Consolidation of Public Sector Banks

On Friday 30^th August When FM Sitharaman announced merger of several Public sector banks, she metamorphosed Indian Banking industry forever. From structural point of view, this is being considered as the biggest game changer after nationalization of Banks in two tranches on 19^th July 1969 and 15^th April 1980. Biggest consolidation exercise in Indian banking industry will result in merger of 10 banks into 4, thus reducing the total number of Public sector banks from 27 in 2017 to 12 now.  To summarize, United Bank of India and Oriental Bank of Commerce shall merge into Punjab National Bank, Syndicate Bank into Canara Bank, Allahabad Bank into Indian Bank and Andhra Bank alongwith Corporation Bank shall merge with Union Bank of India.

Seeds of this consolidation exercise were sown 28 years back in 1991, when the Committee on Financial system headed by former RBI Governor M Narsimhan had recommended  3-4 mega Banks at the top who can have a Global footprint with other Banks serving  regional needs. Successive Governments kept Narsimhan committee recommendations in cold storage and it was for Modi Government to bite the bullet.

Aim of this write up is to decipher and analyse the merger exercise from a layman’s point of view and understand its implications for the Banking industry and economy as a whole. We shall avoid technical details about business and profitability of merged entities, or to discuss respective balance sheets about which lot has been written and available in public domain.

What does this merger exercise mean 

Till very recently, Indian Government Banks had been classified into 3 groups - SBI and its associate Banks, all other Government Banks nationalized in 1969 and 1980 and a special category for IDBI Bank (developmental financial institution converted to a bank).

In a three stage exercise all associate Banks were merged with SBI with final merger effective 1^st April 2017. IDBI Bank was denotified as a Public sector Bank wef 21^st January 2019  as Life Insurance Corporation of India, acquired  51 % share in the Bank. Dena Bank and Vijaya Bank were merged with Bank of Baroda wef 1^st April 2019 and the current  exercise has covered rest of the Government Banks  These Banks have now been grouped into 3 categories (Business of individual Banks in lakh crore as on 31/03/2019 given in Parenthesis) primarily on the basis of core banking IT platform being used -

                                  

National Banks -    Punjab National Bank (11.82) with United Bank of India (2.08 )  and Oriental Bank of Commerce (4.04) using Finacle core Banking solution developed by Infosys

Union Bank of India  (7.41) , Andhra Bank (3.99) and Corporation Bank (3.20) using Finacle by Infosys

Canara Bank (10.43) and Syndicate Bank (4.77) using IFlex  developed by IBM

Indian Bank (4.30) with Allahabad Bank(3.78)  using BaNCS developed by TCS

National Banks -      Bank of India (9.03)

Central Bank of India (4.68)

Regional Banks -     Indian Overseas Bank (3.75) - predominantly South India

Bank of Maharashtra (2.34)   - predominantly West India

Punjab & Sind Bank (1.71)    - predominantly North India

UCO Bank  (3.17)                  - predominantly East India

To put the Banking scenario in perspective, as on 31/03/2019 , State Bank had a balance sheet size of Rs. 52.05 lakh crore , while Bank of Baroda (after merger of Dena and VIjaya Bank) had BS of Rs. 16.13 lakh crore.

So prima facie, merger’s primary objective is to step up size of Banks to achieve efficiencies of scale.. Since all the Banks are primarily owned by the Government, it did not make sense to have a fragmented structure which was creating problems in management eg infusion of capital. Consolidation in size would also mean that the respective Bank’s balance sheets become stronger in mid to long term range and it becomes easier for these Banks to raise funds and their dependence on Government funding goes down. In this context it may be pertinent to quote observations of Rating agency Fitch at the time of merger of Dena and Vijaya Bank with BOB. It  said the merger of the three banks could bring about material operating efficiencies over a period of time by lowering the combined operating costs, stronger risk management practices, etc.

The biggest advantage, says State Bank of India (SBI) Chairman Rajnish Kumar, is that bigger banks have greater ability to absorb shocks, reap economies of scale as well as the enhanced capacity to raise resources without depending on the exchequer.

