GS-3, Indian Economy, Uncategorized

Merger of Banks

Finance Minister Nirmala Sitharaman has announced the merger of 10 public sector banks into four entities as an effort to revive the economy.

Current Economic Status of India:

  • India’s Gross Domestic Product (GDP) growth rate dropped to 5% in the April-June quarter due to a sharp deceleration in manufacturing output and farm sector
  • The Gross Value Added (GVA) growth in the manufacturing sector dropped to 6% in the first quarter from 12.1% a year ago.

Details of the Bank Merger:

  • With the merger of these banks, the total number of PSU banks will come down to 12.
  • The date by which these mergers are to be completed will be decided after further consolidation with the relevant banks.
  • Following are the mergers announced:
  1. The largest of the mergers announced is that of Punjab National Bank with Oriental Bank of Commerce and United Bank. The amalgamated entity will become the second-largest public sector bank in India in terms of its branch network, after the State Bank of India.
  2. Canara Bank and Syndicate Bank merger would make the merged entity the fourth-largest public sector bank.
  3. Merger of Union Bank of India with Andhra Bank and Corporation Bank would make the merged entity the fifth largest public sector bank.
  4. Indian Bank and Allahabad Bank.
  • The reforms is significant due to its sheer magnitude, its ability to disrupt the status quo and is also a major change since nationalisation of banks.

History of Bank Mergers:

  • In the late 1990s, Narasimham Committee recommended consolidation through a process of merging strong banks.
  • Successive governments since then have been considering the issue.
  • In 2016, the government has already merged State Bank of India with its 5 affiliate banks and Bharatiya Mahila Bank. Bank of Baroda was merged with Vijaya Bank and Dena Bank.
  • Before it, the number of public sector banks in India was 27.

What were the Criteria for Selection of Banks?

  • These banks were chosen for the mergers ensuring that there is no disruption in the banking services.
  • Another basis for selection was that the banks should benefit from increased CASA [current account savings account] and greater reach.
  • To ensure that their activities are not disrupted, those banks are chosen which operate on the same or very similar platforms.

Factors that will determine the Success of Mergers:

  • Success of mergers is determined by a number of factors that can produce a combined effect greater than the sum of their separate effects. The major factors are:
    • Costs: The most important factor. It can be realised through branch and staff rationalisation.
    • Geographical locations: The fourth set also has geographical synergies. Allahabad Bank, headquartered in Kolkata, is stronger in east and north India, while Indian Bank has a strong presence in the south. This geographical synergy is somewhat missing in the other three sets.
    • Technology: In all the four sets of merger, there is technological synergy as all the banks in a particular bucket have similar core banking solution platforms.
    • Banking Products and business model.

Positive Outcomes of the Move:

  • Out of the total 12 public sector banks, 6 will be able to compete at a global level that can leverage economies of scale. There are too many banks in India that are very small in size with respect to global standards. It constricts their growth by making them unable to expand.
  • These bank mergers will lead to the creation of big banks with an enhanced capacity to give credit.
  • The merger has the potential to lead to large cost reductions due to branch network overlaps.
  • Similar business cultures of the banks would also facilitate a smooth transition.
  • The mergers would also increase the post-merger business by 2-4.5 times.
  • It will enable the consolidated entities to meaningfully improve scale of operations and help their competitive position.
  • India industries hails decision since it aims to consolidate public sector banks and address the slowdown in GDP growth.
  • The decision is lauded for reflecting the government’s commitment to provide the country the financial base on which we can grow and move towards the $5-trillion mark. It will equip banks to manage balance sheet size to serve the needs of a $5-trillion economy by 2025.

