Mix, but also match

The recent recommendation by a finance ministry-led panel to merge small PSBs with large state-owned banks is not a new idea. The Narasimham Committee on banking sector reforms talked about merging PSBs and there have been feeble attempts towards this end by some finance ministers. What is new lies in the detail. The finance ministry panel has stressed the importance of small banks reorienting their loan portfolios, improving operational efficiencies and bettering their risk management capabilities over the next one year — or ahead of the consolidation. It has also proposed that any consolidation should be market driven, and large PSBs should identify relevant acquisition targets. While these are good suggestions and will promote true synergies in mergers, it remains to be seen if the recommendations are implemented in spirit.

Bank mergers in India have been used more as a tool to bail out weak banks than to expand business. There have been very few instances of voluntary and strategic mergers. Weak banks have been forced to merge with healthy banks to avoid failure and to protect the interests of depositors. Since the reforms in 1993, 13 such forced mergers have taken place. Such mergers have eroded the capital of the acquiring bank as they merged with others saddled with huge losses. For instance, Punjab National Bank took over Nedungadi Bank, the oldest private sector bank, after the bank’s networth was completely wiped out due to accumulated losses. Oriental Bank of Commerce, which was forced to acquire Global Trust Bank, took over a large pile of bad loans, eroding its networth. Given the near absence of voluntary mergers, the consolidation attempt by the finance ministry may end up being just another effort to bail out small PSBs. The weakening state of small PSBs, the strains in the central exchequer, and the urgency to meet more stringent Basel III capital norms seem to have encouraged thoughts of consolidation. But given the poor finances of large PSBs, this is hardly the time for it. Large state-owned banks are also grappling with a high level of stressed assets and scrambling for capital to meet their own needs.

That said, the need to create globally stronger financial institutions presents a compelling case for merging Indian banks, which are still very small compared to their global peers. India’s largest bank, State Bank of India, has about a fifth of the total banking assets in India, but ranks 67th among global banks. Consolidation is imperative for growth, as also meeting the country’s financing needs, particularly in a fragmented domestic banking industry. There is also a significant overlap among the 27 PSBs in India in terms of branches, mode of operation and clients. Merger can obviate the need to duplicate infrastructure and bring down costs, through economies of scale. But such synergies — both cost and revenue — can only flow if the motivation for such activity is driven by complementarities, growth potential and cost efficiency.

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