Will the big bank mergers work: An in-depth analysis

Radhika Merwin | Updated on: Sep 16, 2019

The mergers will fold 10 PSBs into four. What will it mean for investors?

There are some ideas that start out brilliant, fade away when not acted upon, then make a comeback when all else fails and are finally done to death with poor execution. The merging of public sector banks is one such idea. It was the Narasimham Committee that mooted the merger of public sector banks way back in 1991. The Centre’s recent big bank merger announcement — after the merger of SBI with its five associate banks two years ago, and Bank of Baroda with Dena Bank and Vijaya Bank last year — has finally made this a reality. But sadly, the good news ends here.

The Narasimham Committee had stated that mergers should emanate from bank boards, with the government as the common shareholder, playing a supportive role. Also, it had insisted that mergers should not be seen as a means of bailing out ‘weak banks’ but rather be between strong banks. Above all, such mergers can succeed only if they lead to rationalisation of workforce and branch network.


The mergers announced by the Centre — folding ten PSBs into four — meet none of these yardsticks.

After a tumultuous four to five years, nearly all PSBs are saddled with humongous losses, weak capital and fragile balance-sheets. Being the largest shareholder, the Centre has been throwing good taxpayers’ money into these banks every year, to bail out some of them.

But with the government running out of cash and ideas (such as recapitalisation bonds that involved ingenious financial engineering, wherein the Centre simply borrows from the banks to meet their capital requirements), it seems to have dug out the long-buried notion of bank consolidation to rescue the ailing PSBs.

But is the merger between weak banks to create mammoth institutions really the panacea for all the problems plaguing the banking sector? Can the Centre, by creating four gigantic banks, reboot the credit engine to drive the economy? We deep-dive into the balance-sheets of these PSBs to get the answers.

Bigger….but are they stronger?

The Centre has proposed four sets of mergers. Oriental Bank of Commerce and United Bank will be merged with Punjab National Bank. Syndicate Bank will be merged into Canara Bank and Allahabad Bank with Indian Bank. Lastly, Corporation Bank and Andhra Bank will be merged with Union Bank. Thus, the total number of PSBs will be reduced to 12 from 18 currently.

The merged entities will be bigger banks with large balance-sheets, the Centre has argued. For instance, PNB’s current business (deposits plus advances) is around ₹11.8-lakh crore. Post-merger, the new entity will have a total business of nearly ₹18-lakh crore. Canara Bank too will see a 50 per cent jump in its business, post-merger.

In the case of Union Bank and Indian Bank, the bank’s business would double, post the merger. When the dust settles on the merger spectacle, there will be three more PSBs with business of ₹15-lakh crore and over, besides SBI, that are on a par or above large private players such as HDFC Bank and ICICI Bank.

But such simplistic line addition of loans and deposits alone may not create big institutions. After all, the need of the hour is for stronger institutions that can compete better, bring in greater scale and become huge credit engines. By that count, the major pitfall in these mergers is the marrying of weak banks.


Let us take the PNB merger. While the merged entity would rank second among PSBs, its balance-sheet could remain weak and fragile.

The dismal state of affairs at PNB, which is the main bank (into which the other banks are being merged), lends little comfort. Even before the ₹14,000-odd crore Nirav Modi scam hit PNB in the beginning of 2018, the bank’s fundamentals were shaky. In fact, PNB’s bad loan troubles began much before the RBI’s asset quality review in December 2015, owing to its exposure to stressed sectors such as power and iron and steel. The bank reported huge losses in FY18 and FY19. Currently at 16.5 per cent (as of June quarter) of loans, the large bad loan book remains a cause for worry.

The weak finances of the amalgamating banks — OBC and United Bank — only worsens the situation.

OBC’s asset quality has been deteriorating over the past few years. From 5-odd per cent in FY14, GNPAs had shot up to 17.6 per cent in FY18. While bad loans fell in FY19, owing to lower slippages and higher recoveries, there was also a notable amount of write-offs. Over the past five years, the bank’s loan book has grown by a muted 4 per cent CAGR. The bank was under the RBI’s prompt corrective action (PCA) last year and was pulled out of it this January, after the Centre’s capital infusion.

United Bank’s loan book has grown by a meagre 1-odd per cent CAGR over the past five years, but bad loans have galloped — from 9.5 per cent in FY14 to a high of 24 per cent in FY18. Its Tier-I capital had slipped to 5.8 per cent and 7.1 per cent in the September and December 2018 quarters respectively. The bank is still under the RBI’s PCA.


This merger stands on even weaker ground. Union Bank is the sixth-largest PSB by advances currently. But the bank’s deteriorating asset quality has been a concern. From 4 per cent in FY14, the bank’s GNPAs have shot up to 15 per cent in FY19. What’s more, over 70 per cent of the bank’s bad loans pertain to the large and medium corporate segment, where NPA ratios are high at 23-24 per cent. The bank had made huge losses in the past two fiscals. Net NPAs for the bank are over 75 per cent of its net worth!

