Merging PSU Banks

UPSC Syllabus Topic: GS Paper 3 –Indian economy

Introduction

India’s PSB policy currently prioritises organic growth, governance, and technology with no immediate mergers. Earlier consolidation reduced PSBs from 27 to 12, aligning with Narasimham Committee-II (1998), which envisaged fewer, larger, stronger banks under a three-tier structure. The next phase should build capacity for well-structured, large-ticket lending while safeguarding outreach and financial inclusion. Merging PSU Banks.

Reasons for PSU Banks Mergers

1. Addressing financial weaknesses: High NPAs and low capital in smaller PSBs can be stabilised by merging with stronger banks, enabling better asset management, securitisation, and refinancing.
2. Enhance efficiency and supervision: Economies of scale, branch rationalisation, common administration, and technology integration raise efficiency; fewer, larger PSBs ease RBI supervision to uniform standards.
3. Credit capacity and competitiveness: Larger capital bases lift lending capacity across infrastructure, SMEs, and retail; scale can strengthen ratings and lower funding costs.

Significance of PSU Banks Mergers

1. Economic growth and large-scale financing: Bigger entities can finance major infrastructure essential for development.
2. Enhanced efficiency and cost reduction: Consolidating overlaps in branches and systems lowers costs and streamlines operations.
3. Stronger balance sheets: Pairing weaker with stronger banks improves balance sheets by tackling NPAs and enlarging capital.
4. Increased competitiveness: Well-capitalised large banks compete better with private peers and are more resilient to economic shocks.
5. Wider customer and product base: Mergers expand reach and enable a broader product suite from a single platform.
6. Improved risk management: A larger entity can better manage liquidity and adopt more sophisticated risk management strategies.

Concern Related to PSU Banks Mergers

1. Cultural and Operational Differences: Each bank has its own work culture, management style, and operational systems. Integrating these different cultures and systems can be a complex and time-consuming process.
2. Technological Integration: Merging banks often operate on different banking platforms.Integrating these technologies requires careful planning, significant investment in IT infrastructure and testing in order to make sure that there is no disruption in services.
3. Diluted managerial efficiency: Merging stronger banks with weaker ones can dilute the efficiency of the stronger banks, potentially increasing operational risks and impacting performance.
4. Branch rationalization: Mergers can lead to the closure of overlapping branches, potentially affecting the reach of PSBs in rural and semi-urban areas.
5. Diluted financial inclusion: The focus on regional and local lending priorities for sectors like agriculture and MSMEs may be diluted in a large, consolidated entity.
6. Systemic risk: Creating a “too big to fail” institution could pose a systemic risk to the economy, as the government might have to bail it out in a crisis.
7. Service disruption: Customers often face short-term disruptions like changes to account numbers, IFSC codes, and cheque books, which can lead to temporary service glitches and blocked funds.

Way forward

1. Boost risk capacity: Allocate capital and systems to raise risk appetite and expand asset portfolios for large infrastructure lending. This widens lending capacity for viable projects while keeping balance sheets resilient.
2. Better Structure of loans: Use permitted risk-weight adjustments. Combine non-fund-based limits with funded facilities to enable phased, bankable financing. Synchronise disbursements with project milestones to manage risk.
3. Tighten oversight: Strengthen appraisal, monitoring, early-warning tools, and covenants so mega projects stay on track. This reduces slippages and protects asset quality.
4. Ownership tweaks: Consider raising the FDI cap above 20% and aligning voting rights beyond 10%, while keeping the Government’s 51% stake.
5. Shift to NOFHC: Move to a Non-Operative Financial Holding Company structure to separate ownership from management and improve transparency and autonomy.
6. Sequence consolidation: Prioritise governance, technology, and outreach improvements now. Plan any new mergers only after these reforms deliver results, since mergers combine balance sheets but do not create value by themselves.

Conclusion

Prioritise governance, technology, and risk systems across the 12 PSBs to safeguard outreach and inclusion and build capacity for large, well-structured lending. Consider consolidation only after these reforms show results, so any merger adds scale without weakening service quality, strengthens balance sheets and oversight, and supports sustained infrastructure financing.

Question for practice:

Discuss the rationale, benefits, and concerns associated with the merger of Public Sector Banks (PSBs) in India.

Source: Businessline