Is It A Panacea For The Problems Of Public Sector Banks?
#BANKING & FINANCE7
Prof. V.P. Gupta
Director
Rau’s IAS Study Circle, New Delhi – Jaipur – Bengaluru
The Government of India has proposed to merge 10 Public Sector Banks into 4 large banks. After the mergers, there will be 12 public sector banks in India, including State Bank of India and Bank of Baroda. The idea behind the merger of the banks is to strengthen the balance sheets of the Public Sector Banks and kick start the credit creation in the Indian Economy to propel the GDP growth.
However, a large number of concerns have been raised with respect to merger of the Public Sector Banks. Critics have pointed out that it may not be the right time to undertake the merger. They have also highlighted that undertaking merger without bringing in banking reforms would be disastrous.
In this regard, let us understand the different dimensions related to Merger of Public Sector Banks in India.
Background to the Merger of
Public Sector Banks
The suggestion of consolidation among PSBs has been quite old. Narsimhan Committee Report in 1991 recommended a three-tier banking structure in India through establishment of three large banks with international presence, eight to ten national banks and a large number of regional and local banks. The PJ Nayak Committee on improving the governance of Public Sector Banks (PSBs) had also recommended for merger of PSBs.
In August 2017, the Union Cabinet had given in-principle approval for Public Sector Banks to amalgamate through an Alternative Mechanism (AM). The Alternative Mechanism is headed by the Union Finance Minister and gives in approval for the merger of Public Sector Banks. The final scheme of merger is notified by the Central Government in consultation with the Reserve Bank of India. Subsequently, the Associate Banks of SBI and Bharatiya Mahila Bank got merged into State of Bank of India. It was followed by the merger of Vijaya Bank and Dena Bank into Bank of Baroda in 2018.
Government’s Decision
Under the scheme of amalgamation, Allahabad Bank will be merged with Indian Bank (anchor bank—Indian Bank); PNB, OBC and United Bank to be merged (PNB will be the anchor bank); Union Bank of India, Andhra Bank and Corporation Bank to be merged (anchor bank—Union Bank of India); and Canara Bank and Syndicate Bank to be merged (anchor bank—Canara Bank). This move would bring down the number of Public Sector Banks to 12. The government has also announced capital infusion totalling over Rs. 55,000 crore into public sector banks.
Apart from the announcement of bank mergers, the Government has proposed certain reforms in the Governance framework as listed below:
1. To make management accountable to Board, Board Committee of nationalised banks to approve performance of General Manager and above (including MD);
2. To recruit Chief Risk Officer from market, at market-linked compensation to attract best available talent;
3. To enable succession planning, Board to decide system of ‘Individual Development Plans’ for all senior executive positions;
4. To ensure sufficient tenure, Boards given flexibility to prescribe residual service of two years for appointment of GM and above;
5. Flexibility given to Boards of large PSBs to enhance sitting fees of non-official directors (NODs).
Rationale for the Merger of Public Sector Banks (PSBs)
Fragmented Banking Structure in India: Indian Banking Sector is highly fragmented, especially in comparison with other key economies. Additionally, most of the PSBs in India are competing within themselves; most of them have same business models and compete in the same segments as well as same geographies. Thus, merger of the banks would lead to consolidation of Banking Structure in India.
Need to build capacity to meet credit demand: India needs to have global sized banks that can support the investment needs of $5 trillion economy and sustain economic growth. To meet the growing credit demand of the economy, the Public Sector Banks need to be well capitalised and need to enhance their capacity to lend to larger companies and larger projects.
Need for larger capital base to manage NPAs : Public Sector Banks (PSBs) which form approximately 72% of the Indian banking system are among the most affected by the high non-performing asset (NPA) problem at present. This has further resulted into a slowdown of credit growth in our economy, thereby reducing private investment and our potential economic growth. The merger of banks would lead to reduction in the net NPA ratio of the merged bank and kick start credit creation.
Merger of Weak Bank with Strong Bank: The merger of weak banks (higher NPAs and low profits) with the strong banks would prevent the collapse of the weak banks and protect the customers and financial system.
