Banking Mergers

What one cannot do, two can; and what one can do, two can do still better. This has been proved time and again and has been the basis of family life, or society. What will succeed and what will not, only time would tell.

A sound, robust and resilient financial system is a prerequisite for a modern economy that involves all sections of its society in sharing equitably the benefits of economic and social progress. Reforms are an ongoing process.

This year marks the 50th anniversary of bank nationalisation, arguably the biggest structural reform introduced in the financial sector during the post-Independence period.

Evolution of banking in post-Independence India, inherited a system where small private banks proliferated — 56 per cent of all bank deposits in 1947 lay with the 81 scheduled and 557 non-scheduled private banks. These private banks were lopsidedly concentrated in the provinces of Madras, West Bengal and Bombay. Between 1947 and 1955 there were 361 instances of bank failures, with many depositors losing their life savings along with their faith in the banking system.

It was in this backdrop that new laws of banking regulation, capital adequacy, licensing and inspection were enacted followed by a phase of liquidation and amalgamation, which brought down the number of scheduled banks to 71 and non-scheduled banks to 20, by 1967. The Government of India issued the Banking Companies (Acquisition and Transfer of Undertakings) Ordinance, within two weeks the Parliament passed and it received presidential approval on 9 August 1969.

Government nationalised the 14 largest commercial banks with effect from the midnight of 19 July 1969. These banks contained 85 percent of bank deposits in the country. A second round of nationalisations of six more commercial banks followed in 1980. The stated reason for the nationalisation was to give the government more control of credit delivery. With the second round of nationalisations, the Government of India controlled around 91% of the banking business of India. Some of the main objectives of nationalization of commercial banks were : Social Welfare : Agriculture sector, small and village industries were in need of funds for their expansion and further economic development.

In the early 1990s, the then government embarked on a policy of liberalisation as part of it privatization, liberalisation and globalization programme – The New Economic Policy 1991, licensing a small number of private banks. These came to be known as New Generation tech-savvy banks, and included Global Trust Bank (the first of such to be set up), which later amalgamated with Oriental Bank of Commerce, IndusInd Bank, UTI Bank(since renamed Axis Bank), ICICI Bank and HDFC Bank. This move, along with the rapid growth in the economy of India, revitalised the banking sector in India, which has seen rapid growth with strong contribution from all the three sectors of banks, namely, government banks, private banks and foreign banks. Later on, in the year 1993, the government merged New Bank of India with Punjab National Bank. It was the only merger between nationalised banks and resulted in the reduction of the number of nationalised banks from 20 to 19. Until the 1990s, the nationalised banks grew at a pace of around 4%, closer to the average growth rate of the Indian economy.

The next stage for the Indian banking has been set up, with proposed relaxation of norms for foreign direct investment. All foreign investors in banks may be given voting rights that could exceed the present cap of 10% at present. It has gone up to 74% with some restrictions. The new policy shook the Banking sector in India completely. Bankers, till this time, were used to the 4–6–4 method (borrow at 4%; lend at 6%; go home at 4) of functioning. The new wave ushered in a modern outlook and tech-savvy methods of working for traditional banks. All this led to the retail boom in India. People demanded more from their banks and received more. With state policies shifting towards liberalisation and privatisation in the last three decades and the entry of new private sector banks, the dominance of the public sector banks (PSBs) has been on a decline. The share of PSBs in the total assets of the scheduled commercial banks, which was over 80 per cent in 1997-98 declined to around 70 per cent by 2007-08 and further to below 66 per cent in 2017-18.

In the immediate aftermath of the global financial crisis in 2007-08, which had exposed the dubious financial practices of the private multinational banks, both deposit mobilisation and credit flow of the public sector banks in India had witnessed a phase of higher growth compared to the private sector banks.
Since 2011-12 though, the deposit and credit growth rate of the PSBs declined progressively, with the private sector banks and NBFCs gaining in market share at the cost of the PSBs. Why did this happen?
With declining corporate profitability after 2011-12, loan defaults became the norm with the private corporates offloading their losses onto the PSBs. This phenomenon was termed as ‘riskless capitalism’ by a former Governor of the RBI. This was precisely the reason why the private sector could not be trusted to run the banking system.

