental Bank of Commerce (net NPA ratio of 5.93%), so its NPA levels worsen with the merger. But averages conceal a lot of rot that is not squarely being addressed in this solution.

In general, higher NPA numbers have come down, capital adequacy has gone up and the logic that is being offered is that the amalgamated entity is stronger and will have better lending capacity. Coupled with the announced Rs 55,250 crore bank recapitalization, the hope is that these banks will be ready to support economic growth. The assumption here is that the present slowdown is cyclical in nature and monetary policy intervention through lowering policy repo rate will help turn the cycle, and the banks will be ready to meet the expected credit demand at a lower cost.

However, is the downturn truly cyclical, or is it structural? There are many who believe that deep issues of governance, which are at the core of the rot in the banking sector, cannot be addressed through a mere merger exercise. As former RBI governor Y V Reddy pointed out in a November 2017 lecture:  “Consolidation…by itself does not increase capital or address weaknesses common to all banks being considered for consolidation.” The extent of the rot and how we landed here is amply clear from this statement by former RBI governor Raghuram Rajan, reproduced in his book, ‘I do what I do’: “One promoter told me how he was pursued then (in 2007-8) by banks waving cheque books, asking him to name the amount he wanted.”

This is the ground reality – project appraisal is weak, even non-existent; project monitoring is poor; cost escalation is the norm. With no one on watch, the promoter had a free ride, in general, though not all NPAs are because of fraud. But standards of monitoring are generally lax. In his book ‘Advice and Dissent’, Reddy speaks of the times when there was “lazy” banking but then came “crazy” banking. “Credit was growing too rapidly for our comfort. The fear was that it was flowing for financing of asset bubbles.”

Pros and cons

A perusal of conventional literature on the amalgamation reveals that there are pros and cons. Some of the pros of the mergers are: (a) a large capital base would equip the merged entities to disburse a larger number of loans and of higher magnitude, (b) operational efficiency will reduce costs, (c) the need for recapitalisation from the government will reduce, and (d) better adoption of technology.

The cons of the amalgamation are: (a) it would be tough to manage issues pertaining to human resources, (b) having only a few large, inter-linked banks can expose the broader economy to enhanced financial risks, and (c) the local identity of small banks will be lost, leading to ramifications in the social and cultural space that are often not recognised or understood.

The finance minister has also noted 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.

The important question to be asked is: will the merger alone improve the health of the banking system? The short answer is ‘No’.

(Pattnaik is a former central banker, Rattanani is a journalist. Both are faculty members at SPJIMR.)