Challenges:

  • Due to high bad loans of the merged entities, profitability could be impacted in the near term.
    • Nine out of the ten banks have net Non Performing Assets (NPAs) of over 5%.
    • More than 6% net NPA is one of the risk threshold of Prompt Corrective Action (PCA), the breach of which could invite restrictions by RBI.
    • United Bank of India is under the PCA framework of the RBI due to high NPA.
    • Oriental Bank of Commerce came out of the PCA framework earlier this year.
    • Asset quality of the fourth set of merger is much better. The combined net NPA is 4.39%.
    • Rating agencies have raised concerns over the merger citing weak asset quality.
    • The Narasimham Committee had recommended to shut down weaker banks and not to merge them with strong banks. But, the recent merger goes against that recommendation.
  • There will not be any immediate improvement in credit availability as all of the banks have relatively weak NPA profiles.
  • The Provision Coverage Ratio (PCR) of the banks are also much lower than the compliance level of 70%. PCR measures the provisioning for bad loans from the profit generated by the banks.
  • Punjab National Bank (PNB) has a net NPA of 6.55% and it also suffered a loss of about ₹14,000 Cr. last year in the Nirav Modi scam.
  • In handling staff rationalization which is a sensitive issue, the efficiency of banks is questioned.
  • There are concerns among employees that the proposed merger would result in closure of large number of branches (as happened in the case of State Bank of India) reducing employment opportunities. The All India Bank Employees’ Association has opposed the move.
  • Bank branch rationalisation is another challenge. There is overlap of bank branches in same area. Ex.: Canara Bank and Syndicate Bank merger (in Karnataka and other southern states), Punjab National Bank and Oriental Bank of Commerce (in the north and the west India).
  • Another issue is the IT related synchronisation between banks.
  • It is possible that the current mergers may face more friction than the last ones in which a large and strong bank absorbed much smaller entities.
  • A larger issue is that the government nominees on the boards of banks are often political appointeeswho have little exposure to the banking sector.

Other Reforms announced along with the Merger:

  • A number of smaller reforms to the boards of the banks were also announced aimed at improving their efficiency and accountability.
  • Board Committee would be made in charge of appraising the performance of officers of the rank of general managers and above, including the managing director. It is aimed at making the management accountable to the boards of the banks.
  • The banks will be allowed to recruit chief risk officers from the market at market-linked compensation. It will attract the best available talent.
  • Bank boards will be allowed to reduce or rationalise the number of committees.
  • The effectiveness of the directors on the Management Committees of Boards will be increased by increasing the length of their terms. It is aimed at increasing the engagement of non-official directors.
  • The government has announced that the 10 banks will get ₹55,250 Cr. capital out of the ₹70,000 Cr. that has been allocated for the current year.
  • In addition, Bank of India and Central Bank of India will be able to expand their national presence and Indian Overseas Bank, UCO Bank, Bank of Maharashtra, and Punjab and Sind Bank will be able to strengthen their regional focus.

Implementation of Earlier Announcements:

  • The government had last week announced a transparent one-time policy that will be issued by banks to enable MSME and retail borrowers to settle their dues. Instructions for this had been issued to the banks.
  • Eight public sector banks have launched repo rate-linked loans ensuring the transmission of rate cuts by the RBI to end consumers.
  • Earlier, it was said that banks would return loan documents within 15 days of the closure of the loan. This mechanism would be done through the core banking system and regional managers would be responsible.
  • A system had been initiated to facilitate online tracking of loan documents in which borrowers can track their loans.
  • Partial credit guarantee schemes have been executed, particularly for the NBFCs including housing finance corporations. It will ensure that liquidity is reaching them.
  • The plan for the co-origination of loans between banks and NBFCs had already initiated through with bank-NBFC tie-ups.

Future Prospects:

  • It should be ensured that the proposed merger will not result either in cost cutting, closure of branches or retrenchment of employees.
  • The employees should receive the best of the employee benefits and the admin staff need to be redeployed for business.
  • The merger need to be supported with adequate reforms in governance and management of these banks.
  • Key reforms with respect to appointments, especially of government nominees, need to be made at the board level.
  • The amalgamation will require harmonisation of asset quality (related to NPA) and provisioning levels among the merging banks so as to increase the credit provisions.

Conclusion:

The definition of global banks is not only about the size but also about the professionalism in its governance. The government will have to promptly manage the implementation and outcome of four simultaneous mergers which may disrupt the industry.

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