Are mega bank mergers well thought out?

Subir Roy | Updated on February 20, 2020

If the Centre has developed cold feet over bank mergers, it suggests misplaced notions on what big banks are meant to achieve

The government’s plan to merge 10 public sector banks into four, in order to create stronger entities, seems to be getting delayed. This has raised questions again over the usefulness of the whole idea.

Now, it seems issuance of the enabling notification may be delayed, as a result of which the declared schedule of getting the balance sheets merged by April 1 may not be adhered to. Since the primary need is to get things right as you go along, some delay may not be a bad thing.

But what seems worrying is the likely reason for the delay. According to a news report, the Prime Minister wants to have a clear idea first as to how well the earlier merger of two public sector banks into Bank of Baroda (BoB) has fared. What has seemed disquieting to the Cabinet, which has not acted on the notification to effect the mergers in two of its meetings, is the large loss that BoB has incurred in the latest quarter.

Theoretically, when you merge two intrinsically loss-making banks into a stronger one, then the latter (in this case BoB) can see its profits adversely affected, technically to the extent of the losses of the businesses of the two weaker banks, which are now part of the acquiring bank.

In fact, the losses of the merged entity can even be higher than the sum of the parts. Once the weak banks know that they are going to lose their independent identity, their staff can feel orphaned. Then, the efforts to recover dues lose momentum. Moreover, the losses of BoB will reflect the asset classification norms followed by it, which can be different from that of the two weak banks.

Size doesn’t matter

Hence, merging the weak with the strong can initially lead to a big loss recorded by a hitherto profitable, strong bank. This is really par for the course (BoB’s latest quarter loss is because of higher provisioning). If the political masters are worried over the red on the books of a hitherto strong BoB, then the far bigger question is whether they properly understood what such mergers are all about. To clarify the issues at stake, it is necessary to go back to the basics.

The government had somewhat simplistically assumed that the problem of weak banks could be solved by merging them with strong banks. The latter would thereby become bigger and more capable to fend for themselves. Also, those who want to see India big on the global stage (the current political masters are foremost among them) want it to be able to flaunt a few names which are prominent in the global banking pecking order.

The problem with this is, there is nothing intrinsically great about a bank being big. If a big bank has loads of large non-performing assets, then it is no better off than a small, weak bank. All size does is give a bank some balance-sheet strength, on the basis of which it makes large loans to large corporates.

And when trouble comes, it does in scale. Recall the travails of large American banks when the global financial crisis hit in 2008. Witness the current travails of Deutsche Bank, one of the largest in the world. Today, the Indian banking and financial sector is marked by large banks in big trouble over their large corporate NPAs. On the other hand, it is Bandhan Bank and several small finance banks which are coasting along merrily on the strength of their small microfinance loan portfolios, which have an incredible recovery rate of around 98 per cent.

What really matters for a bank is not size but the quality of its portfolio. In this, a relatively small bank will have the advantage of being close to its small- and medium-size borrowers, knowing them well and being able to lend wisely on the strength of intimate knowledge of its customer base. On the other hand, a big bank can be a bureaucratic behemoth.

So merging two weak banks with one strong, large bank, can give you one bigger, but not so strong, bank.

Addressing the problem

So, under the present circumstances what should the government do with the weak, not-so-large, banks? First option is to see if they can be given a new professional top management (maybe by bringing in private sector managers), have them write off unrecoverable loans and recapitalise them. When they have been turned around, they can be privatised.

But if the government does not have the patience to go through this whole process of restructuring and nurturing, then it is better for the weak smaller banks to be liquidated. The weak part of their loan portfolio can be transferred to a holding company created for taking over such assets. The good assets can be taken over by strong, large public sector banks. Or, the government may simply bring the weak public sector banks under the IBC. But, the worst thing we can do is get cold feet after going through a part of the merger process.

The writer is a senior journalist

Published on February 20, 2020

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