Issue of bank Mergers

Context:

• The Union Cabinet has approved the setting up of panel of ministers, to decide on consolidation proposals for Public sector banks

Introduction:

• The Finance Ministry is ready to provide capital support for facilitating consolidation among state-owned banks, which are reeling under mounting bad loans
• With this, the government seeks to consolidate 21 state-owned banks in the country.
• Details of the banks to be merged are yet to be announced.
• There are now 20 public sector banks (PSBs) other than SBI. These state –owned banks are grappling with Rs 6 lakh crore worth of non-performing assets (NPA), which is about 75% of the total distress.
• After in –principle approval for consolidation, the banks would take steps in accordance with the SEBI requirements.
• The merger could take into account the asset quality, capital adequacy ratio, profit and locations of banks.

Background:

• In the past one month, the PSU Bank index had underperformed the market by falling 8%, against less than 2% decline in Nifty 50 and Nifty Private Bank index.
• The government had approved the merger of SBI’s five associate banks with itself.
• In March, the Cabinet also approved the merger of Bharatiya Mahila Bank (BMB) with SBI.

What are the challenges that Indian Banking System is facing?

• The Indian banking system presently is facing huge challenges including the bad loan problem that has plunged many public sector banks in an unprecedented crisis.

Challenges that Indian Banking system is facing today?

• India’s central bank has some big concerns about he sustainability  of the country’s banking system.
• India’s   banks are struggling with the stresses assets problems.
• In its bi annual financial stability report released recently, the RBI warned that the  banking sector is under severe stress, with mounting bad loans and an increase in bank fraud, among other issues.
• Weak investment demand, partly emanating from the twin balance sheet problem is  a major challenge.

Some major problems are discussed below:

1-Bad loans: 

• Nearly Rs 10 lakh crore, India’s pile of bad loans is bigger than the gross domestic products of least 137 countries.
• The share of gross NPS  in India could inch up to 10.2% by March 2018, from 9.6% in March 2017, according to the fiscal stability report.
• In September 2016, gross NPA were at 9.2%.
• Presently, the worst-hit are the state owned banks, which dominate the Indian banking system.
• In March 2017, the average bad loans of PSBs stood at 75% of their net worth.
• Bad loans are squeezing banks profitability and capital position, threatening the health of some of India’s biggest banks.

2-Cyber threats:

• An estimated 95% of transactions in India are paid for in cash but with the growing penetration of computers, increasing access to internet, Indians are taking to digital channels for their banking needs. Cybercrime is becoming a greater threat as a result.
• The bank frauds like transactions involving cheating, negligence, misappropriation of funds, and forged documents.
• The global ransomware attack is one of the examples of cyber crime that affected the computer system of governments and several companies in various countries including India.

3- Bank Fraud:

• Another pressing concern for the banking regulator is the increased number of fraudulent transactions at Indian banks.
• In the last five years, the volume of bank fraud has increase by 19.06% to 5,064 cases.
• The biggest challenge faced by the PSBs is the rising NPA and will full defaulters and corruption in the system.

What will be the implications of merger?

1-       Positive impact of merger:

• It will help in reducing the dependency on the public exchequer.
• If these banks are merged, a bulk of the businesses in the central region will continue to be concentrated with the merged entity.
• Merger will ensure more bargaining power and better room for negotiations with borrowers for the merged banks.

2-       Negative impact of merger:

• Merger will affect regional focus.
• Immediate negative impact of merger would be from pension liability provisions (due to different employee benefit structures) and harmonisation of accounting policies for bad loans recognistion.
• Mergers will result in shifting and closure of many ATMs, Branches and Controlling offices, as it is not economical to keep so many banks concentrated in several pockets especially in urban and metropolitan centres
• Merger will result in immediate job losses. This will worsen the unemployment situation further and may create law and order situation and social disturbances
• New power centres will emerge in the changed environment.
• Merger will result in clash of different organizational cultures
• The weaknesses of the small banks may get transferred to the bigger banks
• When a big bank books huge loss, there will be a big jolt in the entire banking system and its repercussions will be felt on every stakeholder.
• Presently, India needs more banking competition rather than more banking consolidation. India needs more banks rather than fewer banks.

What are the affects of merger on different stakeholders?

Implications on different stakeholders:

1-       For Banks:

• Merger will help in dealing with the problem of stressed assets.
• Mergers help small banks to gear up to international standards with innovative products and services with the accepted level of efficiency.
• Mergers help many PSBs, which are geographically concentrated, to expand their coverage beyond their outreach.
• A better and optimum size of the organization would help PSBs offer more and more products and services and help in integrated growth of the sector.
• Consolidation also helps in improving the professional standards.
• In the global market, Indian banks will gain greater recognition and higher rating.
• The volume of inter-bank transactions will come down,  it will result in saving of considerable time in clearing and reconciliation of accounts.
• This will help in reducing unnecessary interference by board members in daily business of the banks.
• After mergers, bargaining strength of bank staff will become more visible. Bank staff may look forward to better wages and services conditions in future.
• The wide disparities between the staff of various banks in their service conditions and monetary benefits will narrow down.

