Going ahead with bank mergers

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The prevailing political consensus has held up bank restructuring. The government is not merely committed to holding 51 per cent stake, but also ends up supporting weak banks. A fresh start can be made by initiating the merger of pan-Indian banks, says S. S. TARAPORE.

The consolidation of public sector banks has been on the agenda for many years, but despite many an effort precious little has been achieved on the ground. The first mistake was made at the time of nationalisation of 14 banks in 1969, when the erstwhile entities were all allowed to continue. The second error was when six more banks were nationalised in 1980 and these banks were not merged. The third false step was not merging the associate banks with the State Bank of India.

Unlike in the case of life insurance, when a monolith public-sector life insurance institution was set up on nationalisation, in the case of banks the received doctrine was that the pre-nationalised structure should not be altered. It is nearly 20 years since Narasimham Committee-I articulated the need for consolidation.

There is, however, a contrarian view — articulated among others, by Dr N.A. Mujumdar, the former principal adviser of the Reserve Bank of India (RBI) and a vehement critic of Indian financial sector reforms — that there is nothing wrong with the present structure of public sector banks and that we should not be carried away by the transient fashions of the time in industrial countries that banks should be big, a doctrine which has been questioned in the wake of the recent international financial crisis.


The Government's position is that it would not oppose any voluntary mergers of public sector banks. The ground reality is that proposals for consolidation are scuttled by political pressures and the unions, in the absence of proactive measures by the Central Government.

The patriarchal stance of the government that it would bless mergers based on synergies is unlikely to yield any meaningful results. Furthermore, the government's view that the 19 nationalised banks could be merged into eight or 10 banks appears to be an ex cathedra judgment, not backed by any concrete examination.

The Government faces a contretemps. Successive governments, of different hues, have contributed to a political consensus that any reduction in the 51 per cent minimum government ownership is just not negotiable. As such, the recommendation of Narasimham Committee II (1998) — reiterated by the Committee on Fuller Capital Account Convertibility (2006) — that government ownership be reduced to a minimum of 33 per cent is just not on the cards.

Yet, Government spokespersons, from time to time, give assurances on implementation of the Percy Mistry Committee Report (which recommended that government completely give up its ownership of banks by 2014) and the Raghuram Rajan Committee Report (which recommended that government give up its ownership in at least a few public sector banks). This leads to the inevitable conclusion that apart from lip service, no concrete steps would be taken to consolidate public sector banks.

The novel and pragmatic recommendation by Dr C. Rangarajan, that the minimum 51 per cent Government ownership stipulation should be amended to include holdings in these banks by public sector units which are meant to remain in the public sector, such as LIC, ONGC, and IOC, has also not found favour with the Government. Such an amendment would have at least eased the financial burden on the Government.

At present, there is financial pressure on the fisc to meet the capital requirements of public sector banks. To alleviate this financial pressure, a World Bank loan has been taken. This is clearly a false start.

The banks could have directly raised money abroad at lower rates of interest and the government could have borrowed in the domestic market to meet the enhanced capital requirements of banks. While it is assured that the borrowing from the World Bank will not alter the sanctity of the 51 per cent minimum government ownership rule, the casualty could be giving up of the sound principle of reciprocity in granting banking licences to foreign banks.


The more recent initiatives of encouraging pan-Indian banks (like Canara Bank, Punjab National Bank, Union Bank, Bank of India and Bank of Baroda) to take over smaller public sector banks is unlikely to materialise as very strong vested interests in smaller public sector banks would use political agitation to scuttle such mergers.

Although calculated leaks from the government indicate that foreign consultants are likely to be appointed shortly to assist the larger public sector banks to undertake due diligence before mergers, such initiatives are likely to come to naught. Mergers involve blood-letting and are often very ugly.

The Government needs to give serious attention to a totally different tack. What could be encouraged is a merger of strong pan-India public sector banks, which would be free from narrow sectarian political pressures.

This is, however, easier said than done. The government should set up a high-level Banking Consolidation Commission with specified powers to merge strong public sector banks.

The commission should have a transparent mandate endorsed by Parliament. The merger process could be undertaken after approval by the non-government shareholders of the banks concerned and the commission should carry the system along by giving due attention to the interests of employees and depositors. It should be ensured that such mergers are only undertaken when one plus one is greater than two.


There are certain prerequisites that should be met before undertaking such meaningful mergers.

First, the Government, as majority owner, should restrict itself to proprietary interests and not get into regulatory functions.

Second, the bank boards should be made accountable, and there should be no back-seat driving by the government or the RBI. Independent directors on the boards should be appointed by the bank boards, and government and RBI nominees should be withdrawn. There is already a move to assign to the boards of public sector units the task of appointing independent directors; this practice should also be extended to public sector banks.

Third, the system of appointment of top management of banks should be totally revamped and the Banking Commission should be the final authority for making these appointments.

Fourth, the salary structure of each public sector bank should be determined by each bank taking into account the bank's productivity and profits.

Fifth, to the extent the government wishes to hold on to 51 per cent ownership, it should pump capital only into well-performing banks. Injecting capital into the relatively weaker banks is a doomed policy. Banks which are relatively weak and short of capital should not be allowed to grow.

If the Government does not take hard decisions, the Indian banking system will continue to remain weak. We should not be carried away by macho spirits claiming that the Indian banking system is the strongest in the world.

Tail-Piece: Today is a watershed in Indian monetary policy. It needs to be seen whether the RBI chooses to face brickbats and implements a hard policy of withdrawing the stimulus, or opts for a namby-pamby policy that plays to the gallery. I pray, and am sure, that RBI, true to its tradition, will opt for the former.

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(This article was published in the Business Line print edition dated January 29, 2010)
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