Right direction, challenges aplenty

The sudden announcement of merger of three public sector banks – Vijaya Bank, Dena Bank and Bank of Baroda -- last week was a grim reminder of stronger banks being merged with the weaker ones impacting their performance for a long time. One such case was the 1990s merger of National Bank of India (NBI) with Punjab National Bank (PNB). The whole exercise was done without engaging even the primary stakeholders – the two banks.

The urgency was to reduce the whopping Non-Performing Assets (NPAs) of around Rs 450 crore of NBI which was 2.5 times its entire capital base. As a result, the profit-making PNB recorded losses close to Rs 100 crore in the following year. The announcement by Finance Minister Arun Jaitley in a hurriedly called late evening press conference took the management of all the three banks by surprise. Quite against the recommendations of the Banks Board Bureau (BBB), which requires consultations of all stakeholders before any merger or acquisition of banks and a thorough preparation. It was only towards the end of August that the Reserve Bank of India (RBI) was asked to prepare a list of public sector banks that can be merged.

Last year, the centre had constituted a ministerial panel headed by Jaitley to oversee merger proposals of state-owned banks. The other members of the panel included Railway and Coal Minister Piyush Goyal and Defence Minister Nirmala Sitharaman. The government sources later said that it was the panel that decided on the merger of the three different entities two of which represented north and west and the other, the southern part of India. The finance minister said it was done to create the third largest bank in India after the State bank of India and ICICI Bank. The merged entity would have a combined business of Rs 14.82 lakh crore.

However, the move of amalgamating an extremely weak bank with gross non-performing asset rate of around 23% with two rather healthy ones was seen as a rescue operation by the government running against time to reduce Rs 10 lakh crore worth of NPAs, the interest on whom were multiplying by the day.

Deadline unlikely to be met

Bank of Baroda is comparatively better of the lot with a bad loan rate of 12.5% but Vijaya Bank is probably the only PSU bank whose gross NPA is less than 1%. HDFC Securities in its research note after the merger said the move was negative for Vijaya Bank and BoB.

It also cast doubts on the government’s plan to complete the merger within the current financial year, saying the previous precedence of merger of Kotak Mahindra Bank and ING Vysya Bank took almost a year.

The proposed merger comes close to the government’s decision for LIC takeover of a majority shareholding in the IDBI Bank with Rs 40,000 crore of gross NPAs. Critics are not opposed to merger per say but there is a strong argument that mergers have been of little help in reducing bad loans.

The most recent merger of SBI with its five associate banks last year only saw closure of branches, increase in bad loans, reduction of staff, reduction in business. According to the All India Bank Employees’ Association, for the first time in 200 years, SBI went into losses.

It said the total bad loans of five associate banks as on March 31, 2017 was around Rs 65,000 crore and that of SBI at Rs 1,12,000 crore. In 2018, bad loans of SBI increased to Rs 2,25,000 crore. “So it is clear that merger has not helped to recover bad loans,” AIBEA said.

Analysts also favoured bank mergers only after the RBI was given enough powers to regulate them. At present, the regulators have no such powers vis-a-vis PSBs and setting unwieldy banks without adequate preparations may lead to more problems.

Recently, RBI Governor Urjit Patel sought more powers and cited at least 10 areas where RBI had no control over PSBs. These included, power to remove chairman, director or CEO of a state-owned banks and impose restriction on common directors on PSB boards.

More so, after the global financial crisis of 2007-08, the central bankers had come to the conclusion that big banks were a systemic risk. Nonetheless, too many small banks pose problems for the government to manage them especially when it comes to recapitalising them from time-to-time.

Rating agency Crisil said the success of the three-way merger will be crucial as it will pave the revival path for other weak PSBs, mainly those under the PCA framework.

“The long-term structural benefits are compelling enough to push forth on the consolidation path,” Krishnan Sitaraman, senior director at Crisil said. He said the merger of associates with SBI was relatively easier because of common branding and technology, and the mothership’s strong balance sheet, which could cover asset-side risks of subsidiaries.

Direction to future mergers

However, the option of merging better performing public sector banks with the weaker ones are few. The ability to manage potential challenges in terms of balance sheet, people and processes, and their impact on growth and operating metrics over the medium term, will determine the success of future mergers.

The smaller Dena Bank with large NPAs is under the PCA framework of the RBI and has been restricted from lending and expansion. The better Vijaya Bank has a large presence in South India, culturally different from the north and its people – both employees and customers may take time to adjust in the merged entity. But the assurance from the government that none of the employees of the three banks will face the axe should reduce employee discontent going forward. However, the same was not the case in SBI merger. It faced a huge reduction in staff.

Rating agency Moody’s, which late last year upgraded India’s sovereign rating, said the merger is credit positive.