2-        For economy:

• The merger benefits include getting economies of scale and reduction in the cost of doing business.
• Technical inefficiency is one of the main factors responsible for banking crisis
• The scale of inefficiency is more in case of small banks. Hence, merger would be good.
• The size of each business entity after merger is expected to add strength to the Indian Banking System in general and Public Sector Banks in particular.
• After merger, Indian Banks can manage their liquidity – short term as well as long term. Thus, they will not be compelled to resort to overnight borrowings in call money market and from RBI under Liquidity Adjustment Facility (LAF) and Marginal Standing Facility (MSF).
• Synergy of operations and scale of economy in the new entity will result in savings and higher profits.
• A great number of posts of CMD, ED, GM and Zonal Managers will be abolished, resulting in savings of crores of Rupee.
• Customers will have access to fewer banks offering them wider range of products at a lower cost.
• Mergers can diversify risk management.

3-       For government:

• The burden on the central government to recapitalize the public sector banks on regular basis will come down substantially.
• This will also help in meeting more stringent norms under BASEL III, especially capital adequacy ratio.
• From regulatory perspective, monitoring and control of less number of banks will be easier after mergers.

What should be ensured if the merger is carried out?

• Regional approach to consolidation. It the banks are consolidated region-wise, the post-merger rationalization could reduce operating costs for the merged entity, without compromising on the deposit base.
• With a new format of banking emerging in the form of small finance banks(SFB) and payment banks, PSBs need to think of alternatives to retain and strengthen their deposit base.
• The government shall not have any hidden political agenda, in bank mergers. The government shall not rush through the process of bank mergers
• All stakeholders are taken into confidence, before the merger exercise is started
• After mergers, shares of public sector banks shall not be sold to foreign banks, foreign institutions and Indian corporate entities, beyond certain limit
• Whenever further divestment (dilution of government holdings) takes place, the government share holdings shall not fall below 51% under any circumstances
• This will ensure that the ownership and control of public sector banks remain with the government
• The decision with regard to selection of smaller/weaker banks for merger with larger/stronger banks is to be taken with due care and grouping of various banks for this purpose is the key issue involved. The government shall not yield to pressure from any political or social groups
• Personnel absorbed from the smaller bank shall undergo brief, intermittent training programs to get acquainted with the philosophies, processes and technology in the new environment.
• There shall  be organized efforts to synthesize the differing organizational cultures, for the mergers to yield the desired result
• Huge amount of planning would be required to make the consolidation process smoother
• Integrated approach from all stakeholders including the government is needed.

What are NPA’s?

• A non performing asset (NPA) is a loan or advance for which the principal or interest payment remained overdue for a period of 90 days.
• A loan is an asset for a bank as the interest payments and the repayment of the principal amount create a stream of cash flows.
• It is from the interest payments than a bak makes its profits.
• Banks usually treat assets as non-performing if they are not serviced for some time. If payments are late for a short time a loan is classified as past due. Once a payment becomes really late (usually 90 days) the loan classified as non-performing

What are the laws related to merger?

• The Banking Companies (Acquisition and transfer of undertakings) Act, 1970 deals with the merger of banks.
• The  act to provide for the acquisition and transfer of the undertakings of certain banking companies, having regard to their size, resources, coverage and organisation, in order to control the heights of the economy .
• The objective of this act is to meet needs of the development of the economy in conformity with national policy and objectives and for matter connected therewith or incidental thereto.

What are some international examples?

• In the US, the government has capitalised banks to the extent of $2,270 billion after the 2008 global financial crisis.
• In China, the government helped the banks with capital to the tune of more than $120 billion when they faced problems.
• Two years ago, in Russia, the government pumped $15 billion into banks.
• In Greece, it was $63 billion and in Spain $51 billion when their banks were in trouble.

Has the merger been tried before?

• This is not the first time that the idea of merging the Public Sector Banks has gained momentum.
• In 1991 report on banking sectors, M. Narasimham, a former Reserve Bank of India governor, had recommended mergers to form a three-tier structure with three large banks with international presence at the top, eight to 10 national banks at tier two, and a large number of regional and local banks at the bottom.
• Further  P.J. Nayak Committee had also suggested that state-run banks should either be merged or privatized.
• The SBI first merged State Bank of Saurashtra with itself in 2008.

Recent mergers:

• The country’s largest lender State Bank of India (SBI)  merged with its associate banks in April this year.
• Earlier this year, the government had approved the merger of SBI’s five associate banks with itself. In March, the Cabinet also approved the merger of Bharatiya Mahila Bank (BMB) with SBI, catapulting the country’s largest lender to  among the top 50 banks in the world.
• State Bank of Bikaner and Jaipur (SBBJ), State Bank of Hyderabad (SBH), State Bank of Mysore (SBM), State Bank of Patiala (SBP) and State Bank of Travancore (SBT), besides BMB, were merged with SBI.
• With the merger, the total customer base of the SBI reached around 37 crore with a branch network of around 24,000 and nearly 59,000 ATMs across the country.

Conclusion:

The government needs to focus on consolidating the huge deposit available with the PSU Banks. India being a savings focused banking system, a regional approach to consolidation of banks may be a fruitful exercise and could address the issue of NPA in the long run.