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S. Vaidya Nathan

MOST mergers and acquisitions are likely in the finance sector over the next few years, as consolidation becomes the dominant theme. So far, they have been sporadic and confined to placing financial outfits in trouble in safer hands. The latest is IFCI, which is to be merged with Punjab National Bank. IDBI, which too has been rescued by a bailout package, is set to metamorphose into a bank. There are indications that it may merge with a PSU bank to fast-track to get back to health. With PNB out of the reckoning, if IDBI is to merge with a PSU bank, it would be either Bank of Baroda or Bank of India.

Having effectively dealt with problematic entities such as the UTI, the IDBI, the IFCI and Nedungadi Bank, the focus of the Government and the RBI may shift to consolidation of banks that are in a healthier shape.

Over the past two years, the PSU banks have cleaned up their balance-sheets through a combination of big-ticket provisioning for bad loans using the boost provided by windfall treasury income and asset recovery. Ever-greening of loans, however, continue to be a threat and some studies have estimated weak quality loans at nearly twice the official bad loans figure.

Consolidation can help minimise the risks posed by such undisclosed problem loans and strengthen the financial system. The merger of ICICI with ICICI Bank has highlighted the benefit of such a strategy; it has helped blunt the risks posed by the large NPAs of the former.

There are too many small- and medium-size banks for comfort; quite a few may find it tough to survive with healthy profitability across business cycles, in an environment marked by enhanced competition, and move towards tighter spreads.

Tighter capital adequacy norms, and the need to shore up capital adequacy without expanding the equity base in a big way, lower operating costs and unlock synergetic benefits that are inherent across the PSU banks, may also drive the process. This consolidation is by no means imminent. Efforts to kickstart the process may have to wait for the completion of parliamentary elections.

But over the next few years, it would be a surprise if there is no progress on this issue. For instance, LIC, which has a significant stake in two good banks — Corporation Bank and Oriental Bank of Commerce that have a marginal overlap of business — may prefer a merged entity. The boards of a few other PSU banks may come up with proposals on their own or may by nudged to that end by the RBI.

As for private sector banks, Bank of Punjab, IDBI Bank and IndusInd Bank, as also a host of old generation banks are likely to be very much a part of the consolidation process. Expect Centurion Bank to join the bandwagon once it is restored to a state that it can fetch an attractive price; expect the new kid on the block — Kotak Mahindra Bank — to covet and be coveted by strategic partners; and a merger of SBI and its seven associates cannot be ruled out.

The consolidation and strategic partnership story may be a dominant theme in driving the valuation of banking stocks; when this process is activated, it may place valuation levels out of kilter with fundamentals for a period. This is a theme that has potential to unlock value across the spectrum of banking stocks.

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