Digging Deeper | The big bank merger - What, why, and what next?

In this episode of Digging Deeper, we look at the merger in some detail, what it means for the sector, and also take a look briefly at what the future could look like for the banking sector in India.

27 become 12

Nirmala Sitharaman announced four new mergers. Three banks - Punjab National Bank, Oriental Bank of Commerce, and United Bank of India - will combine to form what will become India’s second-largest lender. That entity will have a combined total of 18 lakh crore business, with India’s second largest branch network - 11,437 branches.

Canara Bank and Syndicate Bank will merge to form another large entity which will be the fourth largest PSB, with business worth 15.2 lakh crore. It will have 10,324 branches - the third largest network in India.

Merging Union Bank of India with Andhra Bank and Corporation Bank will create the country’s fifth largest PSB, with business worth Rs 14.6 lakh crore, and 9,609 branches - the fourth largest network.

When Indian Bank merges with Allahabad Bank, the new entity will be the seventh largest PSB, with Rs 8.08 lakh crore of business.

According to Business Today, these new entities will control “two-thirds of India's banking in terms of advances and deposits are meant to create a stepping stone to India's $5 trillion GDP target.” Here’s a number that will make all this PSB merge business easier to remember:

India will have 6 large public sector banks with Rs 10 lakh crore-plus balance sheets, two national banks and four regional banks.

Indian Overseas Bank, Uco Bank, Punjab and Sind Bank, and Bank of Maharashtra - these banks have a strong regional focus and will continue to operate as separate entities. Bank of India and Central Bank of India will also continue to operate separately as before. For PSBs as a whole, there will be 12 public sector banks in place of 27 public sector banks in 2017. Those 12 will include State Bank of India and Bank of Baroda. Sitharaman said such consolidation of public sector banks will give them scale.

The centre also announced and upfront capital infusion of Rs 55,250 crore for credit growth & regulatory compliance to support the economy. PNB will receive 16,000 crores; Union Bank 11,700 crores; Canara Bank 6,500 crores; Indian Overseas Bank 3,800 crores; Central Bank of India 3,300 crores; Bank of Baroda 7,000 crores; Indian Bank 2,500 crores, and Uco Bank will receive 2,100 crores. United Bank will see an infusion of 1,600 crores while Punjab and Sind Bank will get 750 crores from the centre.

Ms Sitharaman also announced other measures over the last few weeks that were intended to help lift India’s economy as an increasing number of indicators show it slowing down. According to the Economic Times, she announced a “rollback of the super-rich tax on foreign and domestic equity investors, exemption of startups from 'angel tax', a package to address distress in the auto sector...in an effort to boost growth” besides the infusion of capital into public sector banks.

She also claimed gross NPA level has come down heavily and that the centre is monitoring large loans to avert frauds. She also claimed that the sanctioning and monitoring of loans have been separated, and special agencies have been formed to monitor loans above Rs 250 crore to avoid a Nirav Modi-like situation.

This is not the first consolidation of public sector banks - in 2018, the centre approved the merger of Vijaya Bank and Dena Bank with Bank of Baroda that become effective from the start of the current fiscal. That merger created a new, improved Bank of Baroda that is the third-largest bank by loans in the country. The govt claimed no retrenchment, or layofffs, had taken place after the merger of Bank of Baroda, Dena Bank and Vijaya Bank, and that “the staff has been redeployed and best practices in each bank have been replicated in others.”

In 2017, State Bank of India absorbed five of its associates  - State Bank of Patiala, State Bank of Bikaner and Jaipur, State Bank of Mysore, State Bank of Travancore and State Bank of Hyderabad- and the Bharatiya Mahila Bank.

The FM added that in order to make managements accountable to their respective boards, a board committee of nationalised banks will appraise the performances of seniors like general managers, managing director etc. According to a report in Mint, “Post consolidation, the boards will be given flexibility to introduce chief general manager level as per business needs. They will also recruit chief risk officer at market-linked compensation to attract best talent.” Further, Risk Management Committees of banks will be empowered to veto management decisions and the banks board bureau will conduct leadership programs for bankers.

Does it actually help?

