The Global Analyst: Banking Special, 2017

The Global ANALYST, Banking Special, 2017

A Holistic Approach to PSBs Merger*

M G Warrier

“You have to be careful in any kind of merger that you don’t get a big weak bank! You’d hope that the strong bank would clean up the weak bank’s problems but there are very few banks without problems today in the public sector. So, the question you have to ask is are there any dangers in distracting the bankers once again with a new set of issues such as headache with mergers and so on, and not resolving the real problem which is cleaning up their balance sheets.”

-Raghuram Rajan, former RBI Governor

I had concluded my July 2017 article on bank mergers with the following observations: 

“The history and evolution of Indian banking sector during the last 4 decades do not take one to accept privatization of public sector banks as a solution for the present problems. With the exception of State Bank of India, Indian banking sector was under private ownership for decades after independence. The need to nationalise major banks was felt in the context of the refusal of private sector to cater to the development needs of the country including taking banking service to semi-urban and rural areas and meeting the credit needs of small borrowers. Such responsibilities are still met by PSBs is evident from the fact that post-nationalisation, the residual and new private sector banks together could, till date, manage a market share of less than 30 per cent in the country’s banking business.”

At the risk of uncomfortable repetition, let me reiterate that there are certain sectors which will have to be nurtured for some more time by government, as leaving them entirely to the vagaries of the commercial interests of private sector will be perilous. These include healthcare, transport, education and banking. Therefore, we will take the debate forward on the premise that revamp of public sector banks (PSBs) will continue to be the responsibility of their present majority stakeholders, namely GOI.

Dr Raghuram Rajan became RBI Governor at a time when India’s central bank needed a leader who was willing to apply his own mind and did not always need guidance from North Block to lead Team RBI in the performance of mandated responsibilities. This helped RBI to take forward several initiatives which were on the drawing board since 1990’s. Introduction of new institutions (payment banks, small banks, fresh commercial bank licenses), giving the status of “bank” to the banking business done by post offices, handling willful defaulters and stressed assets of banking system and sieving the Financial Sector Legislative Reforms Commission’s report for rational and workable recommendations would not have happened this fast, but for Rajan’s leadership. As his presence at Mint Road was destined to be short-term, restructuring and revamp of the existing banking structure didn’t take off during his tenure. He, however, did have his own independent views on revamp of banking structure.

 In an interview with the Hindu Business Line (published on September 7, 2017) Dr Rajan responded to the specific question on ‘the idea of merging the weak banks with stronger ones to contain the NPA mess’ thus:

“That may well be, but at this point your most urgent task is to clean up the banks and recapitalize them. Once they’re on an even keel you can worry about that decision. But tell me, which are the mega projects that are waiting there to get financed by the big banks? It’s not clear to me that our demand for investment is that strong right now. There might well be some obvious mergers, I haven’t been looking at this in close detail. But I wouldn’t use mergers as yet another way to escape the necessity for cleaning up and hope that somehow you put a stronger bank with a weaker bank and figure out a way to clean up. It’s not clear to me that we have that many strong banks to believe that process will magically happen.”

Inside RBI, time doesn’t stand still. During the year Dr Rajan was observing a self-imposed silence on India’s central bank, Team RBI was coping with the legacy he had left with several open battle fronts and some bleeding wounds. RBI has an institutional identity and mind of its own and never took credit in shirking responsibilities and regretting in leisure. On demonetization, on mercilessly witnessing the depletion of RBI’s reserves to an all time low during his tenure and procrastinating a long pending pension revision issue he inherited from his predecessors, Dr Rajan followed the path of self-protection and expediency. In his recently released book “I Do What I Do” on page 211, he laments on his helplessness in resolving pension revision issue in RBI recording his regret openly:

"...On the internal front, my biggest regret is that I could not solve a long-pending matter that I inherited from my predecessors: securing for retired RBI staff the same pension benefits that government employees enjoy, despite repeated assurances from the government that the matter would be addressed. I hope the government will do the right thing here..."

But Reserve Bank of India takes things in its stride and moves forward.

RBI Deputy Governor Dr Viral Acharya who was pleased to be identified as ‘Poor man’s Raghuram Rajan’ before taking up the present job, concluded his 8^th R K Talwar Memorial Lecture on “The Unfinished Agenda: Restoring Public Sector Bank Health in India” with the following observations:

“The Cabinet Committee on Economic Affairs has recently authorised an Alternative Mechanism to take decision on the divestment in respect of public sector banks through exchange-traded funds or other methods subject to the government retaining 52% stake. Synergistic mergers may also be part of the broader scheme of things. The Union Cabinet has also authorized an Alternative Mechanism for approving amalgamation of public sector banks. The framework envisages initiation of merger proposal by the Bank Boards based on commercial considerations, which will be considered for in-principle approval by the Alternative Mechanism. This could provide an opportunity to strengthen the balance sheets, management and boards of banks and enable capital raising by the amalgamated entity from the market at better valuations in case synergies eventually materialize. All of this is good in principle. There are several options on the table and they would have to work together to address various constraints. What worries me however is the glacial pace at which all this is happening. Having embarked on the NPA resolution process, indeed having catalyzed the likely haircuts on banks, can we delay the bank resolution process any further?”

