The Hindu Business Line : Convergence of public sector banks — Management matters, not just ownership

In India, a heated debate on consolidation among banks, especially public sector banks, has been generated recently, with the Finance Minister welcoming the idea, as part of his convergence, consolidation and competition mantra. Expert opinion on its desirability, however, appears to be divided. While the performance of PSBs has been satisfactory of late, there is need, first, to strengthen their fundamentals, before embarking on consolidation, says Katuri Nageswara Rao.

CONSOLIDATION of banking and finance firms through the mergers and acquisitions route is a global phenomenon that has gained prominence since 1985. The players involved are commercial banks, investment banks, securities firms, financial services conglomerates, insurance firms and asset management companies.

There have been domestic as well as cross-border acquisitions in the US, Europe, Latin America and Asia. The principal objectives are market share enlargement (either through domain strengthening or by acquiring specific business capabilities), economies of scale and scope (either through domain extension or by acquiring a business platform) and financial skills (either through domain exploration or by acquiring a business position).

These objectives, if accomplished, could result in productivity enhancement and higher profitability. Risk management may also improve due to business diversification.

Financial sector mergers have also resulted in convergence of banking, insurance and securities firms, giving birth to banking behemoths called universal banks.

In India, a heated debate on consolidation among banks, especially public sector banks (PSBs) has been generated recently, with the Finance Minister welcoming the idea, as part of his convergence, consolidation and competition mantra. Expert opinion appears to be divided as to the desirability of consolidation of PSBs. There is speculation that some have been even working on the modalities for mergers, taking the clue from the Finance Minister.

While the Centre prefers the initiative to come from the banks themselves, in this regard, as part of their business strategy, banks perceive it as an inevitable consequence to the policy direction of the Government.

Saga of bank mergers

The banking system has witnessed many mergers, big and small, in the past. Between 1969 and 2005, there were 26 mergers. In as many as 22 of them, the transferee bank was a government one.

These 22 mergers were essentially at the behest of the government to bail out sick private banks, with a view to safeguard the interest of the depositors and other stakeholders.

It is a tribute to the PSBs that they shared the burden of bad banks, with insignificant costs to the economy. The merger of Times Bank with HDFC Bank (2000) Bank of Madura with ICICI Bank (2001) and Bank of Punjab with Centurion Bank (2005), all in the private sector, may be classified as the ones that happened for business considerations.

Does consolidation suit PSBs?

In the financial sector, international experience identifies the following drivers for consolidation: Institutional configurations becoming obsolete in terms of competitiveness, faster growth prospects, better returns to shareholders, regulatory and public policy changes, broader access to clients, functional lines and market geographies.

The vital question is, in the context of PSBs in India, do these drivers really work? It is interesting to note that the PSBs are generally moving in one direction. Their business models and strategies, products and services really do not differ from each other significantly.

Some of them may have an edge by way of relatively superior performance but otherwise, all of them look alike.

If a major south-based bank such as Canara Bank is merged with a north-based bank like the Bank of India, will there really be better growth prospects or broader access to clients and markets? Only to a very limited extent.

Mergers between big banks could reduce competition, increase market concentration and enhance monopoly, to the detriment of clients. Some banks may emerge as `too-big-to-fail' candidates, posing moral hazard problems.

Emergence of national champions

With the reduction in the number of PSBs through consolidation, there will be a wider business focus. Will some PSBs become, in the process, national champions to compete effectively in the global arena? Not very likely, if we note that the global rank of the biggest bank — State Bank of India — is 98 in terms of assets.

Also bank branches, functioning overseas have been still doing only `ethnic banking', without much success in attracting an overseas, non-Indian origin clients. But if the consolidation process starts now, some of the Indian players may become global over a period of time.

The protagonists of consolidation, therefore, argue that a beginning has to be made sooner than later. Bigger banks may be in a better position to be technologically competent and competitive as they can invest larger amounts for IT upgradation. This appears to be a distinct advantage. With higher penetration of technology, financial products and services could be produced on a massive scale cost effectively.

More risk management instruments such as derivatives can be developed. With effective data storing and mining, customer relationship management (CRM) could become more meaningful. However, we must be aware of the fact that with information technology, even small banks can reap cost advantages, if they are innovative.

There may be no significant scale or scope economies either, due to consolidation, as operational efficiency cannot easily be improved in bigger banks if their business lines do not complement each other.

PSBs, with same kind of business lines, cannot be expected to perform better. Could there be reduction in risks due to diversification across business streams, client segments, etc.? Not to any appreciable extent, as the business streams themselves are not different. Nor the client segments, for that matter.

If Indian banks achieve greater degree of convergence between banking, securities and insurance streams, risk mitigation through diversification may happen; but not for the time being, as PSBs still follow the pure conventional banking model.

Time to concentrate on fundamentals

While the performance of PSBs has been really satisfactory of late, there is need to strengthen their fundamentals, first, before embarking on consolidation. These banks need larger capital bases and organic growth alone does not answer this challenge.

Higher foreign direction investment has to be encouraged. The RBI's insistence on a well-diversified ownership structure has to be critically re-examined with a view to providing the necessary flexibilities for the inflow of FDI.

Similarly, the Central Government's rigid policy of preserving the `public sector character' needs a re-look, as it is an outdated concept in the present era of deregulation and globalisation. What matters in banking is not ownership but management.

PSBs need to face the challenge of financial exclusion, not by merely offering `no-frills accounts' but by innovatively financing weaker sections through bankable schemes.

In fact, digital exclusion within the banks is also a challenge. There could be another voluntary retirement scheme (VRS) initiated to send out senior employees with inadequate IT skills. The HR policies have to be reworked to incentivise good performance and penalise non-performers.

PSBs have to learn the skills of investment banking, insurance selling and outsourcing to be competitive.

SME sector may suffer

Consolidation increases the size and complexity of the business. Bigger banks have a tendency to look for bigger players to the exclusion of the SME sector. The economy can hardly afford such a consequence.

Consolidations now bring challenges such as cultural and IT integration issues. It is, therefore, essential to critically conduct a due diligence procedure before embarking upon consolidation. Otherwise, the whole process may only result in creating bigger empires for the CEOs, without any tangible benefits to the stakeholders.

(The author is Associate Dean, ICFAI University, Hyderabad.)