Creating humongous banks may turn out to be ideal, when the financial institutions are in the pink of their health. But merging four weak public sector banks, which posted losses, to create a “stronger bank” is an idea that has triggered a big debate in the Indian banking sector.
The rationale behind merging banks is to ensure capital adequacy, economies of scale, and tackle the non-performing assets (NPA) and governance issues. But if two loss-making banks are merged, the situation may not change per se, say banking experts.
“To make merged entities remain viable, the government should opt for selling at least some of the toxic assets of the weakest banks to the asset reconstruction company (ARCs) and then merge them with the relatively stronger banks,” G Chokkalingam, founder of Equinomics Research, said.
The government has proposed to merge Bank of Baroda, IDBI Bank, Oriental Bank of Commerce and Central Bank of India to create India’s second-largest bank with assets of Rs 16.58 lakh crore, next only to the State Bank of India. Ironically, the combined losses of the four banks are pegged at Rs 21,646.38 crore at the end of FY18.
“Two PSU banks (IDBI and UCO Bank) have outstanding net NPAs at more than 150 per cent of their respective financial net worth. These two banks’ adjusted (for outstanding net NPAs) book value is deep negative. Merging such banks with relatively stronger PSU banks even at zero price would hit their (acquirer) own capital adequacy (net worth) quite badly,” he explained.
“The government should sell bad assets over and above the financial net worth of the weakest banks to ensure that the merged entities do not deplete their own net worth. The merger should be net worth-neutral for the merged entities as compared to acquirers' standalone net worth. This would allow the merged entities to remain stronger and keep growing the business,” he said.
“Merger is not an option for Indian public sector banks, at least 12 months down the line. When the banks do well, merger can be considered,” said Santanu Mukherjee, retired managing director of the State Bank of Hyderabad.
There are issues of culture, software and policies which follow mergers. “The mixture of the two has not been successful even in a single case in this country,” the former banker said.
India has witnessed two cases of bank mergers since the idea of consolidation of PSBs (public sector banks) was mooted by the Narasimhan Committee in 1991 in the initial leg of economic liberalisation.
In the first case, merger of New Bank of India into Punjab National Bank (PNB) in 1993 led to the new entity posting its first ever losses of Rs 96 crore in FY 1996. Employees’ integration also plagued PNB for a long time. In the second case, the merger of associate banks with the State Bank of India brought 20 per cent non-performing assets into the SBI’s balance sheet, weakening its asset quality.
“Despite SBI and its associate banks having the same software, structure and culture, its merger took almost a year to stabilize, said Mukherjee.
When it comes to credit growth, however, G Chokkalingam, founder of Equinomics Research, believes the merger of PSBs would be a right solution.
“With net worth (i.e. outstanding net NPAs being more than their financial net worth) of about 12 PSU banks eroding, the viability of some of them (especially the ones which have net NPA more than 150 per cent of their respective financial net worth) is doubtful,” Chokkalingam said.
Even if these banks managed to survive, the credit base of “these weakest PSU banks” may continue to degrow. Hence, the merger with relatively stronger PSU banks is necessary for their survival and growth.
Further recapitalisation not right
The Union government announced a recapitalisation of PSBs through infusion of Rs 2.11 lakh crore in 2017. The same financial year, all PSU banks together wrote off bad loans worth Rs 1.20 lakh crore and posted a combined loss of Rs 85,370 crore.
Further recapitalisation is not an answer to the problem plaguing the banks, feels Mukherjee.
“All government infusions are cash-neutral. It doesn’t result in any additional cash to the banks,” he observes.
“There is no point in giving further capital to the weakest PSU banks - considering their past experience in generating net NPAs in double digits and finally ending in degrowth in their business, there is no guarantee that these weakest banks would get bank to positive growth and also avoid generating toxic assets once again. It would be better to merge the weakest banks with relatively stronger ones and then make capital infusion for the merged entities,” said Chokkalingam.
Meanwhile, economic growth is key to solving problems in the banking sector, said Mukherjee. “If good projects come, banks will be keen to finance them and deploy the deposits,” he said.
On the impact of these mergers, write-offs and NPAs and losses on bank stocks, Chokkalingam said the pain would continue at least for another six months in the short term. Once accretion to NPAs tapers off (which is likely in the next 6 months), and the weakest banks are handled properly through consolidation, the bitter story would be forgotten after a year or so.