Benefits for the Government: The merger of the Public Sector Banks would reduce the financial burden on the Government on undertaking frequent recapitalisation of the Public Sector Banks. It would also help the Government in meeting the stringent capital requirements stipulated under the BASEL III Norms. The reduction in the number of the Public Sector Banks to 12 would enable the government and RBI to monitor the performance of the Public Sector Banks easier.
Significant cost benefits from synergies: Larger distribution network will reduce operating and distribution costs with benefits for the amalgamated bank, its customers and their subsidiaries. The merged bank would be able to provide wider range of products and services through leveraging of bank subsidiaries and leveraging of a larger network for offering more value-added non-banking services and products.
Risks and Challenges
Systemic Risk: It has been argued that a failure of a very large bank may have adverse impact on the economy as witnessed during the financial crisis of 2008. The 2008 crisis highlighted that presence of large financial institutions poses systemic risk to the economy and such institutions are “too big to fail”. Further, in event of any such crisis in future, the onus would lie on the government to bail out the institutions, thus posing a moral hazard.
Merger of Weak Banks with Strong Banks: The merger of banks is undertaken to prevent the collapse of the weak banks. However, in some of the instances, poor balance sheets of the weak banks could end up hurting the balance sheets of the strong banks. This may in turn lower the profit margin of the strong banks.
Low Positive Correlation between Size and Efficiency: The merger of PSBs is undertaken on an assumption that a large sized bank would be more efficient than a small sized bank. However, such positive correlation between Size and Efficiency is not always true. In case of India, some of the small sized banks are considered to be much more efficient than the large sized Public Sector Bank.
Human Resource Integration: One of the most challenging problems which could hinder the consolidation process would be in terms of human resource integration and management as many employees would fear job loss and disparities in the form of regional allegiances, benefits, reduced promotional avenues, new culture, etc.
Employment Creation: The Merger of banks would reduce the need for hiring fresh employees and hence this could in turn aggravate the present unemployment situation in the Indian Economy.
Timing of the Merger: Some of the economists have questioned the timing of the present merger of the PSBs. Instead of focusing on credit creation to boost the present economic slowdown, the PSBs would end up concentrating more on completing the necessary formalities and paper work in completion of merger and thus it may end up hurting the economic growth in the near term.
Customer Retention: The other challenge is customer retention. SBI’s recent merger with its associate banks saw customers of associate banks opting to move their business to rival lenders as result of a lack of comfort in banking with the larger parent.
Way Forward: While there are clearly benefits in this merger, it is important to note that the merger is not the panacea to remove all the economic ills of the PSBs. It is being argued that such mergers only push problems below the carpet, as the fundamental challenges are not being addressed. If governance issues afflicting the PSBs are not addressed, merging two or three public sector banks may not change the architecture. There is urgent need for the government to implement the recommendations of PJ Nayak Committee to strengthen the governance of the Public Sector Banks. Further, some of the other measures which the government should undertake include:
Focus on Strong Leadership: The Merger of banks would require strong leadership at the top accompanied by integration of technology and human resources. We need to have the people at the top level who should be able to focus on integration planning, revamp the Human Resources (HR) practices and culturally integrate the expanded workforce. Hence, the current heads of the anchor banks must be provided with security of tenure of 3 years so as to avoid any uncertainties in managing the merger process.
Strengthen Human Resources: The Public Sector Banks are underequipped in key areas of technology, Human Resources Management and Risk Management. Hence, there is a need to recruit professionals from the market so as to improve the competitiveness and efficiency of the PSBs.
Focus on Service Delivery: The PSBs should ensure that they do not face shortage of the front-line staff which can Compromise the service delivery. Further, these front-line staff must be provided with necessary training and capacity building to improve the effectiveness of service delivery.
Banking Reforms: The Government should also consider the Narsimhan Committee recommendations on converting some of the weak banks into regional banks. Banks such as Bank of Maharashtra that have higher regional concentration could be turned into vibrant regional banks to serve agriculture, trade and commerce.