What has merger resulted into

The first cluster of  Punjab National Bank, Oriental Bank of Commerce and United Bank of India shall be the 2nd largest Bank in the country after State  Bank with a network of 11, 437 branches. As on 31/03/2019 the 3 Banks had Tier1 capital of 6.21 % (PNB), 9.86 % (OBC) and 10.14 % (UBI). The combined entity shall have T1 capital of 7.46 %  Non-performing assets of PNB and OBC have reduced substantially to 6.55 % and 5.93 % respectively, while Net NPA of UBI is still high at 8.67 %. While PNB and OBC have similar culture and integration would be easier, UBI has a totally different culture and its integration into merged Bank shall be a challenge. At the same time, PNB and OBC have similar areas of operation and branch rationalization for paring down costs, may be an advantage.      

The second cluster of Union bank of India , Andhra Bank and Corporation Bank shall become the 5^th largest PSB with branch network of 9,609 branches in India. As on 31/03/2019 the 3 Banks had T1 capital of 8.02 % (Union), 8.43 % (Andhra) and 10.39 % (Corporation). The combined entity shall have T1 of 8.63 %. Net NPAs have reduced substantially to 6.85 % (Union), 5.73 % (Andhra)  and 5.71 % (Corporation) . The biggest challenge would be human resources integration as all the 3 Banks have very diverse work culture.

The third cluster of Canara and Syndicate Bank shall be the 4^th largest PSB with 10,342 branches.. As on 31/03/2019 the 2 Banks had T1 capital of 8.31 % (Canara) 9.31 % (Syndicate).. The combined entity shall have T1 of 8.62 %.  Non-performing assets are at 5.37 % (Canara) and 6.16 % (Syndicate). This may be one of the better merger exercises, as both the Banks have similar Balance sheet condition and  work cultures. There may be some overlapping of branch network which need to be rationalized.

The fourth  cluster comprising of Indian and Allahabad Bank shall be the 7th largest PSB with 6,104 branches. As on 31/03/2019 the 2 Banks had T1 capital of 10.96 % (Indian) 9.65 % (Allahabad). The combined entity shall have T1 of 10.36 %. Net NPAs are 3.75 % and 5.22 % respectively.  While both the Banks are almost similar in size, but Govt has probably decided to merge Allahabad Bank into Indian Bank as the latter has a better balance sheet. But HR integration shall be the biggest challenge as both Banks have very diverse cultures. There may not be any cost savings also as both Banks have very different geographical footprint.

Objectives and End goal of Merger Exercise

According to Government the proposed merger of PSBs, which together control a major share  of India's banking pie,  is meant to create a stepping stone to India's USD 5 trillion GDP target. Three broad gains have been listed namely increased capacity to lend, strong national presence and global reach, and operational efficiency gains to reduce costing.

While the four mergers listed out above are different from each other, but the Government is aiming to achieve similar goals from all the four exercises. Almost all the Banks are suffering from asset quality deterioration which has impacted their capacity to raise capital. So one of the avowed objectives of consolidation is to aggregate and strengthen the Balance sheets which may enhance their ability to raise capital in the medium term..

Let us examine and analyse the three objectives listed out by the Government in quantitative and qualitative terms.

First objective ie. increased capacity to lend assumes that stronger Balance sheets will help the Banks in raising capital and may be result in an  increased flow of credit. While this may be true but it needs to be understood that the stressed assets in these Banks are not the result of any choking of credit flow to industry but weak credit and project evaluation and credit appraisal skills. This further needs to be supplemented by putting in place better risk management and monitoring structure. In this context,  FMs announcement of induction of Chief Risk Officers in PSBs through lateral industry level recruitment is a welcome move.

Second objective  is the strong national presence and global reach. Bigger and stronger Banks with large branch network (like State Bank)  may definitely result in a wider national reach under one umbrella. It may also result in better customer service like availability of larger number of ATMs but the human resources challenge will have to be tackled carefully, Otherwise disgruntled staff who are not able to adjust to the new culture of anchor Bank may cause  worsening of customer service rather than any improvement. As far as global reach is concerned, merger may not have any significant impact, because a consolidation of overseas operations has already taken place in last 2 years whereby quite a few PSB branches in the same station have been closed down. Indian Banks except for State Bank have still to reach that critical size where they can standup and get counted in international Banking.

