Bank Consolidation: Welcome step for Efficiency

Bank Consolidation: Welcome step for Efficiency

Bank Consolidation: Welcome step for Efficiency

The Finance Minister Arun Jailtey, made his intention very clear in his budget 2016-17 speech proposing consolidation of Public Sector Banks (PSBs). Infact, the Finance Ministry is planning to bring down number of PSBs to around 10 from the present number of 27.

The purpose of consolidation in public sector banks is to improve efficiency, reap the benefit of scale economics and create financial institutions of global scale to cater to the needs of a growing economy. Following the announcement and intention of the government, the process of consolidation has started with State Bank of India (SBI) proposing to merge its five associate banks and three years old Bharatiya Mahila Bank.

The discussion between SBI board and board of associate banks took place last week and as reported, the merger is on its way in principle, though the time frame is yet to be confirmed. It seems SBI has got the approval in principle from ministry to go ahead with the merger and the finance minister has already proposed to look at the merger positively. Though the consolidation will have differential implications on different stakeholders, it is a welcome step for India’s banking sector in particular and financial sector in general. It is good for the Indian economy, provided it is done properly. Here is why.

Benefits galore

First, the merger of associate banks with SBI will certainly bring in efficiency in terms of operating cost to income, rationalization of bank branches, rationalisation of organisation structures and high ranking officials. For example, at present there are bank branches of SBI as well as of associate banks in the same area vying for the same client base leading to high operating cost. Similarly, every associate bank has its own organization structure with higher officials and this associated cost could be better utilized and managed after merger. Therefore, the efficiency indicators, namely loans and investment per employee, net profit per employee, interest expense to deposit, loans and investment to capital among others, are likely to improve after the merger. In a globalised world where instability of the banking and financial markets is one of the major reasons for large scale economic crisis, bringing efficiency into the banking sector through merger is a welcome move.

Second, if the merger goes through as planned, the parent bank, SBI, will enter into the group of top 50 (exactly 45) banks in the world with assets worth of $550 billion.
The scale has certain advantages in terms of funding large and mega projects, withstanding external and internal shocks, adopting new technology among others. Generally, bigger banks with large asset base are better users of capital, good at recovery and providers of low cost funding. The financial need of the Indian economy is enormous and mega projects like industrial corridors, modernisation of transport infrastructure and others need banks of global scale to fund mega projects. Smaller banks with low asset, if not managed with the best of business practices and efficiency, would find it difficult to compete with bigger private and public sector banks due to their higher operating cost.

Therefore, the scale achieved in the Indian banking sector through this merger would certainly help. Having many small banks with low asset base but multiple branches and ATMs serving the same purpose does not add value to the objectives.

Third, though the consumers of associate banks may face some difficultly initially because of differential interest and deposit rates they are subjected to on financial instruments - finally these products and services would be integrated with the parent Bank, SBI. Infact, costumers are likely to benefit in future as most of the associate banks have higher lending interest rates than the SBI. In an economy, which is growing and getting more unified, prevalence of differential interest rates on different financial products is not efficiency enhancing.

However, it is not always big is best or small is beautiful. Today all PSBs have more than 70% of total banking business in India but most of them are suffering with bad balance sheets. Sometimes small, both public and private, banks do much better than big banks.

Therefore, it’s all about due diligence in banking when it comes to lending, asset management and bringing efficiency in business operations. Moreover, simply merging associate banks with SBI will not solve the bigger problem of bad balance sheets in PSBs due to high NPAs and the need of funds for recapitalisation. Government needs to not only help bank improve their efficiency, but also provide more funds for recapitalisation then it did in the last budget with Rs. 25,000 crore.

The flip side

The flip side to this consolidation is that it faces stiff resistance from employees and trade unions of the associate banks. There are apprehensions of lower bank branches and thereby downsizing employees of associate banks. However, there have been assurances from the government on this and if at all there is any such impact on the employees, it will be taken care of.

 However, there will be some rationale for setting up number of branches and business will see shifting of base, positions and responsibility for employees. Overall it’s a good move for the Indian economy.

(The author is the Associate Professor at Institute of Economic Growth (IEG), Delhi University)

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