With such dismal finances of the anchor bank, the merger appears shaky right from start. Marrying it with even weaker banks will only accentuate the problem.

Andhra Bank’s asset quality has deteriorated sharply over the last five years, owing to its exposure to stressed infrastructure and iron and steel sectors. While the corporate segment still brings in a chunk of the NPAs for the bank, the sharp rise in bad loans in the MSME segment over the last two fiscals, is a growing concern. The bank’s CET 1 (common equity) ratio had slipped to 5.6 per cent in FY18 owing to steep losses.

Corporation Bank’s performance has been equally dismal. The bank’s loan book has shrunk over the past five years, while bad loans have risen sharply, eating into earnings and capital.

Even after the government infused about ₹2,100 crore into the bank in FY18, its CET 1 ratio slipped to an abysmal 5.7 per cent by the end of FY18, as bad loans moved up to a high 17 per cent. During FY19, the government pumped in a tidy ₹11,641 crore into the bank and it was pulled out of PCA (in February 2019).

Stronger banks could get weaker

While in the case of the merger of Canara Bank with Syndicate Bank and Indian Bank with Allahabad Bank, the main bank is relatively stronger, the merger would still lead to weaker banks--- debilitating the few stronger PSBs left in the sector.




Indian + Allahabad

Indian Bank has been among the fundamentally strong PSBs sporting a healthy capital ratio. It is the only PSB that has not received capital from the Centre since FY15 fiscal. The bank has been reporting profit over the last five years, even as other PSBs reported losses and sharp rise in bad loans.

Over the years, the bank has been reducing its exposure to the corporate sector and has, in turn, increased its focus on higher-yielding retail and MSME portfolio. This has resulted in better profitability for the bank. Subsuming a far weaker bank will be a huge setback for Indian Bank.

But for the significant ₹11,740-crore capital infusion during FY19, Allahabad Bank’s capital ratios would have remained below the RBI’s regulatory requirement and the bank would have continued to remain under PCA. In the June 2018 and September 2018 quarters, the bank’s CET 1 ratio stood at 4.79 per cent and 4.98 per cent respectively. It has been reporting net loss for four consecutive years.


In the Canara Bank and Syndicate Bank union, the former has been one of the relatively healthier PSBs, with a large balance-sheet. The bank has mostly been able to meet its capital requirement, though it reported a loss of about ₹4,200 crore in FY18, with GNPAs shooting up to 11.8 per cent. But it has been able to bring down its bad loans over the past four quarters. The merger with Syndicate Bank, at a time when the bank’s recovery efforts are starting to pay off, will be a big dampener.

Syndicate Bank has been weighed by asset quality woes with NPAs shooting up from 2.6 per cent in FY14 to 11-odd per cent over the past two fiscals. A muted loan growth of 3-4 per cent CAGR over the past five years has not helped much either. The bank continued to report a loss of ₹980 crore during the latest June quarter, after reporting steep losses in FY18 and FY19.

More capacity to lend?

One plus one is two. But for those talking of bank mergers outside the realm of the ongoing challenges within the sector, one plus one could happily add up to 11. Sadly, the Centre’s own exuberance in building banks with greater capacity to lend, stands on weak ground. While the mergers will create banks with larger balance-sheets, they may not necessarily spur lending. If anything, integration issues in the near term will only lead to more disruption in lending activity.

Let us look back at the recent two mergers.

SBI that grew bigger in April 2017, after merging its five associate banks, has since been saddled with huge legacy of bad loans it took over from its associate banks (on a standalone basis, SBI’s GNPAs stood at 6.9 per cent of loans as of March 2017 and that of its associates stood at 20 per cent). This has weighed on the lender, leading to weak earnings and muted credit growth. SBI reported a loss of ₹6,500 crore in FY18, with GNPAs at near 11 per cent of loans.

In FY19, while bad loans inched lower, much of the reduction (about ₹60,000 crore) was on account of write-offs rather than recovery or upgradation, which kept earnings under pressure. The largest lender reported a muted ₹862 crore profit in FY19, as against ₹9,000-10,000 crore annual profits over the past several years until FY18.

Credit growth in FY18 — the first year after merger — remained muted at 4.8 per cent. On this low base, loan growth was higher at 14 per cent in FY19, but still lower than large private sector banks such as HDFC Bank and ICICI Bank that sported 17-25 per cent.

It may still be early days to assess the Bank of Baroda merger, but the first quarterly results of the merged entity (June 2019 quarter), revealed tell-tale signs of stress on profitability and asset quality. Credit growth for the merged entity was a modest 6-odd per cent in the June quarter. While BoB’s standalone domestic book grew by 12 per cent, a near 9 per cent fall in loans of the other two banks dragged the credit growth for the overall merged entity.