The third objective is in the area of gains in operational efficiency so as to reduce the cost of lending. This entails consolidation of branches and redeployment of staff to, may be marketing functions.  This needs a very detailed road map because shifting of customers between branches shall be a mammoth task. Apart from quantitative techniques, Banks will have to reduce turnaround time in disposing off credit requests so as to increase productivity and consequently  decrease costs. Major investments will have to be made to update employee skill sets .

In this context it may be pertinent to quote from a report by  Centrum Broking Research who said that “the consolidated banks will likely see an improvement in economies of scale and efficiency of operations over the medium-long term. "The government has also announced some measures on reforming the practices in the boards of these banks. These could result in more efficient management of leadership, higher levels of accountability and control, and easier administration from the government's viewpoint," It also pointed out that banks might face integration challenges over the near-term. "The logic behind the selection of banks in the merger plan is synergies in geographical presence, technology platforms, and benefits of scale, with minimal disruption to customers. "In our opinion (and going by recent precedence), consolidation has generally been near-term detrimental to the stronger (acquiring) banks and an extended integration period remains a challenge for these entities," the report said "We believe the proposed mergers will face near-term challenges by way of integration of processes, human resources, consolidation of financials, and branch network rationalization," it added.

Merits and advantages

Scale - To realize the dream of a USD 5 trillion economy, we need a few mega Banks that can ensure investment in large projects. Chinese example has shown that growth of economy and emergence of mega Banks goes hand in hand. Indian Banking industry is highly fragmented with a strong regional bias and this cannot meet the needs of an emerging world power.

Resource mobilization - A lesser number of Banks to deal with, shall make it easier for the owner ie. GOI to judiciously deploy scarce capital. At the same time a bigger consolidated balance sheet shall make it easier for individual Banks to access overseas markets for raising resources at a lower cost.

Efficiency - Consolidation may result in cost efficiencies. With the advent of technology, a single brick and mortar structure can now handle ten times customers what it could handle earlier. Reduction in number of co-existent branches shall result in huge cost savings in medium term .

Better Risk management - Its easier for a large Bank to spread its risk by building a diverse  portfolio. At the same time a small Bank has a limited risk appetite which not only hinders the growth of the Bank but reduces its utility to society at large.

Better growth opportunities for Staff - A larger talent pool with opening up of  a larger hierarchy , ensure that staff get better placements in more diverse roles with faster growth opportunities.

Improved customer service - Apart from the fact that Banks get access to a larger customer base, which in itself strengthens Bank’s balance sheet, the customers too gain though better access to ATM networks or offer of various Banking schemes and products.

Demerits and disadvantages

Cultural issues - Most of the Banks have a regional character although they may have a pan India presence. Customers and staff of these Banks identify themselves very closely with this regional character . Merger with a Bank form a different region tends to kill this culture and this may sow great dissatisfaction amongst staff and customers alike. So onboarding of  these two biggest stakeholders during the merger process, is going to be a major challenge.

Unmanageable size -  Large size of Banks is not a guarantee for success. If proper systems are not put in place, large size may become a liability and ring in chaos. Larger Banks may also be susceptible to wider range of risks while smaller Banks may survive global risks due to their regional character.

Needless distraction - Several experts have opined that while consolidation may or may not achieve some or all of its stated objectives, but the exercise itself shall be time consuming and may take away focus of top bankers from Stressed asset management which is the most crucial factor in improvement of balance sheets.

To conclude, it could be said that there are more pros to bank consolidation, rather than cons. If properly leveraged, it can bring in immense benefits to the economy. But, consolidation should be a well thought out strategy, by looking at synergies and balancing costs and benefits, so that post- merger, there is a distinct improvement in the balance sheet of banks. Consolidation should be done as a business tool and not for the sake of policy rhetoric.