The government has announced that 10 public sector banks will be merged to create four large lenders. Under the plan, Indian Bank will be merged with Allahabad Bank (anchor bank - Indian Bank). Punjab National Bank (PNB), Oriental Bank of Commerce (OBC) and United Bank will be merged (anchor bank - PNB). Union Bank of India, Andhra Bank, and Corporation Bank to be merged (anchor bank - Union Bank of India). Canara Bank and Syndicate Bank to be merged (anchor bank - Canara Bank). The government, which is the majority shareholder of state-owned banks, thinks these mega bank mergers will create next-generation banks, creating better efficiencies, better economies of scale and improved cost of funds. While it remains to be seen whether merged banks could create competence at the global level and improve their operational efficiency, the share-swap ratio for these proposed bank mergers have not been disclosed nor the timelines for merger completion announced. What does the merger of banks mean and what are the potential downsides? Investors should not be overly bullish about the merger and be cautious. One should know that the public sector banks being merged are riddled with several challenges. For one, they carry the legacy of bad loans. In fact, the four new combined entities have net non-performing assets ratio of between 4.3% to 6.6%, which are high. How does the government and the investors gain from the merger of banks? Let us have a detailed look.
How Does The Govt Gain?
The government being the controlling owner of these banks gets the advantage of lowering the number of banks it owns. In 2017, there were 27 public sector banks. Post consolidation, there will be 12. In the past, the SBI has merged smaller banks into it. Last year, Bank of Baroda merged Vijaya Bank and Dena Bank into it. The Bank of Baroda merger experiment is still work in progress. From an operational point of view, a lower of number of banks is a relief for the government in terms of handling. By merging different banks, the government hopes it will not have to do frequent fund infusions. When PSBs suffer due to bad loans i.e. non-performing loans, they cannot lend more money. So, the government does a 'top-up' and basically keeps them alive. Efficient banks will not need this.
PSBs are not mean profit-making organizations unlike the private sector banks. They help in furthering the political, economic and social agenda of the government. Will big banks do this better? Punjab National Bank is a classic case of how fugitive diamond merchants Nirav Modi and Mehul Choksi pulled off massive frauds for years in collusion with the bank's employees. PNB had failed to detect multi-thousand crore fraud, how will it be able to manage the situation with the Oriental Bank of Commerce and United Bank? To solve this problem, the government announced that it has empowered PSB boards so that management is accountable, more flexibility in hiring, succession planning is done and more teeth is given to non-official directors (NoDs).
A few questions remain unanswered. What was the necessity to announce mega bank mergers? At a time when the Bank of Baroda merger is still taking shape, would it not be prudent to wait for a few more years before initiating another bank merger? While accepting that bank consolidation is a good step, Prakash Agarwal, Head- Financial Institutions, India Ratings and Research (Fitch Group) says, "It is possible that the current mergers may face more friction than the last one with BoB, Dena and Vijaya. In that case, a large, well-capitalized strong bank absorbed two much smaller entities. In the present case, the mergers are mostly among larger banks, with absorbing bank not necessarily in strong health."
The bad loans problem will not disappear overnight. Management attention and bandwidth of the entities being merged could get split impacting the loan growth and reduce the focus on strengthening asset quality in the short term, says Agarwal. "The consolidation will aid economies of scale for these banks, resulting in an improved cost of funds and operating efficiency. Nonetheless, merger-related issues including HR/IT related synchronization, branch rationalization and realigning of NPAs could impact interim profitability," says Mona Khetan, Banking Analyst, Reliance Securities.
How Can Investors Gain?
If you are a bank customer, you probably have nothing to worry about. Charges and costs may not be hiked by bank managements. As a result of mergers, bank branches close to each other belonging to merged banks will be rationalized. But as a customer, irrespective of which bank, you are likely to have access to one branch. From a customer point of view, one should be open about experiencing newer technologies at PSBs. This is because when 2-3 banks are merged, there are some alignments that are brought in. “The consolidation among public sector banks is a welcome move. It enables them to reduce their operating costs and improve operational efficiency. But a technology overhaul is the need of the hour in the banking industry,” says Bhavin Turakhia, founder and CEO, Zeta.
Operating redundancies can be eliminated and cost productivity can be improved over time which could lead to higher profits. "A bulk of the budgeted Rs 70,000 crore capital allocation now goes to the merged banks to help them grow while discovering synergies. Various governance reforms announced are welcome too and will improve risk oversight," says Rajiv Mehta, executive vice-president at YES Securities. However, Mehta points out that the key would be to not have an extended NPL (Non-Performing Loan) cycle, driven by continuing corporate stress and impairments in SME and retail loans. The steps taken create uncertainty for minority shareholders of the involved banks, he notes. A lot of work needs to be done in terms of making these bank mergers successful. "More work needs to be done on changing the compensation structure, work culture and governance with tough calls needed to be taken to ensure availing the cost rationalization/reductions and operational efficiencies/synergies assumed for the consolidation," says Deepak Jasani, head of Retail Research, HDFC securities. "Real estate will benefit in numerous ways, including ease of credit for the right projects. A robust, efficient and well-funded nationalized banking system is the need of the hour. ,” says Kanika Gupta Shori, founder and COO, Square Yards. ((The author is a journalist with 14 years of experience)