Consolidation of public sector banks had been discussed in banking circles for many years now. P Chidambaram, Finance Minister in the previous United Progressive Alliance (UPA) Government, had highlighted the need for large-sized banks to fund the huge infrastructure requirements of the country as well as compete with global lenders. But the UPA Government had always maintained merger proposals should come from the respective bank boards — which did not happen. A tongue-in-cheek question that went around was: ‘Which chief executive will propose to merge his bank with another and lose his job?’
But, it appears that the present government has no intention to make it ‘voluntary’ for the board of a bank to decide on a merger. It is evident from the fact that it has followed up on the issue with communication to the banks to kick start the process of mergers and get their respective boards’ approval. This may be the first time in recent history that an official communication has been made by the government to the banks asking them to act on mergers.
Nudge to banks
The government has also set up an ‘Alternative Mechanism’, which would comprise a ministerial group, to oversee proposals for mergers among banks last month. While announcing the mechanism, Finance Minister Arun Jaitley stressed that the decision to create strong and competitive banks will be solely based on commercial considerations and such decisions must start from the boards of the banks.
The government had also ensured that some key chief executives, who would steer the process of mergers, were in the loop. In the last few months, it had discussed the issue with some top bankers before dashing off official communication to them last week.
A framework had been conceived in which a bank’s board would first clear the decision to merge and then send the proposal to the ‘Alternative Mechanism’ for its in-principle approval. After the in-principle approval comes through, the bank will take steps in accordance with law and SEBI’s requirements . The final scheme will be notified by the government in consultation with the Reserve Bank of India (RBI).
Simultaneously, some hurdles have been removed to expedite the process. For example, approval requirement from the Competition Commission has been done away with.
What drives mergers?
Bankers involved in discussions with ministry officials said technological synergy and geographical complementarity are the two most important factors that would drive mergers.
While steps are now being taken to facilitate consolidation, the thinking around bank consolidation began after the current government assumed office — the first week of January 2015, to be precise.
At the bankers’ retreat, known as Gyan Sangam, the idea of consolidation was first floated. In 2015, however, bank chiefs — reeling under bad loan pressure — vetoed the idea on the grounds that first they need to put their houses in order.
While the asset quality problem worsened to became a full-blown crisis, this has not deterred the move to push the consolidation idea further. In fact, at the second edition of Gyan Sangam in 2016, Finance Ministry officials wanted to know from banks what their plan B was, if the government stopped capital support. Bankers, who attended this retreat said that the discussion was not ‘whether to consolidate’ but only ‘how to consolidate.’
Bankers familiar with the ministry’s thinking said the present asset quality crisis has actually became an opportunity for the government to push for consolidation. Many banks are not in a position to raise equity from the market. Shares of most of them trade at a discount to their book value. Investor appetite for PSU bank shares has been typically low, barring state-run insurance behemoth Life Insurance Corporation of India. In other words, there is no Plan B for raising capital, which has been depleted by rising bad loans.
Further, banks would also need capital for complying with Basel-III norms, apart from supporting business growth.
The Reserve Bank of India has also played a key part in pushing the idea of consolidation. Revisiting the norms on prompt corrective action (PCA) after many decades was an indication. The revised PCA norms, applicable if certain threshold levels are breached, can cramp prospects for a bank’s business growth. There are already some banks that are under the PCA framework.
Viral Acharya — the youngest deputy governor of RBI — has already made his thoughts clear on mergers among public sector banks. “As many have pointed out, it is not clear we need so many public sector banks. The system will be better off if they are consolidated into fewer but healthier banks,” Mr. Acharya said in one of his speeches. “Historically, bank stress of the order we face has almost always involved significant bank restructuring.”
Elara Capital, in a note to its clients, has identified five weak banks which could be first in line for consolidation. These are Bank of Maharashtra, Dena Bank, Indian Overseas Bank, Punjab and Sind Bank and United Bank of India.
“These banks with less core capital, low provision buffer and high level of un-provided NPLs [non-performing loans] would need substantial amount of equity capital for NPL resolution, going ahead. Some of these banks are expected to have made presentations to Finance Ministry,” the note said. Elara has identified Punjab National Bank, Canara Bank and Bank of Baroda as the lenders who will acquire smaller banks.
“The likely merger would create a lot of complexities in terms of lesser core capital, high net NPLs, branch rationalisation and reduction in human resources productivity for the merged entity. At present, we’ve an example of the merger of SBI with associate banks and Bhartiya Mahila Bank; post merger, the merged entity fundamentals have weakened significantly,” the note cautioned.
SBI, following its merger, has seen non-performing assets rising significantly, from ₹1.01 lakh crore (6.94%) to ₹1.88 lakh crore (9.97%).
Of the 20 public sector banks, nine have had impaired loans in excess of 20% and 12 had common equity tier-I capital ratio below 8%. For example, if Bank of Baroda were to take over two small banks such as Dena Bank and Bank of Maharashtra, its impaired asset level could exceed 18%, analysts said.
It is to be seen if the big banks can bear the pain of a merger and put their house in order quickly so that the objective of creating a big lender that can fund large projects is fulfilled.