Government Grants In-Principle Approval To PSU Bank Mergers

The Union Cabinet on Wednesday gave its in-principle approval for the merger of state-owned banks. With this, the government seeks to consolidate 21 state-owned banks in the country. Details of the banks to be merged are yet to be announced.

The proposal to merge will come from respective PSU bank boards, Finance Minister Arun Jaitley told reporters during after the Cabinet meeting. A panel of ministers, whose members will be decided by the Prime Minister, will examine these consolidation plans. After an in-principle approval from this panel, banks will abide by Securities and Exchange Board of India and Reserve Bank of India regulations.

The alternative mechanism will help fast-track approvals, Jaitley said. The objective is to create strong entities and any decision regarding consolidation will be based on commercial feasibility, the finance minister added.

The consolidation plan follows a successful integration of State Bank of India with its five associate banks and Bharatiya Mahila Bank. The merger, announced last year, became effective on April 1 and did not see much opposition from employee unions. While the merger process went through smoothly, the consolidated book of SBI has seen its gross non performing assets jump to just under 10 percent. SBI is also in the process of rationalising branches and re-deploying staff within the consolidated entity.

Similar issues are likely to crop up in any other mergers to be initiated among state-owned lenders.

In the short term there will be a lot of pain, said DK Mittal, former banking secretary to the Government of India, while adding that the government must be credited with taking a politically tough decision.

A former RBI official, speaking on the condition of anonymity said that consolidation will be good for the sector. In geographic areas where we see a lot of bad loans and weaker banks, consolidation will help in better governance and capital allocation, said this official.

An Idea Whose Time Has Come

The idea of bank consolidation is certainly not new.

In 1998, a committee headed by M Narasimham had recommended a series of reforms needed to strengthen the banking sector. Among them was a need to consolidate banks in a way to create a handful of large national lenders and a few strong regional lenders. The committee had also urged the government to allow these banks to function with greater autonomy.

Similar approaches have been suggested by other committees. The PJ Nayak Committee, which submitted its report in 2014, had noted that the government needs a radically different approach towards state-owned lenders if it hopes to reduce the fiscal burden it incurs due to the constant need to recapitalize these lenders. The committee had noted that the government has two options - to privatize these banks and allow them to be subject to market competition or design a new governance structure.

With the plan to merge some of the state owned lenders, the government has taken a step forward in banking reform. The issue of governance reform, however, remains unaddressed.

Other issues such as a willingness to cut back on jobs in public sector banks also remain unaddressed. KC Chakrabarty, former deputy governor of the Reserve Bank of India said that a merger will only be successful if it succeeds in reducing costs.

Also Read: Four Large Public Sector Lenders Asked To Consider Mergers

Why Now?

The consolidation plan comes at a time when most public sector banks have seen a pile up of bad loans. Data compiled by BloombergQuint shows that the gross NPA ratio of public sector lenders range from 7 percent to 24 percent across banks. IDBI Bank has the highest bad loan ratio of 24 percent while Indian Bank has the lowest ratio of 7.2 percent.

A high level of bad loans has also meant that banks need to set aside more funds for provisions, which has reduced the capital levels on bank balancesheets. The government has committed to infusing Rs 10,000 crore into banks this fiscal, which most external agencies believe will be inadequate.

Consolidation may do nothing to reduce the amount of capital that the government needs to infuse into public sector lenders in the short term, said Mittal while adding that in the long term there will be considerable savings.

Consolidation will also present individual implementation challenges for the banks. Apart from dealing with a possible rise in bad loan ratios following consolidation, the lenders will also have to do a significant amount of rearranging of their branch networks.

Over time, most of the lenders have set up branches in similar locations particularly in Tier-1, Tier-2 towns. The same is the case for ATM networks. Banks would also need to consolidate loan books to ensure that individual company and group exposure norms are not breached. Bad loan accounts will have to be merged and dealt with a combined manner.

Abhishek Bhattacharya,director at India Ratings & Research noted that regional mergers make more sense as compared to the idea of creating four or five large banks. That will help in better capital allocation and rationalising credit to same clients, he said. Bhattacharya, however, added that unless the individual banks are sustainable on a standalone basis, the merger would only create a bigger headache for the government.

At the end of the June quarter, public sector banks accounted for more than 75 percent of the banking sector’s outstanding loans and nearly 80 percent of its deposits.