After dwelling in some detail on the urgency to address the issue of restoring the financial health of PSBs, Dr Acharya concluded that he was not comfortable with the slow pace at which the current initiatives are progressing and expressed  the fear that time was running out. He mentioned that the Indradhanush was a good plan, but to end the Indian story differently, we need soon a much more powerful plan – “Sudarshan Chakra” – aimed at swiftly, within months if not weeks, for restoring public sector bank health, in current ownership structure or otherwise.”

Consolidation and restructuring an ongoing process

Banking Sector in India, during the pre-independence days, mainly catered to the needs of the government, rich individuals and traders. 1950’s with a democratic government with a new outlook to planning and economic development saw GOI and RBI taking quick initiatives to exploit the potential of the banking system for mobilization of resources and channelizing their deployment in public interest opened its door wider and set out for the first time to bring the entire productive sector of the economy – large as well as small, in its fold. During this period number of commercial banks declined remarkably. There were 566 banks as on December, 1951; of this, number scheduled banks was 92 and the remaining 474 were non-scheduled banks. This number went down considerably to the level of 281 at the close of the year 1968. The sharp decline in the number of banks was due to heavy fall in the number of non-scheduled banks which touched an all time low level of 210. The banking scenario prevalent in the country up-to—the year 1968 depicted a strong stress on class banking based on security rather than on' purpose. Before 1968, only SBI and Associate Banks of SBI were mainly controlled by Government. Some associates were fully owned subsidiaries of SBI and in the rest, there was a very small shareholding by individuals and the rest by RBI.

The above recap is to emphasize that for RBI, equipping the Indian Financial System to meet the changing needs of India’s economic development is always a ‘work in progress’ and given the policy support from the political leadership and GOI, the central bank has been remolding and reskilling the banking infrastructure and training the personnel responsible for implementing projects and programmes on an ongoing basis.

Raghuram Rajan has given a new direction to rebuilding the institutional structure supporting banking business in India during his short three year tenure as RBI Governor. Those who have been following RBI’s history are aware that the introduction of new institutions and merger of existing one initiated by Rajan during 2013-16, were in fact a continuation of RBI’s ongoing efforts to make Indian Banking System serve the financial sector better and more efficiently. Rajan didn’t get the ‘breathing time to convince India the rationale behind the introduction of new institutions (Payment Banks, Small Banks and conversion of Post Office Banking Buiness into a separate ‘Postal bank’) or to apply his mind to a holistic approach to the revamp of Public Sector Banks and Private Sector Banks which should have considered capital needs, structural reforms including mergers and amalgamations/closures of banks/branches and the roles of GOI and RBI in planning and implementing the ‘best action plan’. In fact he started filling his backpack for his return journey to Chicago sometime during February/March, 2016.

Present status

The finance ministry (read GOI) seems to be serious about taking up consolidation of public sector banks (PSBs) simultaneously with other measures aimed at improving the health of Indian Banking System. Each merger decision will be guided by various factors including financial performance of individual entities taken up for merger. These include regional balance, geographical reach, financial burden and smooth human resource transition. Care will also have to be taken to ensure that there should not be merger of a very big weak bank with a smaller strong one as it could adversely affect the financial health of the latter.

In the last consolidation drive, five associates and Bharatiya Mahila Bank (BMB) became part of SBI on 1 April 2017. The process helped State Bank of India to become one of the top 50 banks in the world. Besides BMB, State Bank of Bikaner and Jaipur (SBBJ), State Bank of Hyderabad (SBH), State Bank of Mysore (SBM), State Bank of Patiala (SBP) and State Bank of Travancore (SBT), were merged with SBI.
With the merger, the total customer base of the SBI reached around 37 crore with a branch network of around 24,000 and nearly 59,000 ATMs across the country. The merged entity began operations with deposit base of more than Rs 26 lakh crore and advances level of Rs 18.50 lakh crore.
Way forward

Shankkar Aiyyar writing in The New Indian Express during July 2017 analysed the current merger proposal and inter alia made the following observations:

·       Every season an old idea finds new life. The  idea in currency currently is merger of public sector banks (PSBs). Branded as consolidation, the agenda is to reduce the number of government-owned banks by merging smaller banks into larger anchor banks—Bank of Baroda, Canara Bank, Punjab National Bank and Bank of India. The road map for this consolidation, we are informed, is being worked out by the Niti Aayog.

·       The promoted thesis is that there is no need for so many, that is, 21 PSBs. The bare-bone details of the proposal suggest that the objective is to bring down the number from 21 to 12.

Questioning the sanctity of 12 banks he posed the question: “Why not consolidate to five zonal banks, and do it now?”

Leaving Aiyyar and his arguments at this point, let us consider the rationale behind the current ‘consolidation’ efforts. Reading between the lines, there seems to be near convergence of thought processes among stakeholders on the following points in regard to merger of PSBs:

(a)             India doesn’t need the present number of public sector banks with same pattern of ownership and management and using the same resources base and serving the same clientele from different ‘offices’.

(b)            There is waste of infrastructure when same service is offered by multiple outlets with focus on the same clientele. While competition need to be encouraged, it should not be between institutions under the same ownership.

(c)             Stressed assets of the banking system need to be managed without affecting the credibility of the institutional system in the financial sector.

(d)            Weak banks/branches should have a smooth exit route. As there is enough potential to expand banking business to unbanked or under-banked sectors and geographies, this may not pose insurmountable HR issues.

The challenge before GOI and RBI is how fast decisions are taken and implemented considering the above aspects and more.

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*Submitted version of article published in the October 2017 issue of The Global ANALYST