Policy | Merging banks pays at the margin, but misses the big picture

Second, operational and managerial synergies between the banks can be exploited in a better manner. For instance, if one bank is better at mobilising deposits and another at disbursing loans by assessing creditworthiness of SMEs, post-merger, they can do financial intermediation without routing their funds through the inter-bank market.

Third, as the number of banks comes down, competition in the banking sector is reduced and the banks’ profitability may go up, albeit at the cost of customers’ welfare. As banks are reeling under losses due to provisioning for bad debts, this may help them a bit.

Four, since a merged bank may be expected to be more stable and creditworthy, the mobilisation of deposits from retail customers and mobilisation of funds from the money market may become easier and frictionless.

Finally, the merger entails organisational restructuring which can be creatively used to make a leaner entity. The number of managerial positions comes down as well. In theory, it is possible to make future managerial power contingent on past performance, thus rewarding better performance.

These are the anticipated benefits of the merger. However, there are significant downsides as well.

First, the job of collapsing multiple organisational hierarchies into four is unlikely to be smooth and easy. There is bound to be resistance, partly due to perceived loss of status by the incumbent managers and real difficulties in managing transition. At the very least, there may be turmoil in the next couple of quarters. Given the otherwise critical state of the economy, it is not clear what macroeconomic implications of such turmoil are likely to be.

Second, the political economy of Indian banking is complex. There is no guarantee that the merger will reward those who took the best credit decisions and punish those who took the wrong call. So, perverse incentives are likely to persist.

Third, the merger creates another banking behemoth. United Bank of India and Oriental Bank of Commerce will be merged with Punjab National Bank, making it one of the biggest players in the banking industry. This may accentuate the problem of moral hazard by creating a too-big-to-fail systemically important financial institution (SIFI).

Four, as pointed out by economist Ronald Coase in his much-cited paper ‘The Nature of the Firm’, firms and markets are alternative and complementary ways of organising economic activity. Which one is better suited to a sector depends on the internal and external transaction costs. The relevance of this point in the current debate is that the gains of organisational restructuring will be limited to the saving of transaction costs, which are unlikely to be substantial.

Finally, the time, professional expertise and political capital available to policymakers are not unlimited. There is always an opportunity cost associated with implementing a certain policy. Quite often, the biggest cost of pursuing a policy is not pursuing a more effective policy.

Bank merger is not a policy that substantially increases financial mobilisation of domestic savings, say, by enlarging the pool of credible borrowers or increasing the collateral value of certain assets.

Similarly, post-merger, there would be no change in the political economy of banking sector either. The fundamental conflict of interest in the banking sector -- the government having substantial control over the regulator and regulated financial intermediaries and at the same time being the largest borrower -- is likely to persist.

It is said that a crisis is too important a thing to be wasted. One is afraid that the bank merger, while being useful at the margin, may fail to transform the banking sector stress into an opportunity to implement fundamental reforms.

Avinash M Tripathi is Associate Research Fellow (economics) at Takshashila Institution. Views are personal.