Why PSU Bank Mergers Won’t Solve Indian Economy’s Most Pressing Problem
Against the background of slowing gross domestic product growth, the government has been announcing a number of measures to revive the economy. Among these was the announcement last week on the proposed merger of several public sector banks. The Finance Minister, in a detailed powerpoint presentation, explained the synergies that would accrue as a result of these mergers.
The government has been talking of these mergers for some time now, arguing that larger banks are required to drive economic development, and that management and supervision efficiencies would lead to greater competitiveness. In this particular announcement, there were no reasons given as to how these particular groups had been arrived at - Punjab National Bank with Oriental Bank of Commerce and United Bank; Canara Bank with Syndicate; Indian Bank with Allahabad Bank, and Union Bank with Andhra Bank and Corporation Bank. At first glance, the advantage of these combinations appears to be that the digital platforms within the combinations are common, which might help quicken integration of the IT architecture. Apart from that, while Indian Bank has its strengths in the south and Allahabad Bank in the east, and Canara Bank and Syndicate Bank have a presence in the west, no such synergies are seen in the other two combinations.
More importantly, the combinations do not relieve stress on either the provision coverage ratio or the net non-performing asset provisioning. In fact, in the case of Indian Bank, the net non-performing assets figure deteriorates after the merger.
None of the combinations are able to achieve a provision coverage ratio of 70 percent that is required. All would require equity infusion, of varying amounts to shore up their balance sheets.
There are some positives and some anxieties about this move.
- On the positive side, given that there is a move towards more digital and paper-free banking solutions, the integration of banks would lead to synergies and some competition among similar-sized entities. This would, in turn, help to improve enterprise value, and as and when the government decides to reduce its equity to below 51 percent, would help it benefit from improved valuations.
- Second, the span of control by the Department of Financial services reduces, enabling greater oversight and improving early warning signal systems.
- Third, over a period of time, staff rationalisation is also possible. Thus, if the target is to ensure effective management and to eventually unlock a higher value through stock sale, then the mergers make sense.
In terms of commercial viability and growth prospects of this move, only time will tell. It is clear that of the four groups, some have advantages, while the others would have a stiffer haul. The last merger of Bank of Baroda is yet to enthuse the financial markets, with share prices falling significantly from Rs 150 per share of the combined entity. There are yet no signals that this has resulted in increased business efficiency or better margins. The arguments that bigger banks would have the flexibility to give larger and better credit, with better operational efficiencies, has yet to be seen on the ground.
There are other worries as well. How much autonomy is going to be available to the management? The part about non-official directors performing the role of independent directors is worrying, as currently, the bank boards have a number of such directors with little background in credit and banking. There is little in the message about freedom in decision making. If the current mood of avoidance of credit risks continues, there is little that size alone can do.
The reason is, that at the core are issues of the past. Banks are facing stressed balance sheets primarily because of large ticket project lending to several infrastructure initiatives, up to 2013. Several of these projects fell by the wayside due to regulatory delays, cost-overruns and land acquisition issues. There is thus a hesitation, in all banks, in going back on the path of infrastructure lending. If the focus continues to be on retail lending for cars and homes and consumer durables, then the government objectives of growing investments in infrastructure will not be realised. Without large investments in industry and infrastructure, there is little chance of reviving manufacturing and industry. If this does not happen, growth would falter.
Finally, this measure is unlikely to have an impact on the current slowdown.
The mergers would take six to eight months to complete and for the new entities to lay out their wares. That would be late in terms of addressing the current economic concerns.
There is despondency and fear in the economy. Manufacturing growth is close to zero and credit flows are low. At the same time, there is sufficient liquidity with the banks — the State Bank of India chief recently said that he could give out credit up to Rs 2 lakh crore, but there are no investible projects. It is important to address the slowing of consumer demand. If car sales are dropping by 11 percent, inventories are dropping by a larger amount, and car manufacturing is dropping by 30 percent, it indicates that there is risk aversion among the stockists and expectations of lessening of demand. Lowering consumption demand is affecting small businesses the most. MSMEs are short of working capital and shrinking order books.
The next big NPAs for the banks are likely to arise from the MSME sector, especially Mudra loans, about which there is little data.
In short, the decision to merge these banks is no doubt a well thought one, against the backdrop of privatising some and creating strength in the banking system, but it is unlikely to have any significant impact on the slowdown that the economy is facing.
S Narayan is a former Finance Secretary and has served on the boards of a number of leading companies.
The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.