The proposed mergers can prove more challenging and cause further disruption to lending, given the much weaker balance-sheets of the merging banks and lack of strong leader at the helm to steer the integration process.

Fewer banks, lesser capital infusion…really?

The Centre has been pumping in huge amounts of money year after year into the vortex of bad loans. Sample this. Between FY09 to FY15, the government infused nearly ₹70,000 crore of capital into all PSBs. The capital infusion jumped to a little over ₹42,000 crore in the ensuing two fiscals alone (FY16 and FY17).

The big bang recapitalisation plan announced by the Centre in FY18 made all earlier figures look like midgets. After infusing a massive ₹90,000 crore in FY18, the government brought in another ₹1.06-lakh crore into PSBs in FY19. Sadly, the magnanimity of the Centre has proved inadequate, with few PSBs just about meeting the capital requirement even now.

So what does all this have to do with the Centre’s proposed bank mergers?

The general view is that the mergers can ease the burden of capital infusion for the Centre, by reducing the number of PSBs. But this theory could fall flat. PNB and Union Bank being a case in point.

Despite the Centre’s tidy capital infusion over the past two fiscals, PNB’s capital ratios are down to precarious levels — Tier 1 at 7.6 per cent as of June 2019, below the mandated requirement of 8.875 per cent. In the case of Union Bank, the Centre has pumped in nearly ₹8,500 crore into the bank in the past two fiscals. Still, the bank’s CET 1 ratio is 7.8 per cent as of June 2019 quarter — is just above the regulatory requirement.

Given the stress and possible rise in provisioning, both these banks would continue to need significant amount of capital. The fact that the Centre has to pump in a tidy ₹7,000 crore into BoB this fiscal, a year after the merger, indicates that the buck will not stop with creating big banks alone. In fact, the 80-pound gorillas created by the government may well run its kitty dry.


PSU Bank mergers: Takeaways for investors

The countdown has begun. The big bank mergers may fructify over the next 12-18 months. The integration process will be long-drawn, with imminent disruption in lending. There is also the issue of book dilution, which would happen as a result of the government infusing capital at low valuations and issuing additional shares to investors of the amalgamating banks.Radhika Merwin paints a broad picture of the ‘Big Four’ based on various metrics. Note that the analysis is based on assumptions that could change as clarity emerges.


PNB, which is already under stress, will make the merger process more complex. On the network front, given that PNB and OBC both have significant presence in similar regions — North and Central — cost synergies could come into play if infrastructure is rationalised. United Bank has a dominant presence in the eastern market and, hence, the combined entity would gain from the wider presence.

As far as advances go, all banks have similar mix of loan portfolios. So there will be minimal change in the loan mix of the combined entity, though loan growth will be muted in the near term. The combined GNPA levels will remain elevated.

Capital infusion by the Centre will lead to notable dilution. Added to this, OBC trades at a slight premium to PNB and United Bank, which could lead to further dilution (overall 20-22 per cent).

Deep dive into the numbers


Aside from the weak finances of the anchor bank, the fact that the combined size of the amalgamating banks in terms of business and employees is equal to that of Union Bank, is an added challenge. Andhra Bank’s dominant presence in the South will be complemented by Corporation Bank’s presence in the same region. Union Bank’s stronger presence in the Central region would help widen the reach. The combined GNPA levels will remain elevated.

The Centre’s capital infusion would hurt investors, given that the stock trades at a low 0.4 times book. Add to this, both Andhra and Corporation Bank trade at a premium valuation, leading to further dilution (overall 30-35 per cent)

  Deep dive into the numbers


The presence of Canara Bank, a relatively stronger bank, is perhaps what will make this merger relatively easier than the rest. The dominant presence of both the banks in the South — particularly in the State of Karnataka — is also a key positive, as it can lead to cost synergies.

But the weak finances of Syndicate Bank could weigh on the overall performance of the merged entity. Given that both the banks trade at similar valuations, the pain for investors may be relatively less. However, the Centre infusing capital into Canara Bank, would lead to dilution of about 12-15 per cent.

Deep dive into the numbers


This merger could be one of the toughest, given that Indian Bank has a smaller market capitalisation than Allahabad Bank, and just a marginally larger balance-sheet. In terms of geographies too, integration could pose several challenges, given that Indian Bank has a dominant presence in the South while Allahabad Bank operates mainly in the eastern and central regions.

For investors of Indian Bank, the merger is a big setback. Allahabad Bank, which was pulled out of PCA in the beginning of the year, could drag the overall performance of the merged entity. The dilution will be significant (25-30 per cent) for shareholders of Indian Bank, as the anchor bank trades at a steep discount to Allahabad Bank, despite its stronger performance.

 Deep dive into the numbers


Click here to read Valuation metrics / Swap ratio

Published on September 14, 2019
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