Banking too much on merger

Subir Roy

Columnist and Author

The government has promised a lot while going in for the merger of three public sector banks — the well regarded Bank of Baroda, the healthy small player Vijaya Bank and the goner Dena Bank. Official sources say it is expected to bring in savings of Rs 1,000-1,200 crore which works out to 2.5 per cent of the net profit of the entire banking sector in financial 2017.

Simultaneously, the Secretary of the financial services department of the government, which controls the public sector banks, has said the ‘amalgamation will help improve operational efficiency and customer services’ and offer customers a ‘wider bouquet of products and services’.

The rating agency Moody’s has said the merger of the banks would bring in benefits of scale and governance, but qualified it by adding that the new entity would need capital injection. This should be forthcoming as the government has assured the entity ‘capital support’.    

As ballooning NPAs have hurt banks’ ability to offer commercial loans, Finance Minister Arun Jaitley has said the entity ‘will increase banking operations’. Thus the merger is a way of getting a bit of the banking sector back into business.

Now the historical experience across the world is that mergers, more often than not, fail to deliver what they promise. That apart, the merger of competing firms in the same economic sector tends to yield an entity that is more cost efficient and stronger, so as to be able to land better deals.

Since these banks mostly operate in the same geographies and have branches in the same areas, the obvious course that the new entity will follow is to rationalise its branch networks, that is close down some of the competing branches in the same area.

It is the prospects of this and the resultant need for fewer staff that has automatically led the unions to oppose the merger. But the Finance Minister has assured that no employee will face adverse service conditions and ‘nobody will have to worry’. The government has likely budget the fact that a good number of employees will retire soon.

The staff that remains will obviously have to be redeployed, but the question is where and how. It is important to remember that the banking sector across the world is going through a process of technological transformation, at the apex of which stands the core banking system that enables electronic inter-office banking. Significantly, all three banks have the same Finacle core banking technology.

The onward march of electronic banking will need fewer hands, so it remains to be seen how the government will square the circle — not go in for any kind of retrenchment, even while reaping the economies of scale which the merger ought to bring.

This brings us to the issue of why the government has gone in for the merger. The declared aim of not just the current NDA government, but its predecessor UPA is to have fewer banks, the underlying logic being that India, even with 19 public sector banks after the latest round of merger, will have too many.

But the issue is, size has nothing to do with whether a bank is strong or not. Banking in both the US and Spain was severely hit by the global crisis of 2008, but whereas the US had several thousand banks, Spain had a few hundred. The health of a bank depends partly on whether it has adequate capital to tide over a rainy day. But the overriding requirement of good health for a bank is to have healthy customers. The health of the twin balance sheets — that of the bank and its customer — is critical.

That apart, there are many smaller regional banks which not only have a strong client base among small and medium businesses, but also have a deep knowledge of business conditions through historical roots in its area of operation. These banks live on the interest they earn from their commercial customers.

On the other hand, once a bank gets large, the option of operating in the financial markets opens up. It is the crisis in the market for securitised assets of the sub prime housing loans which hit large US financial institutions in 2008, requiring the government and regulator to step in. Once an institution gets too big, it also becomes too big to be allowed to fail. So there are strong doubts whether it is a good thing for the country to have fewer and bigger banks.

At the end of the day, it seems that what weighed with the government is the need to do something to save the 11 banks that have been put under ‘prompt corrective action’ (PCA) by the RBI, turning them into semi-zombies which cannot lend. The FM has said the Centre is keen on saving all banks under PCA, while noting that Dena is one of them. The capacity of the two healthier banks to swallow a weak bank was a key factor which influenced the government’s decision. To put it unkindly, the government got BoB and Vijaya to get it off the Dena hook, the same way as it is getting LIC to get it off the IDBI Bank hook!

But the crucial question is: will mergers like these rid the banking system of the ills which have cause the huge pileup of bad loans? Because if it is not, then more bad loans will eventually reappear. The long-term solution has been outlined by Raghuram Rajan, former RBI Governor, who has said in his note to the estimates committee of Parliament: ‘Improve governance of public sector banks and distance them from the government’ and ‘delegate appointments entirely to an entity like the Banks Board Bureau’. The tragedy is that after having created the bureau, the government disregarded most of its recommendations and Vinod Rai, the former CAG who headed it, left disappointed.