The government has listed three broad gains from the consolidation. They called it 'Unlocking potential through consolidation'. Let’s examine them briefly:

The first benefit is enhanced capacity to increase credit. The consolidated entities will have a higher capacity to lend, but also need capacity building, especially in project appraisal, risk management and monitoring. A bank like SBI, with its huge balance sheet, has also found itself in trouble with similar asset quality issues as other PSBs.

The second gain the govt claimed is strong national presence and global reach. But these PSBs already control two-thirds of all banking in India. As far as global reach goes, Indian banks have a lot to catch up. Competition from private banking institutions is eating into the share of PSBs, thanks to better digitisation, faster processing of loans, and much better customer service.

The third potential gain is the operational efficiency gains that reduce the cost of lending. This is one area where the entire operating model has to change. PSBs still operate in an old fashioned manner. Banking has changed significantly in the last decade, with product-focused banks. We  now have retail banks, small finance banks, payments banks and more. Meanwhile, PSBs seem to be caught in the relatively outmoded loop of corporate banking while private banks are exiting the space due to asset-liability management issues.

One analysis in Business Today, writing about PSBs, concluded, “The PSB model of banking with government ownership, control and also lending support to government's agenda (priority sector, financial inclusion, Mudra, etc.) has been a big stumbling block for bringing about a change in their functioning. The merger announcement doesn't address the core structural and fundamental issues plaguing the PSBs. The setting up of Banks Board Bureau...was path-breaking, but this model was not pursued to its logical end. The power of BBB was restricted only to appointments of senior management and directors. The government didn't extend BBB's scope to human resource (HR) reforms, NPA and stressed assets resolution, risk management, etc.”

That said, the mergers are all somewhat similar in nature. Prakash Agarwal, Head - Financial Institutions at India Ratings, observed, "The mergers are mostly among larger banks with absorbing bank not necessarily in strong health.” They all face similar issues like falling profitability, asset quality deterioration, an ageing workforce, and laggardly approach to digitisation. They all are also corporate banks in nature while retail banking is still very small.

Rating agency Moody's upgraded the outlook on Punjab National Bank yesterday from 'stable' to 'positive'. PNB is, as mentioned earlier, slated to merge Oriental Bank and United Bank of India with itself. The agency said PNB receiving a positive outlook reflects Moody's view that the bank's baseline credit assessments are likely to improve following capital infusion from the government, and its financial metrics will also gradually improve. That said, Moody's did caution that it could lower PNB's BCA and ratings, or change the rating outlook to stable, if asset quality, profitability, and capital deteriorate on a standalone basis or as a result of the merger.

It was suggested at a meeting by the 10 banks that they should form joint committees on various verticals, under an apex committee to oversee the process. For instance, different committees with representatives from all of the entities to be merged could work on various parts - like risk management, products, technology or policy. The apex committee for the merger will anchor the process. Business Standard reported that the meeting was anchored by the ministry of finance, and the more on processes considering the many statutory and legal stipulations involved in a merger. Many senior pros across all the banks are involved in the world on the mergers. One of the bankers said, “We do not want the feeling of large banks taking over control of small banks to dominate the process. Best practices of various banks will be adopted to get business benefit for an organisation, post merger. The priority is minimal disruption to business and customers.” Meanwhile, Rajkiran Rai, MD and CEO of Union Bank of India, said it was more of learning from Bank of Baroda’s experience of merging with Vijaya Bank and Dena Bank.

State Bank of India Chairman Rajnish Kumar said the biggest advantage 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.

That is, of course, no guarantee of success. SBI itself is an example. As Business Today pointed out, India’s largest bank does not figure in the top quartile in terms of performance. An analysis in BT explained the situation like this: “Product differentiation is completely missing and it seems the technology platform was one of the major drivers for deciding the banking mix of banks. Do we need more clones of each other? Experts suggest there should be a differentiation in terms of product category, say SME or emerging corporate-focused banks or purely retail banks or large corporate banks. Currently, there are specialised banks in the market. For instance, HDFC Bank, Kotak Bank, etc. are emerging as retail banks. There are Bandhan Bank and a host of small finance banks that are focused on catering to unbanked and underserved segments of microloans. In a slowing economy where the asset quality deterioration of PSBs has still not receded, the merger move could be counterproductive.“ 

Anil Gupta, Vice President at rating agency ICRA, told BT, “The choking of management bandwidth should not result in a slowdown in credit flow to the economy.”

