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PSB consolidation: Here's what experts think

In an interview to CNBC-TV18, DK Mittal, Former Secretary, Financial Services, Pradeep Kumar, Former MD, SBI and KC Chakrabarty, Former Deputy Governor, Reserve Bank of India (RBI) shared their views and outlook on the proposed merger of public sector banks.

August 23, 2017 / 08:41 PM IST

The union cabinet has approved to the framework for consolidation of public sector banks. A ministerial panel will be set up to supervise merger proposals from banks' boards. The names of the banks to be merged will be decided on four major points, profit of the banks chosen, similar geographical coverage, comparable asset quality and capital adequacy ratios.

In an interview to CNBC-TV18, DK Mittal, Former Secretary, Financial Services, Pradeep Kumar, Former MD, State Bank of India (SBI) and KC Chakrabarty, Former Deputy Governor, Reserve Bank of India (RBI) shared their views and outlook on the same.

Below is the verbatim transcript of the interview.

Q: You have seen this both as a regulator and as a chairman of a bank. We know the very deep problems that banks are facing now on an average, 15-20 percent of non-performing loans (NPLs). The same question as Ritu Singh was asking Arundhati Bhattacharya, at such a time, the pain of a merger, is that a wise thing?

Chakrabarty: No problem. You can take the pain provided your objective is very clear. Our financial system is inefficient. There is financial repression. If your objective is with the merger I will make the financial system more efficient, more robust, yes you can take pain, that all pains you can take together. But it generally does not happen. When you are in the problem what will happen, you will not be paying attention to other vital aspects, non-performing assets (NPAs) recovery, NPA management.

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So merged institution will become weaker and in the process what will happen, your entire financial system will become more inefficient because if the units are smaller, it is easier to resolve. Now you will be making the measure units bigger and it will be more difficult to resolve. So in future, it will be more difficult for the government to resolve the problem in these banks.

Q: From the government point of view, it is not a very enviable situation. I would think there are maybe a couple of banks where the NPAs are in single digits as a percentage of total loans. Indian Bank is standing at 6 percent and maybe Bank of Baroda (BoB) is a little south of 10 percent. Now if you were to give a 20 percent NPA bank to one of these then even the ability of Indian Bank or Bank of Baroda to go to the market will get reduced. On the contrary, if it is a merger between Dena Bank and Indian Overseas Bank (IOB), then is anyone going to get stronger? How do you combine this pack?

Mittal: What Dr Chakrabarty has said, that is certainly a very major dimension, but let us also understand that government has not said that we are going to merge everybody. The regulator as well as all experts in financial system have been saying that we need lesser public sector banks. So if the government decided and I think that is a welcome step. This is a process which is not easy, which is not short-term, it will take quite some time and in that process, we should also realise that if there are NPAs, then those NPAs are spread over to many banks.

It is not that the borrower is only having loan from one bank, they are from multiple banks and if there is a merger taking place perhaps, it is much easier to handle those borrowers who have loans spread over to six banks and some of them merged into – those six banks merge into three banks or two banks, then perhaps they can handle it much better. So that is also an aspect which we need to keep in mind.

But I fully agree, initially there will be pain. Let me also say that it is a process driven by the boards. We should realise that in private sector it is the promoter who drives acquisitions and mergers. So I do not think any board would like to say that I want to merge with anybody. That is not going to happen. It is only when some other board says that I want to take you, then the other board will say yes or no.

So that is a process which will have to be driven by the government from the back side because they are ultimately the key promoter. They hold more than 51 percent equity in all these banks. So it is ultimately to be decided by the government from the back side to decide that these two banks should merge and there will be a number of considerations and most of them will be political considerations, they cannot be left out.

For example, all banks of one state cannot be taken away and merged with other bank, that is not politically feasible. It will have a lot of political backlash. So those considerations will also come into play and I think that is a political reality, which we need to understand that we function in that political reality.

Q: You mean for instance, a Bank of Maharashtra cannot be merged into an Andhra Bank because it would be a Maharashtra-Andhra Pradesh thing? That is also a consideration?

Mittal: These considerations would play, local political sentiments will play up. There are banks for example in Chennai, there are some banks in Kolkata, there are some banks in Bengaluru, there is a bank in Hyderabad, there is a bank in Pune, so all these issues will also come up and they have to be gradually negotiated. There is no single solution straight away.

Q: First of all, board driven and commercial reasons, we just saw that the managing directors of two banks were summarily removed and the boards did not even know about it. It did not even go through the board. Are we really going to believe that this is going to be board driven? Will not be government driven?

Kumar: The minister said commercial considerations. At this point of time, I do not think any of the 20 PSU banks will take another bank for commercial considerations at the current level of NPAs. Only three or five banks are in single digit NPAs. 15 banks have double digit NPAs. And out of five, one is SBI, if you knock out SBI, do you think any of these four banks will take over any of the other banks for commercial considerations? I doubt very much.

