Insights into Editorial: The risks of creating giant banks

Insights into Editorial: The risks of creating giant banks

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20 May 2016

Summary:

The government has decided to push for the creation of a new banking giant by merging the State Bank of India with its associate banks. The quest to create an Indian bank that will be in the league of global giants is an old one. It has been talked about since the 1991 economic reforms. However, not many are happy with this move. Large banks have lost their charm in recent years, especially since the global financial crisis.

• The merger move comes at a time when the most important issue facing Indian banks—and the Indian economy—is the growing pile of bad loans with the baking system.
• If the merger of the five associate banks with the SBI goes through, the latter’s assets will jump from about 21.50 lakh crore to 28.25 lakh crore. The number of branches will increase from 16,500 to over 21,500.

Why merger is good?

• The merger benefits include getting economies of scale and reduction in the cost of doing business.
• Technical inefficiency is one of the main factors responsible for banking crisis. The scale of inefficiency is more in case of small banks. Hence, merger would be good.
• Mergers help small banks to gear up to international standards with innovative products and services with the accepted level of efficiency.
• Mergers help many PSBs, which are geographically concentrated, to expand their coverage beyond their outreach.
• A better and optimum size of the organization would help PSBs offer more and more products and services and help in integrated growth of the sector.
• Consolidation also helps in improving the professional standards.
• The size of each business entity after merger is expected to add strength to the Indian Banking System in general and Public Sector Banks in particular.
• After merger, Indian Banks can manage their liquidity – short term as well as long term – position comfortably. Thus, they will not be compelled to resort to overnight borrowings in call money market and from RBI under Liquidity Adjustment Facility (LAF) and Marginal Standing Facility (MSF).
• This will also end the unhealthy and intense competition going on even among public sector banks as of now. In the global market, the Indian banks will gain greater recognition and higher rating.
• The volume of inter-bank transactions will come down, resulting in saving of considerable time in clearing and reconciliation of accounts.
• The burden on the central government to recapitalize the public sector banks again and again will come down substantially.
• This will also help in meeting more stringent norms under BASEL III, especially capital adequacy ratio.
• Synergy of operations and scale of economy in the new entity will result in savings and higher profits.
• A great number of posts of CMD, ED, GM and Zonal Managers will be abolished, resulting in savings of crores of Rupee.  
• This will also reduce unnecessary interference by board members in day to day affairs of the banks.
• After mergers, bargaining strength of bank staff will become more and visible. Bank staff may look forward to better wages and service conditions in future. The wide disparities between the staff of various banks in their service conditions and monetary benefits will narrow down.
• Customers will have access to fewer banks offering them wider range of products at a lower cost.
• From regulatory perspective, monitoring and control of less number of banks will be easier after mergers. This is at the macro level.
• Mergers can diversify risk management.

Why merger is not so good?

• Merger will affect regional flavour and end regional focus.
• The argument that size is going to determine the future of the bank in a globalised scenario is facile. Remember the fate of large global banks, which collapsed during the global financial crisis? On the contrary, small banks have survived the crisis due to their nimbleness and the niche areas they operate in.
• Immediate negative impact would be from pension liability provisions (due to different employee benefit structures) and harmonisation of accounting policies for bad loans recognition.
• There are many problems to adjust top leadership in institutions and the unions.
• Mergers will result in shifting/closure of many ATMs, Branches and controlling offices, as it is not prudent and economical to keep so many banks concentrated in several pockets, notably in urban and metropolitan centres.
• Mergers will result in immediate job losses on account of large number of people taking VRS on one side and slow down or stoppage of further recruitment on the other. This will worsen the unemployment situation further and may create law and order problems and social disturbances.
• The weaknesses of the small banks may get transferred to the bigger bank also.
• New power centres will emerge in the changed environment. Mergers will result in clash of different organizational cultures. Conflicts will arise in the area of systems and processes too.
• When a big bank books huge loss or crumbles, there will be a big jolt in the entire banking industry. Its repercussions will be felt everywhere.
• Also, India right now needs more banking competition rather than more banking consolidation. In other words, it needs more banks rather than fewer banks. This does not mean that there should be a fetish about small-scale lending operations, but to know that large banks are not necessarily better banks.

What should be ensured by the government?

• The government shall not have any hidden political agenda, in bank mergers.
• All stakeholders are taken into confidence, before the merger exercise is started.
• After mergers, shares of public sector banks shall not be sold to foreign banks, foreign institutions and Indian corporate entities, beyond certain limit.
• Whenever further divestment (dilution of government holdings) takes place, the government share holdings shall not fall below 51% under any circumstances. This will ensure that the ownership and control of public sector banks remain with the government.
• The central government shall not rush through the process of bank mergers.
• The decision with regard to selection of smaller/weaker banks for merger with larger/stronger banks is to be taken carefully and grouping of various banks for this purpose is the key issue involved. The government shall not yield to pressure from any political or social groups.
• The acquiring bank shall not attempt to dominate or subsume the acquired bank. Good aspects of both the banks before merger shall be combined, in order to instil confidence in all stakeholders and to produce better results.
• Personnel absorbed from the smaller bank shall undergo brief, intermittent training programs to get acquainted with the philosophies, processes and technology in the new environment. The management must be ready with a good roadmap for this and allot considerable budgetary resources for this purpose.
• There shall be conscious and organized efforts to synthesize the differing organizational cultures, for the mergers to yield the desired results.

Various committees in this regard:

Various committees appointed by the government and RBI have studied in detail the aspects of consolidation through the process of mergers.

• Narasimham committee (1991 and 1998) suggested merger of strong banks both in public sector and even with the developmental financial institutions and NBFCs.
• Even the Khan committee in 1997 stressed the need for harmonization of roles of commercial banks and the financial institutions.
• Verma committee pointed out that consolidation will lead to pooling of strengths and lead to overall reduction in cost of operations.

Conclusion:

Merger is a good idea. However, this should be carried out with right banks for the right reasons. Underperforming shall not be the only reason for merger. Now that the move has been initiated, the bigger challenge is consolidation in the rest of the banking system. This is tricky given the huge challenges banks face, including the bad loan problem that has plunged many public sector banks in an unprecedented crisis. Also, since mergers are also about people, a huge amount of planning would be required to make the consolidation process smoother. Piecemeal consolidation will not provide a lasting solution and what is required is an integrated approach from all stakeholders including the government.