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Banking sector consolidation revisited

— PHOTO: R. V. MOORTHY

ENSURING FINANCIAL STABILITY: Union Finance Minister Pranab Mukherjee and Minister of State for Finance Namo Narain Meena during a meeting with the chief executives of public sector banks in New Delhi recently.

The proposal to form fewer but stronger banks in India through consolidation is not new. In this context official policy has tended to favour the merger of the public sector banks (PSBs). The idea gathered momentum after the Narasimham Committee-II (1997) on financial sector reform recommended the creation of a few big banks by merging public sector banks.

The UPA government in its earlier term had vigorously advocated consolidation but achieved very little. The only merger of consequence was the takeover by SBI of its smallest associate, the State Bank of Saurashtra. Surprisingly, despite all the talk of mergers and amalgamations, there were few policy inputs. Whatever decisions the government took to speed up individual mergers were ad hoc and mostly prompted by concern for the depositors of a failed institution.

Finance Minister Pranab Mukherjee had recently supported the idea of consolidation. This, according to him, is necessary to improve the competitiveness of Indian banks globally and also ensure financial stability. PSBs ought to look at consolidation as a serious option, he had stated. The government, as a majority shareholder, would continue to play a supportive role to the process.

Any discussion on bank consolidation in India seems to centre almost exclusively on government-owned banks. For many reasons that is understandable. These banks continue to occupy a dominant position long after they came into government fold (The great wave of bank nationalisation began in 1969). Any structural alteration of the financial sector will have to involve them. At the same time, it is a fact that bringing two or more PSBs together has posed intractable problems.

It is naïve to think that the opposition to bank mergers is confined to trade unions. One should really examine whether the presumed benefits would really accrue. The idea of creating bigger banks to take on competition sounds attractive but one must realise even the biggest among Indian banks are small by global standards. A merger involving banks in the top rung say, SBI, Bank of India and Punjab National Bank will not create a ‘world champion’ as the merged entity will still be small.

The argument that a merged entity will be in a better position to raise capital than individual banks may not be strictly correct. Government-owned banks will have to always reckon with the condition that their majority shareholder will not let its shareholding fall below 51 per cent. Some of the PSBs, including SBI, are near that floor. Other banks may have some leeway, but they too will be soon constrained. A merger between two such entities will not help.

Other routes to raise capital such as divestment in India or sale to overseas investors are ruled out for now. It is futile to talk of the government — any government for that matter — relinquishing its majority stake in the PSBs. Denationalisation cannot have many votaries. The world over, the biggest private banks are seeking the sanctuary of government investment and ownership. In India, government ownership has once again stood the banks in good stead during the financial sector crisis. So for now the only alternative is for banks to receive capital from the government.

Privatisation of banks is a discredited idea the world over at the current juncture. The possibility of some foreign buyer acquiring an Indian bank is remote, given the current state of the financial sector abroad. ICICI Bank Chairman K. V. Kamath has referred to this recently.

A bill introduced in Parliament some years ago to bring down the government stake to 33.33 per cent in PSBs is languishing even though the then Finance Minister has said that the public sector character of these banks will be maintained post-dilution.

Merging PSBs is a highly complex task. Many legal hurdles will have to be crossed and parliamentary approvals obtained. The government will have to do plenty of preparatory work. Even if practicable, the time horizon is likely to be long.

Most importantly, the merger advocates ignore the fact that beyond a point size does not increase efficiency. Creating behemoths from two already large banks will not help in either facing competition or raising capital. On the other hand, several more layers will be added to the existing bureaucratic structures in government-owned banks.

Inexplicably, the debate has sidestepped some crucial issues such as rationalising the manpower and branch network after bank mergers. In the reform era, the strengths of public sector banking — the branch network and superbly trained manpower — have been initially discounted. Yet today’s urgent tasks of the financial sector — social banking and financial inclusion — require these strengths to be harnessed to an even greater degree than before. Bank consolidation will create redundancy, demotivate staff and make the financial sector less inclusive. There are lessons to be learnt from past mergers involving PSBs. Punjab National Bank was asked to take over New Bank of India at what turned out to be an enormous cost for the former. PNB, among the top rung banks, went down by several notches after the merger. The same fate befell government-owned Oriental Bank of Commerce after it was asked to take over the failed Global Trust Bank.

Surprisingly, cultural issues and regional strengths are not discussed when mergers among banks are discussed. Almost all banks in India have grown from specific regions and have retained certain unique strengths despite some of them coming under the government fold. A merger of such institutions with another bank would whittle down such strengths. An outstanding example here is the decision to merge State Bank of Saurashtra (SBS) with SBI. The SBS had a strong tradition in the Saurashtra region of Gujarat and it is difficult to see the merged bank’s strengths accruing to SBI. The SBI and its associates have a common technology platform and use the same logo. The rationale for adding some more bank branches to SBI’s already large network under a merger is highly questionable.

Finally, it is good to remember that bank consolidation in India is very different from moves to consolidate companies in specific industries or segments. For all the excitement it evokes, consolidation is a slow process and is best not dictated by the government.

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