I think, ultimately the government, through its nominees on the board will have to indicate. Otherwise this is not going to happen. If you remember, some years back, an earlier finance minister also said that we welcome consolidation, it has to come from the bank boards. I think it is more than a decade since he said that. No more consolidation has happened outside the State Bank ambit. So I am very sceptical that if you leave it to banks, nothing is going to happen.

I agree consolidation is required. That is the need of the day. I remember there is a right time, as Dr Chakrabarty said with the current NPA crisis, resolution of NPA should get priority over any other issue. But if you leave it to banks, nothing is going to happen.

Q: I am trying to get even one advantage at all because advantage would be when you are able to reduce the number of branches and as you say, reduce the number of probably CGMs who handle an account because two or three banks are going to merge. Will we have even one or two mergers and first of all, will there be any benefit, say year one?

Chakrabarty: Nothing is going to happen in year one. Let us understand, first year will be turmoil in the bank when there will be merger but then this is expected. I am not saying that there will be no problem, but all what I am saying, what is the objective. If the objective is to make the financial system more efficient, merging inefficient units will not bring the efficiency. If you merge them, they will become bigger inefficient units.

You have to bring competition. That means you have to bring, from outside, bigger banks. You have to allow more stronger players to float the bank. Then only there will be competition. Otherwise, entire financial system will become inefficient and you will not be able to resolve. Today, smaller banks, you are not able to close, when they will become bigger, how are you going to close them?

Q: Then are you saying that private sector should be allowed to buy out public sector banks?

Chakrabarty: Exactly, if you want that then that should be the case because Pradeep Kumar says no PSU bank is going to do. Maybe some privates or allow some foreign banks to take over or allow industrial houses to float the banks.

Unless you bring the stronger player, you are making existing inefficient player stronger, that means for the next 20 years, there will be no competition in the banking. So financial system will remain inefficient and that is my first worry that unless it is followed up by the structural changes in the thinking of the government, the public sector can be merged with the private sector, I do not think it is going to give you the result. The problems will be much more difficult after five years.

Q: When it comes to the private sector, there are immediately two problems. One, the government has not even started speaking about amending the law. Unless the law is amended, we are not going to be seeing the first step taken towards private sector buying up public sector banks. I did a dipstick survey with private sector bankers and their big fear is we do not know the unfunded pension liability. So while they are very attracted by the branch network, they are not at all sure what is the pension liability they will undertake. So first legal and financial, I do not think there is a great deal of private sector interest immediately.

Chakrabarty: All the things which are not know, even in fact, we do not know what is the NPA of the banks. When you are saying single digit NPA, I do not know whether you are taking right of advances or not. Look, we do not know what is the stressed assets, what is the flexible restructuring, what is unflexible restructuring, what is the restructured advances, which are the advances which are still NPA, but not declared.

Now unless you put all of them together, even you do not know what is the NPA position of the banks -- similarly pension liability, any private sector bank or any public sector bank, when he is taking over another bank, they will make the calculations. It is not a very big ball game, you know what the number of employees, what is their salary structure, etc. and what is the pension liability, you can work it out. It is not a difficult job.

But all what I am saying that by merging the inefficient public sector banks, you are making the banking system more inefficient. That means 70 percent of the banking system will remain more inefficient. We are through very high financial repression. Even 20 percent people are not having access to credit. We are reducing the number of players. Unless you bring alternate players, equally stronger players from the private sector, the financial system will become unstable.

Q: The other point you are saying that private sector is bringing strength to the system or can bring, that is happening. Already from 70 percent, I think incrementally, almost 80 percent of the credit is being lent.

Chakrabarty: This is not happening. The private sector is also becoming inefficient. If you have 70 percent inefficient system, this is what I am saying, we have not borne the fruit of competition, fruit of privatisation in the banking system. Customers have not realised that there is any benefit. I am sorry, I do not agree with that. Private sector neither gives any higher interest rate on deposit nor they charge any lower interest rate on advances.

In fact, these private sectors cannot bring the competition. We want much stronger players just like Reliance Jio in the banking. They can give only competition to the existing players.

Q: It is a very impassioned point you are making but the only thing is it is outside the realm of this discussion.

Chakrabarty: I know, but then the existing system will become more inefficient.

Q: What is feasible under the current policy which the government is trying to put through in terms of merger? You pointed out to the problems, but what is the most efficient way in which we can start this merger? There are people talking about similar geographies. I thought that would be a recipe for disaster because then crop failure will affect the entire set. Would not diversified geographies be a better idea? What should be the building blocks of the merger?

Mittal: We have the example of SBI and their subsidiaries merging, but because they were from the same family and three were lesser mortals in the SBI scheme if things, so there was no issue.

When we are merging two other public sector banks, the challenges would be both in terms of the internal processes, the manpower issues, the branch network technology, all those issues will be there and they have to be addressed in a commercial basis, that is a fact. Which core banking service (CBS) to be taken, how the merger will happen, what are the challenges, now they have 3,000-4,000 branches, how are they going to deal with it.

So those issues will have to be considered. And I do not think the geographical consideration can be the only point. This would be one of the points, but there will be many more considerations which banks will have to keep in mind when they decide that I want to merge with you and I want to take over you.

