7 PM | Bank for the buck | 5th September, 2019

Context: consolidation of banks

More in news: In what comes as the second wave of the government’s efforts to revive the economy, Finance Minister Nirmala Sitharaman on Friday announced a slew of banking reform measures, including merger of 10 public sector banks into four entities.

Need for bank mergers in India:

• Fragmentation: Indian banking sector is highly fragmented, especially in comparison with other key economies. Additionally, most of the PSBs in India are competing within themselves; most of them have same business models and compete in the same segments as well as same geographies. Thus, there is a huge scope of consolidation in this sector.
• Credit demand:India needs to have large banks (global sized banks) that can support the investment needs of economy and sustain economic growth. To meet the growing credit demand of the economy, the Public Sector Banks need to be well capitalized and need to enhance their capacity to lend to larger companies and larger projects.
• Consolidation of Public Sector Banks into 4 or 5 banks would create larger banks with capacity to fund larger size projects of economic importance.
• Capital base:Public Sector Banks (PSBs) which form approximately 72% of the Indian banking system are among the most affected by the high non-performing asset (NPA) problem at present. This has further resulted into a slowdown of credit growth in our economy, thereby reducing private investment and our potential economic growth.
• There are suggestions that a consolidation of PSBs can help them manage the challenge of NPAs more effectively. In effect, it is argued that a large bank will be better capitalized, will have deeper expertise to handle large credits and large NPAs
• Capital adequacy: Clearly, the core idea behind exploring merger of banks is to enable creation of large sized banks of adequate capital base to enable disbursement of greater credit, especially for large developmental projects as well as for effective management of NPAs.
• Hence, the likely capital size of the merged entity needs to be considered while evaluating the decision for consolidation. As discussed earlier, with SBI merging with its 5 associates and Bharatiya Mahila Bank, the remaining 20 banks if consolidated into 4 large banks, the average size of assets of the merged entity would be around Rs 15.5lakh crore.
• Cost rationalization: Merger of two or more banks should thus ideally result into value maximization and efficiency gains. The benefits may entail through rationalization of branches, productivity gains through proper deployment of skilled resources, common treasury pooling, enhanced scale of operations and rationalization of common costs.
• Additionally, the volume of inter-bank transactions will also come down, resulting in saving of time in clearing and reconciliation of accounts. However, these cost benefits need to be carefully weighed against other parameters such as the likely increase in non-performing assets, and loss of business with closure of some branches.

Challenges and problems of merger:

• Human resources:One of the most challenging problems which could hinder the consolidation process would be in terms of human resource integration and management as many employees would fear job loss and disparities in the form of regional allegiances, benefits, reduced promotional avenues, new culture, etc.
• To ensure that the integration of entities is a smooth process, the most important task would be to embark on a human resource strategy that can help address the core concerns of employees, mitigate their anxieties, and create an environment of trust.
• Technology: Another big challenge for integration post banks’ merger relates to integration of technology as various banks are currently operating on different technology platforms.
• Systems integration plays an important role as it involves integration of infrastructure components such as data centers, operating platforms and enterprise applications, and alignment of IT and business strategies of the merging entities.
• Hence, IT integration strategy should be aligned with the business strategy right from the beginning to ensure a successful merger.
• Regulation and control: From regulatory perspective, monitoring and control of less number of banks will be easier after mergers. Also, for meeting the norms under BASEL III, for ensuring capital adequacy ratio, the larger banks will be at ease.
• However, it has also been argued that a failure of a very large bank may have macro implications on the economy and may have to be bailed out during stress periods. Existence of excessively large banks may also create significant moral hazard costs for the entire system as witnessed during the Lehman collapse in 2008.

Way forward:

• From a global perspective, the consolidation process among banks has been driven primarily by synergies, efficiency, cost saving, and economies of scale.
• It is essential to evaluate the proposed merger of banks by assessing the likely benefits such as cost rationalization, additional business, etc. against the likely future costs that may arise on account of harmonization of various procedures, technology and integrating human resources.
• It is also essential that banks work to mitigate exposures in areas related to interconnectivity, the market, regulatory compliance, credit quality, etc.
• These risks can be mitigated through advance planning and due diligence to ensure a smooth transition. The consolidation process in India should aim at strengthening the banks’ bargaining power, help save costs; improve supervision and corporate governance across the banking system.
• Besides, the government along with RBI should also start streamlining the PSBs especially in terms of their chosen areas of business so as to help them to focus on their core capacity and strengths in the times ahead.

Source: https://indianexpress.com/article/opinion/columns/public-sector-bank-merger-nirmala-sitharaman-5966812/.