On the other hand, an analysis in BloombergQuint approved of the centre’s move. The report said, “This initiative is a welcome move in the right direction...One of the causes for the slowdown was the reduction in lending following the financial problems we saw from the IL&FS issues since last September. Consequently, the banks started going slow on lending to NBFCs, which in turn did not have the money to lend for purchases of cars, two-wheelers, houses, etc. That aggravated the slowdown caused by poor and erratic monsoon as well as the lingering effects of demonetisation and GST. This initiative by the central government is a measure to help improve banks in their capital adequacy.”

That analysis also explained that the central government, the owner of the PSBs, is trying to improve the governance of these banks. We have witnessed in the past how ineffectively these organizations were run. There were news reports on lending decisions being made not on merit but based on other considerations. Bloomnberg’s column explained, “The improvement in governance is focused on objectives sought to be achieved, systems and processes within the bank itself, merit-based lending and oversight by the board. The government had taken a decision in the past on the separation of the role of the chairman and the managing director—earlier the public sector banks were run by one person who was chairman and managing director, but this separation is not efficiently implemented. It should be implemented immediately by giving...more powers to the chairman so that the chairman has some oversight and responsibility over the board and also over the chief executive officer.”

According to Moody's, the govt’s measures also give rise to some execution challenges and do not yet reflect the potential positive impact on the banks' ratings. It is worth noting that public sector bank shares have been on a selling spree following the government announcement to merge banks.

What do the experts say?

PNB’s MD and CEO, Sunil Mehta, said this merger will be beneficial for the banking system, and the country as a whole. He said the merger of three banks will bring a lot of synergies into the existing entities and that the capital infusion announced by the government for the merged entity is adequate. He added, “All the requirements of the bank, including the minimum regulatory requirement as well as the growth requirements have been completed while working out the Capital infusion.”

Canara Bank MD and CEO RA Sankara Narayanan said the move will provide better opportunities to do quality business. He explained, “we will be taking the proposal to the board in the next 7-10 days, and once we get the approvals from the government and the gazette notifications, the actual integration may happen sometime in first week of April.”

Arundhati Bhattacharya, former chairman, State Bank of India, told ET, “I have always said that India needs bigger banks…many PSBs were sub par in size and this merger will help them...The kind of investments one needs to make in compliance and technology is enormous and…the return on investment is not enough (for smaller banks). The bigger the entity, the stronger you become.”

Kuntal Sur, partner at PwC India, said, “All these banks were thin at the top because they were struggling to get good quality GMs and CGMs, and these mergers will create the bandwidth for better midmanagement. This will, in turn, help in better loan monitoring, overseeing the end-use of funds, and better recovery.”

Saurabh Tripathi, partner, Boston Consulting Group, explained, “A bigger bank helps in more independent decision making. SBI is a case in point...Its size and scale allow its management the bandwidth and stature to deal with government ministries with confidence and make faster decisions. The smaller banks still wait for government signaling.”

Conversely, a report by Credit Suisse claimed the merger is unlikely to revive credit growth or have meaningful cost synergies. The report said, “Coupled with the ongoing moderation in growth for private banks led by auto sector slowdown and increased cautiousness, credit growth, thus, is unlikely to be revived by PSB mergers." It explained that the merger is unlikely to meaningfully revive the flow of credit to the liquidity pressed NBFCs - given the already high share of NBFC exposure in constituent banks, the four new entities will have more than 10% of their loan exposure towards NBFCs. About cost synergies, the report said that “the limited flexibility on restructuring and rationalisation indicates that meaningful cost synergies from PSB mergers are unlikely. While the large recapitalisation improves the capacity for banks to grow loans, recent experience of State Bank of India and Bank of Baroda indicates that focus on integration impacts near-term growth .” The report summarized that the merged banks will continue to depend on external infusions inviting frequent dilutions.

Taking a middle path, a report by Centrum Broking Research claimed, “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...We believe the proposed mergers will face near-term challenges by way of integration of processes, human resources, consolidation of financials, and branch network rationalisation. The report claimed the consolidated banks will likely see an improvement in economies of scale and efficiency of operations over the medium-long term.