PSB Merger: Background; Rationale & Challenges

On August 23, 2017, the Union cabinet has given an in-principle approval for the merger of public sector banks (PSBs) via a recently mooted alternative mechanism (AM). This move is aimed at creation of ‘strong and competitive banks’ by synergy and consolidation. As per newspapers, the government is mulling to merge the weaker banks with stronger ones. Alternative Mechanism is nothing but a ministerial panel led by Finance Minister.

Background on Merger of Banks

Consolidation of state run banks was first mooted by the first Narasimham Committee in 1991. This committee had recommended that all government run banks should be merged and a three tier structure should be created from it. That committee gave the opinion that all the PSBs should be merged and the resulting entities should be:

• Three large banks with international presence
• Around 8-10 national banks
• Several other regional banks.

We note that mergers and consolidation is not a rare process in banking reforms. There have been around 32 mergers so far involving the private sector banks. In 2004, RBI had forced the merger of privately owned Global Trust Bank (GTB) with the public sector Oriental Bank of Commerce. While such mergers have been more common with private banks, there has been only one instance of merging two PSBs other than the SBI merger. This was in 1993 when New Bank of India was taken over by Punjab National Bank (PNB). However, this merger resulted in a loss of Rs. 96 Crore to PNB. It took PNB more than five years to get over the merger effect.

Then, in recent times, all the seven associate banks of SBI were merged with it. These seven banks aka. “Seven Sisters” were originally established by princely states before independence and they became SBI’s subsidiaries when government passed the SBI (Subsidiary Banks) Act in 1959. Their progressive merger was also recommended by Narasimham Committee in 1991; however, this could not take place soon. It was 17 years later in 2008, when State Bank of Saurashtra merged with SBI. Two years later, State Bank of Indore got merged. In June 2016, the government issued a directive to merge all the remaining 5 associate banks by March 2017. This merger also led the reduction of number of scheduled PSBs in India to 21.

There are several questions on SBI merger. Some viewed this merger sceptically because at that time the collective net loss of Rs 11,865 crore reported by all associate banks was more than the net profit of SBI. But then, it was said that the merger should be seen as an internal reorganization rather than a merger. Several reasons given were as follows:

• The Associate Banks always shared a common identity with SBI and has a shared logo with SBI.
• Since inception, the SBI was exercising tight operational control of the Associate Banks. The chairperson of SBI was seen presiding over the individual boards of the associate banks. In addition, top executives of SBI were appointed on the individual boards of the associate banks on deputation. As a result, these banks had common operational systems and procedures with the SBI.
• All the associate banks and SBI have common code and linkages and operate under the same information technology platform. In the mid 1990s, the SBI launched massive computerisation and had included all the associate banks in that exercise. In 2002, the core banking solution was launched covering all the banks.
• The treasury operations of the associate banks have been integrated with the SBI for several years now.

SBI’s mounting troubles

The SBI’s debt burden thus can be seen as a collective debt burden from all the associate banks. In place of getting any benefit from the economy of scale; SBI is a beleaguered mammoth today. It would take considerable time for the bank to recuperate from its troubles. Right now, apart from NPAs, it is also struggling on human resources front. SBI is fifth largest employer in the country and it need to absorb 70,000 employees of the associate banks also post merger. The salaries, pension and retirement benefits are expected to take a dent on SBI’s profitability for several years from now. There also exist challenges in evaluating the issue of rationalising the branch network post-merger. It is estimated that around 1000 branches need to be rationalised/relocated. SBI is also facing challenges in enhancing the skill levels of the employees of erstwhile associate banks who had so far worked with regional focus and little exposure.

Stated Rationale of proposed Merger

The current proposal to merge all the state PSBs comes in the backdrop of increasing Non-Performing Assets (NPAs) and consequent deteriorated asset quality and lower earnings. Top 5 banks with highest NPA are none another than the public sector banks (PSBs) namely SBI, Punjab National Bank, Bank of India, IDBI Bank and Bank of Baroda (BoB). These banks account for 47.4% of total NPA.

Some of these banks have lost their ability to raise resources on their own and needed capitalization / bail out from government. But government cannot keep infusing tax payer money into banks endlessly. So, the state rationales behind the PSB merger are as follows:

• There is no need to have so many government banks with different identity, operation and mechanism while their core business is one.
• The consolidated entities would be stronger, will be able to invest in technology, will be able to better realign their ways and methods of credit disbursal, and would be effective in achieving their objectives of financial inclusion.
• The mergers will provide scale efficiencies and improve the quality of corporate governance.

Is it a wise decision? Where is the Money?

The question is – is the merger a wise decision. All arguments of economy of scale, synergy, better technology etc. are valid until we decide to not to see the elephant in the room that is – weak capital. Can merger provide strong capital? No, the max it will provide is a huge balance sheet. Most of the PSBs have weak capital and merging two or more of these banks will result in creating larger entities with weak capital levels. So, the real question is- from where they will bring money? Right now, the money can come only via capital infusion either from government or from market. Borrowing from market would lead to beggar-thy-neighbour while government is reluctant to provide tax payer money to banks for their sins. It is evident from the amount provided in budget (Rs. 10,000 Crore) for this purpose when NPAs are in lakhs of crores. Thus, all other benefits would be overshadowed by the real problem unaddressed.

Challenges

Now, let’s discuss the challenges in proposed merger: First is related to integration of human resources, particularly at junior and middle level. Integrating human resources in matters such as compensation, deployment and performance appraisal could pose several challenges. It created many problems in the past during the merger of PNB with New Bank of India, IDBI Bank etc. Second major challenge is that PSBs do not possess uniformity in the information technology architecture. Each bank has developed a unique system by engaging with different vendors. So creating an entity that can seamlessly cover all aspects of the banking business will take a long time.

Suggestions and Conclusion

The proposed merger will result in economies of scale but that needs both time and money. Right now, what will be coming out of this merger could be a large balance sheet but weak(er) fundamentals. It could be better if merger was carried out at a time when NPAs were brought down to some realistic levels. The government can also start the merger initially with two anchor PSBs, each of them absorbing one smaller bank in next 12 months. If this experiment is successful, it can carry out further mergers. The government can also consider merging banks with similar cultural quotient and network streamlining. Thus, banks like Punjab and Sind Bank can be merged with PNB. Similarly, Vijaya Bank could be merged with Canara Bank. Post-merger, it should be made sure that branch rationalisation is carried out swiftly within a prescribed timeframe to eliminate overlaps.

Before merging, it is important to critically evaluate areas such as insurance, broking and investment banking. It is necessary as there is a need to focus on banking instead of dissipating scarce talent to pursue unrelated areas.It would be wise to assign some PSBs with exclusive roles in the segments they specialize. For example, Dena Bank which is highly profitable bank focused on trade financing could be made as a bank exclusively for catering to small and medium enterprises (SMEs) and traders. Similarly, the Bank of Maharashtra could be made as a bank focussing on rural Maharashtra as it enjoys great recognition among the local population.

The government should initiate steps to hire talents in anchor PSBs before proceeding to merge the banks. The government needs to maintain mix of efficiently run PSBs and aggressive private banks to achieve development goals and social justice.