The Hindu Business Line : Bank reality-check

Indian banks have to take the merger route to face the global competition; but the process needs proper homework and planning to avoid the roadblocks and pitfalls.

The banking sector appears headed for a consolidation phase. By 2009 , entry barriers to international banks and other financial intermediaries are set to fall, and the largely fragmented Indian banking sector may be hard put it to withstand the assault.

There are other compelling drivers too for consolidation. The Indian corporate sector is acquiring global status and smaller banks may not be able to cater to the complex credit and non-credit needs of the companies. To cope better with a testing interest rate environment, the margin between funding costs and lending rates will have to be finely maintained. The deadline for implementing Basel II guidelines is fast approaching. This has necessitated strengthening the risk management architecture at banks, implying massive investment in technology and human resource, which could be beyond the pale for Indian banks.

Mergers a necessity

None of India's banks today enjoys a global status. India is fast emerging an economic power and in keeping with this stature, it requires two-three banks that can be termed truly global. `Consolidate or perish' is thus the reality staring the Indian banking industry in the face today.

The theoretical arguments in favour of the consolidation are sound. Yet, it is necessary to subject these to a reality check. It must also be remembered that the road to consolidation has many roadblocks and pitfalls. Without a proper homework and planning, the process may not be seamless but, worse, be counterproductive.

Is Big Beautiful?

First, take the argument in favour of bigger banks. Economic theory is that bigger firms are able to reap economies of size and scope. They are better able to withstand competition. By the same theory, size, if not handled properly, can result in diseconomies of scale.

Managerial diseconomies of scale might set in as the numbers go up. Then there is an argument against reducing the competition in the market place. It leads to X-inefficiencies, arising from cost inefficiencies in the case of monopolies or near monopolies, as these have no incentive to reduce costs.

Size has many hues

In the context of banks, the term `size' has various connotations: Size in terms of branch network, of balance-sheet, or business turnover (deposits and advances). It is important to note that the biggest Indian bank having the largest branch network does not find a place among top 100 global banks. On the other hand, not having a national network does not stop a bank from acquiring international status. Bank of America, a global bank, has branches in 29 of the 50 US states. Its arch rival, Citigroup, the world's largest bank, has a much smaller network. Having a vast national network is thus neither necessary nor sufficient condition for a bank to be reckoned international. However, a nationwide network gives bank access to cheap funds in the form of customer deposits.

Focussing on urban centres

The argument of X-inefficiency may not be valid in the context of banks as the turf is being opened to new players. It needs to be realised, however, that their presence will be limited to metro and urban centres, say, Tier-II and -III towns; the rural and semi-urban centres may face X-inefficiencies, though. When one talks of size in terms of balance-sheet and business turnover, it is important that the bulk is more muscle than fat. This applies to the quality of assets, manpower and technology.

Biggies better placed

There is no denying that the big banks have some obvious advantages over small ones. They can raise money cheap and therefore, offer competitive lending rates. Their assets are more diversified, sector-wise and in terms of geographic coverage, and, therefore, less risky. They are able to offer a broader range of services for which fees can be charged. This reduces their dependence on the net interest income. Over reliance on the net interest income has been identified as one of the causative factors for banking crises.

The real benefits of consolidation are derived from developments in technology, the need to maintain economic capital in relation to the risks a bank is exposed to, and the imperative of conforming to best international practices and standards in risk management. Given the size of their operations, and the financial and human resource at their command, bigger banks have a natural advantage in these areas. Such "soft" benefits from consolidation are often more meaningful and beneficial than that of size per se.

Post-Merger Blues

However carefully a bank merger might have been planned, the consolidated entity faces certain risks. A major risk is that in its eagerness to create internal synergy and support, the new organisation's external focus may be lost, making it ripe for poachers; competitors woo customers and key employees. Disruptions involving IT, harmonisation of practices and rationalisation of branches are particularly sensitive areas.

Bank merger does not end up merging two balance-sheets. Integrating two banks following a merger is far too complex and a highly sophisticated exercise to be left to chartered accountants. Banks are highly people oriented organisations and managing employee and customer relationships post merger is the biggest challenge.

Marriage of cultures

Banks are living organisms, each having a unique culture that has evolved over time. Merger of two banks involves marriage of two cultures. It is necessary to ensure that this process is handled professionally by specialist teams. Appropriate organisational interventions aimed at smooth integration can prevent employee alienation and feeling of powerlessness.

Inorganic growth through a well-planned and executed process of mergers can be a cost-effective alternative to the painfully slow process of organic growth for Indian banks.

It can catapult some large Indian banks into the global league. It is perhaps in recognition of these major spin-offs that the Government is encouraging consolidation. There is, thus, a certain degree of inevitability to the process. However, the path towards consolidation may not be smooth. Only a careful and planned approach can yield the desired results.

(The author is a senior executive of a public sector bank.)

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