So these will be commercial considerations which will be there. Whether ultimately the merged entity will create value for the shareholders as well as for the public, both considerations will have to be kept in mind. And I will disagree with Dr Chakrabarty's point that public sector needs to be taken out.

We are the only country in the developing world where the financial inclusion is the best. It is only because of the role played by this stupid public sector, whatever we may blame them for. And for that, if there is anybody responsible it is the government. We cannot blame the public sector enterprise and their employees for this because ultimately it is the shareholder who is responsible for this. But despite that, whatever they have done, and which private sector bank has done financial inclusion, we would like to know from that bank.

Certainly my understanding is very much updated on this subject, but which private sector bank has done this, that is also an issue. So we need private sector banks, that is a necessity for the country. The poverty level which we have and the financial inclusion what has been done by this public sector banks is something to be cherished and to be respected by the public. We may keep on saying that they are the worst fellows, but they are the guys who are lending to infrastructure. Which other private sector banks has lent?

Q: I just want to know, whom do you marry with whom and on what principles?

Mittal: It has to be mutual consideration. I do not think we can lay down any guidelines on that. The question is we want consolidation in public sector banks.

Q: But you just said that mutual is going to be very difficult.

Mittal: No, I am saying that only territory consideration will be very difficult. There will be many more consideration for us to decide. A lot of exercises have been done. In the last 15 years there is so much of documentation done on the subject in the government. There are so many other reports available on different sides, different ways, territory merger, technology merger, manpower merger. So everything is available there. So somebody will have to sit and say what is to be done what and then make the banks ready that okay, you want to merge with them, this is how the merger will happen.

I must say that the government has taken this step forward, this is a positive thing. Initially, there will be problems, I fully agree. But ultimately, it is going to lead to positive results. Mr Pradeep Kumar will confirm that SBI merger, which is passing through a tough time will yield so much of benefits to SBI in terms of their branches being reduced, their manpower getting rationalised and volume, they are going to get through. But it will come in year two or year three, not in year one.

Q: If you were given a free hand to merge banks, tell me one appropriate set of banks that you can merge, two-three-four any which way?

Kumar: As I told you earlier if it is a commercial consideration, no merger is going to happen. We have to at best look for some complementarities because all banks have a similar business plan, everybody is universal bank when there is a slight difference in the extent of corporate lending in a couple of banks otherwise if the bank’s business plan is similar, business mix is almost similar -- only marginal variation.

So for commercial considerations, I don’t think the mergers can happen. Merger has to happen only for certain complementarities meeting, branch location, concentration of branches and things like that. Let us say for example, bank based in Bangalore where I am, Canara Bank has got very low presence in the East, maybe they can go for the bank in the east but unfortunately, most banks in the east are very much stressed. Whether Canara Bank is interested, is a moot point at all. So what I believe government is seriously interested in consolidation, it has to decide.

I don’t think they can allow it to the board of the banks to decide.

Q: Capital is supposed to be one reason why banks are getting merged. We would be running the tier-I or the common equity tier 1 (CET1) capital of the various banks, it is not as if there are any large number of banks which have a comfortable tier-I position or a CET position. Then what is the point of the merger, which two banks would you suggest for instance?

Mittal: We should look at how the banks are concentrated. We have three banks in Delhi, about six banks in Maharashtra then five banks in Bangalore, three banks in Chennai and one bank in Hyderabad. Now these locations themselves -- suppose you have to merge two banks at one location – at least you can save the cost of head office management, everything else, you also save the cost of the multiple branches being done, the multiple regional offices being done, the zonal offices being done, so I do not think merger is such a bad idea. It is a very good idea.

I would mention that there would be political limitations for the government to go forward which is the reality for the country but merger should come in that way only. The consideration will come, merger itself will bring a lot of economies of scale when these banks will come.

Coming to capital, I fully agree initially it may not bring anything, the government may have to come up with more capital infusion in whatever form they bring but ultimately the savings will come in year two. If they were to implement it faster then they can have savings coming in 2018-2019 or 2019-2020 onwards which itself will be beneficial for each of the banks which are getting merged.

Q: No benefit for at least FY18-FY19?

Mittal: It will take that much time. Before that, I don’t think anything can come in very short-term.

Q: I am trying to look at all the eastern banks, UCO Bank, United Bank of India, Allahabad Bank, all of them are in big double digit NPAs, nothing much by way of profits, so similar geographies is not very helpful, isn’t it?

Kumar: I agree because unfortunately in our country, the banks in eastern area have a very high NPA percentage. So it will be difficult and I agree with Mittal that there will be political consideration. Let us say, we have two banks in Chennai, IOB and Indian Bank and if they get merged -- let us say one bank gets merged with the Bombay based bank and another gets merged with Delhi based bank and the two headquarters are in Chennai. That will be politically very difficult. That is why I suggest the government must sit down and prepare a roadmap for this merger. Government must decide which banks to merge. Please do not allow it to the boards, I don’t think any board is going to recommend any merger.
first published: Aug 23, 2017 06:46 pm
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