The Hindu Business Line : Bank consolidation not inevitable

Bank consolidation is again in the news. The boards of State Bank of India (SBI) and State Bank of Saurashtra (SBS) are reported to have approved the merger of the latter with the former.

Predictably, and almost axiomatically, the merger has been welcomed and an SBI official has been reported saying that “there is a lot of business synergy and the merger would enhance the capital and balance sheet of SBI”. The SBI official has also observed that the consolidation would benefit all stakeholders — shareholders, employees and customers.

At just around 3 per cent of State Bank of India’s balance sheet size of Rs 5,70,000 crore, State Bank of Saurashtra’s present balance sheet will make little material impact on the overall operational parameters, financials and profitability of the parent bank. Indeed, it is possible that the business levels of a couple of branches of the SBI match that of the entire State Bank of Saurashtra. It is difficult to understand how the merger would enhance the capital and balance sheet of SBI, given those numbers.

Stakeholder benefits

As for the benefits to various stakeholders, it is possible that the merger benefits the employees of State Bank of Saurashtra and also the limited number of external (minority) shareholders in the merging entity. As indicated above, given the fact that State Bank of Saurashtra’s operations are so minuscule in relation to the parent bank, it will not have any material impact on its (parent bank’s) financial performance and consequently for its shareholders.

The merger of the smallest associate of the State Bank of India, though, will have significant implications if it has set in motion the process of consolidation of the other associate banks with the parent bank. The associate banks together account for close to 40 per cent of the parent’s current balance sheet. They could provide a significant boost to the overall operational parameters — in terms of liabilities and assets — and a formal merger would provide enhanced operational flexibility to the parent company in re-directing/re-drawing business strategies on a much bigger liability/asset base.

Some numbers provide a perspective here. In the five years to March 2007, State Bank of India’s advances portfolio grew around 23 per cent, on average. In the same period, the parent company’s deposits have grown at a much lower rate of 10 per cent. SBI’s advances growth is broadly in line with what has been achieved by some key players in the public sector banks space — Punjab National Bank, Bank of Baroda and Canara Bank. SBI, though, has fared not as well on the deposits front, where the other public sector banks have registered growth in the mid to high teens in the last five years.

These figures, though, pale in comparison to the 30-35 per cent plus growth posted by other key banking players such as HDFC Bank, UTI Bank or ICICI Bank in the same five-year period. Given SBI’s standing and stature, the comparison necessarily has to be with these private sector players. And the fact that SBI has been growing at a fairly tepid pace in relation to many of its competitors is also reflected in the steady decline in its overall market share — declining from around 21-22 per cent at the turn of the decade to around 15-16 per cent currently.

Boost from larger consolidation

These numbers and the parent bank’s market share will get a one-time boost if the SBS merger provides the momentum and culminates in the formal merger of the other associates. The key questions, though, will follow thereafter. How will a formal merger enable SBI to restructure its balance sheet? Will it enable it to step on the accelerator and regain/increase market share? How different, if at all, are the business models/strategies followed by the other associates?

If different, how easy will it be for the SBI to integrate such strategies with its own or to re-focus strategies for the entire group with a much larger liability/asset base? If the overall business profile of the associates is not much different from that of the SBI, what difference will the merger make, apart from creating a bigger financial institution?

Merger and consolidation, by itself, is not the end. More critical will be how the merger will affect the overall financial performance of SBI. The consolidation could possibly give SBI the opportunity to re-draw its balance sheet and thereby attempt to improve its overall profitability. A single balance sheet could possibly enable the bank to direct more resources to what it perceives as higher earning or margin businesses.

At present, it may not be possible to achieve such re-direction of resources because of the localised nature of the activities of the associates. (To be sure, such a re-drawing of business strategies and diversion of resources cannot be accomplished easily or quickly). As a consequence, there could be a sharper segregation of the branch network into two broad categories — resource mobilisers and resource users.

Scale economies will possibly improve on a much larger business base and that could provide increased leverage for SBI in pricing both assets and liabilities. Against that would have to be factored in the possible upward pressure on non-operating expenditure on a vastly expanded branch network, despite the likely elimination of overlapping branches in many places.

The foregoing are issues specific to the SBI. The merger of all the associates into the SBI could have larger system-wide implications also.

Larger implications

For one, it could throw into sharper focus the issue of consolidation among the other public sector banks. Though the associate banks could be considered a somewhat homegenous grouping given their decades of existence under the overall SBI umbrella, their history also invests them with some elements of heterogeneity. A “successful” merger of the associate banks could up the ante, so to say, with respect to the consolidation of the even more heterogenous groups of other public sector banks.

More generally, it could throw up for debate the continued relevance of smaller and regionally focussed banks. Indeed, there could be a significant, long-term impact on the structure and operation of smaller and regional banks in the country (not necessarily in the public sector), if a broader movement towards consolidation takes ground. If such a movement were to gain traction and lead to the gradual whittling away of the smaller and regional banks, the consequences may not all be beneficial.

Despite the extensive reach of the public sector branch network, it is a fact that smaller and regionally focussed banks have created their own niches over the past many years. Size does play a role but these smaller banks have proved that in a vast, diverse country with varying credit and banking/financing needs, it is possible to create unique niches and profitably run these niches as a business model.

Niche models

A Tamil Nadu Mercantile Bank or a Karnataka Bank or a Karur Vysya Bank are standing examples of this niche-driven business model. There have been failures, too, among the smaller banks, which have seen them merged into larger banks but that does not totally undermine the continued relevance of the regional/locally oriented bank.

Quite apart from the profitable business strategies that these banks have proved and which have benefited their shareholders (and possibly benefit them even more if a larger consolidation process gains momentum and such banks are identified as take-over targets) these smaller/regional banks have been playing a crucial role in the overall credit purveying mechanism in their respective regions.

In a larger sense, therefore, the stakeholders of the smaller/regional banks are not only the shareholders concerned but also the assiduously built-up customer base of these banks.

It is this regional and local focus of the overall credit dispensation mechanism that could be under threat in an environment where smaller/local banks are not present. Even in the case of the SBI, for instance, it is quite possible that the parent (merged) entity is not able to appreciate the nuances and peculiarities of local borrower needs, which may be better recognised and acted upon by an associate. The system could just bypass and ride over the uniqueness present in local banking.

Having said that, consolidation in Indian banking or even in the broader financial sector is certainly not inevitable. The US financial services industry, with its well-knit network of global, national, state, local and community banks, credit unions, savings and loans associations and thrift companies clearly shows how even the smallest financial intermediaries can co-exist, profitably and in a socially relevant manner, with complex financial organisations such as a Citigroup or a JP Morgan Chase.

These many tiers have created their own niches in how they go about borrowing and lending — the essence of financial intermediation — and continue to be as relevant for the future as they are today. If that is the situation in the US, the Indian case for a multi-tiered system of financial intermediation needs no more emphasis.

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State Bank of Saurashtra to be merged with SBI

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