Merging of Banks on an urgent basis

Context

• Urgency on bank consolidation is priority today but it must not distract from the bad loans mess, or problems of governance.

What is Bank merging?

• A bank merger occurs when banks join to become one.
• The merging of Banks is a step forward towards development in the banking sector.

Recent mergers and talk of mergers:

• The Shares of PNB and Bank of Baroda rose more than 2.5 percent each. The Union Government is working on next round of consolidation, which could see PNB and Bank of Baroda taking over smaller lenders.
• With the ‘Indradhanush‘ plan, the Government has announced to infuse Rs. 70,000 on the state-run banks till 2009merger of Public Sector Banks.
• 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 BharatiyaMahila 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.
• Large public sector banks (PSBs) like Punjab National Bank, Bank of Baroda(BOB), Canara Bank and Bank of India are looking for potential contenders for acquisition.

What is the procedure for merging of banks?

• No matter how many banks are involved, the merger results in a single bank with one identity rather than multiple banks with multiple identities.
• There are two common ways in which a bank merger may be accomplished: one is through a buyout and another is via cooperation with bank shareholders.

SBI merging process:

The merger process inter alia includes:

1. Integration of data and IT system of all associate banks with that of SBI.
2. Since 3 out of 5 associate banks are listed ones so what would be the share swaping ratio i.e. for each share of listed associate banks how many shares of SBI a shareholder will get. It has already been done.
3. At some places you will find branches of SBI nearby its subsidiary banks. These branches will be required to be rationalized. That is closure of all except one in that place and shifting their business to that one branch.
4. There are other things which need to be taken care of but they least affect the customers like issues related to transfer of employees of associate banks into SBI, their salary, perks, allowances etc.

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 organization, 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.

Why consolidation of Banks urgently?

• The government recently announced a new framework to oversee proposals for merger of state-run banks.
• The initiative is aimed at consolidation has now been taken forward.
• The finance ministry has recently written to banks to consider mergers and to discuss such proposals at the board level, reflecting a sense of urgency.
• The urgency is to do with the balance sheets of the majority of the almost three dozen banks owned by the government, of which at least half a dozen are under Prompt Corrective Action or PCR initiated by the banking regulator.
• This implies severe restrictions on lending.

The RBI’s Financial Stability Report

• Released a few months ago, warned of a further deterioration of bad loans from 9.6 per cent of total assets at the end of March 2017 to possibly 10.2 per cent of total loans if economic conditions do not improve this fiscal.
• The health check for PSU banks is far worse.
• The gross bad loan ratio could top 14 per cent by March 2018 and the capital adequacy level of many banks could fall below 9 per cent in a severe macro-economic scenario, according to the Stability Report.
• Clearly, the requirements of capital will be substantial over the next couple of years, with growing stress on account of bad loans and the need to meet the globally mandated norms on capital adequacy by March 2019.

How is consolidation of banks going to take place?

If Consolidation of banks takes place, then banks will have higher asset strength & increase in the capital base. Also, the problem of Non-Performing Assets (NPAs) & other problem like Capital Requirement which are faced by the banks can be resolved to some extent.

The Consolidation in the banking sector can be done on the following lines:

• SBI, BoI and BoB should be merged to be among the largest banks in the world.
• The second step is the merger of Canara Bank, Indian Bank, BoM, IOB and UBI to form the second largest bank.
• PNB, Vijaya Bank, Andhra Bank and IDBI can be merged to form the third largest.
• Allahabad Bank, Central Bank, Corporation Bank and P&S Bank should be the fourth largest.
• OBC, Syndicate Bank, UCO Bank and Dena Bank can become the fifth largest bank.

What is the history behind the merging of banks?

• In the year 1993, the government took a drastic stride towards economic affluence and took a step towards merger of banks.
• The New Bank of India was merged with the Punjab National Bank (PNB). This was the first merger between nationalized banks, ever witnessed in Indian history.
• SBI first merged State Bank of Saurashtra with itself in 2008. Later in 2010, State Bank of Indore was merged with it.

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 are:

• India’s central bank has some big concerns about the 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 evils of Indian banking system are discussed below:

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 bankingsystem.
• 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.

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.

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 are the effects/implications of merger on different stakeholders?

Implications on different stakeholders:

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 Public Sector Banks (PSB), which are geographically concentrated, to expand their coverage beyond their outreach.
• 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.
• 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.
• 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.

On 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.
• Merger will result in immediate job losses. This will worsen the unemployment situation further and may create law and order situation and social disturbances
• Mergers can diversify risk management.
• 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.

On 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.
• 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 affect regional focus.

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.

Conclusion

• Government has been infusing money continuously to help PSBs to come out of the uncompetitive situation and that cannot be the best solution, hence trying new strategies like merger and acquisitions would be a better solution.
• 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 Non-Performing Assets (NPA) in the long run.