In this context, successive doses of capital infusion by the government have not been able to improve the capital ratios of the PSBs significantly. PSB recapitalisation under the present dispensation has been more of a taxpayer funded bailout of the loan delinquent corporates and fraudsters. The process so far has not been very effective in yielding timely NPA (Non-Performing Assets) recovery. The average recovery rate was around 43 per cent, which implies 57 per cent haircut for the banks. Mergers have been seen as a tool to tackle the problem of NPA’s. The situation is unlikely to ease any time soon—in fact, it may worsen, the RBI has warned.

In 2017, India’s largest lender, SBI, merged with five associate banks and the Bharatiya Mahila Bank to enter the league of the world’s top 50. The government allowed state insurer Life Insurance Corporation of India to take over IDBI Bank, the worst performer in terms of bad loans. Last year, the government had merged Mumbai-based Dena Bank, Bengaluru’s Vijaya Bank, and Bank of Baroda (BoB) from Vadodara, Gujarat. The merged entity, with total assets of over Rs14 lakh crore ($190 billion), will be India’s third-largest lender behind the State Bank of India and HDFC Bank. One of the reasons for choosing these three banks was that the two stronger ones will be able to absorb the weaker entity – being Dena Bank. The government unveiled a mega plan this month to merge 10 public sector banks into four as part of plans to create fewer and stronger global-sized lenders as it looks to boost economic growth from a six-year low.
Oriental Bank of Commerce and United Bank will merge into Punjab National Bank to form the nation's second-largest lender with ₹17.95 lakh crore business and 11,437 branches.; Canara Bank and Syndicate Bank will merge to form the 4th largest with ₹15.20 lakh crore business and a branch network of 10,324.;
Union Bank of India will amalgamate with Andhra Bank and Corporation Bank to be the 5th largest with ₹14.59 lakh crore business and 9,609 branches.; and Indian Bank will merge with Allahabad Bank will be the seventh largest public sector bank with ₹8.08 lakh crore business. After the mergers, the country will have 12 public sector banks, including State Bank of India and Bank of Baroda. Bank of India and Central Bank of India will continue to remain independent. The merger proposal will first have to be approved by the board of directors of the banks. Then the government will prepare a plan to be vetted by the union cabinet and both houses of parliament. The process can take up to a year.

There have been critical issues in the area of operations, regulation and supervision of banks. Mergers if implemented well would definitely bring synergy. This would help:

1. Lower operational and funding costs, and also strengthen risk management practices for banks. As a result, operational efficiencies are likely to go up significantly.
2. Bring about governance reforms:
• enhance their quality and stability through further streamlining appointment process, succession planning and compensation.
• performance of MDs/CEOs of both public and private sector banks should be closely monitored by the Board of Directors
3. Create potent risk management systems in banks,
4. Compliance function have to be adequately strengthened and made sufficiently independent.
5. Most bank frauds can be traced to absence of effective controls. An essential element of an effective system of internal control is a strong control mechanism, which can be implemented.
6. In the light of various developments in the financial sector such as the use of complex financial products and rapid technological innovations which give rise to interconnectedness and spill over effects within and between entities, there has been a move globally towards building specialized teams of bank supervisors. This can be strengthened.
7. The merged bank will be a strong competitive bank with economies of scale, network synergies, low-cost deposits and subsidiaries, and the possibility of greater outreach and expansion,”

According to some PSB mergers, disinvestment or the FRDI Bill are non-solutions, which will further weaken the PSBs. What is required is a major course-correction. We need to wait and watch. Some of the banks might outperform post-merger and there could be some, which might not be able to withstand and just wither away. It would take a minimum of three years to know the outcome. India’s economic growth has decelerated for five straight quarters to the weakest level since early 2013 and the 5% headline number for the second quarter may actually understate how painful the slowdown has become. When it is becoming increasingly difficult to deliver jobs for the millions of young Indians who enter the work force every year, how the mergers are managed becomes crucial. Without major reforms, India could face a structural slowdown that keeps long-term grown far below the 8% rate that many economists say India needs to create enough new jobs. The risk is that as the economy slows, reforms will take a back seat to heavy-handed appeals to nationalism. Mergers might not help to rectify the loans which have turned out to be NPA’s; but hopefully it would be a stepping stone to push the economy towards a better direction.