Will the Big Bang merger drive, of Indian Public Sector banks, provide the required impetus to the slowing economy?

• India’s Government announces plans to merge 10 of the country’s public sector banks
• Probable impact of the mergers

India’s Finance Minister, Nirmala Sitharaman, recently announced the Centre’s plan to amalgamate 10 public sector banks (PSBs) into 4. With this, the total number of PSBs in the country reduces to 12, down from 27 till 2017. The Centre stated that the objective of the current merger drive is to increase banks’ capacity to lend, strengthen their national and global reach, help them reap operational efficiency gains and reduce lending cost. The government intends to improve the credit flow through large banks and eventually fuel growth in the economy, which has been witnessing deceleration during the past few quarters and recorded 5% growth in Q1 2019-20 – lowest in last 6 years. This is the second round of consolidation in PSBs in the recent years other than the change in the corporate structure in the country’s topmost bank, State Bank of India which in 2017 saw amalgamation of five of its associates - State Bank of Patiala, State Bank of Bikaner and Jaipur, State Bank of Mysore, State Bank of Travancore and State Bank of Hyderabad- and the Bhartiya Mahila Bank. In the previous round (in 2018), the government merged Bank of Baroda with Vijaya Bank and Dena Bank to form the country’s 3^rd largest PSB.

In an emerging country like India, banks are the backbone of the economy as they play a primary role in credit intermediation. Hence, with these mergers, the government aims to create fewer, but larger banks which will help the Centre to gauge their performance better, ease credit decisions and facilitate quicker restructuring plan to a consortium in the event of default.

Post-merger, these banks will be at least double their original size. Calling the drive - “Unlocking potential through consolidation”, the Finance Minister explained that the increased size of banks will result in cost reduction through economies of scale. It will help eliminate branch overlaps, reduce administrative and infrastructure related expenses along with IT and other fixed costs. It is also expected to enhance banks’ capacity to lend effectively as well as better manage the manpower.

Apart from cost benefit, the amalgamation is also expected to strengthen the management as individually some of these banks were short of experts at senior level positions. It will also improve their ability to take independent and faster decisions as banks’ management will now be answerable and accountable to professional boards instead of political leadership.

Undoubtedly, post-merger these banks will be bigger in size, however, the idea of resultant increase in credit flow and cost reduction sounds more theoretical than practical, primarily because these mergers seem ill timed. Currently, when most public banks are already struggling with deteriorating NPAs and declining lending, this merger drive will drift the management focus from such critical issues to making these mergers happen. The expected outcome of cost savings and credit growth might take a few years to materialize and in the meantime, this time lag will have its impact on already deteriorating economic conditions.

Beside this, the basic motive behind any merger – which is to provide support to the merging bank as the anchor/acquirer bank is strong enough to absorb the weaker one – is also defeated here as, except Indian bank, all other anchor banks are themselves ailing.

Amongst four anchor banks in this drive, Indian bank is better off with lowest cost to income ratio, 2^nd lowest figures for net NPAs (after SBI), highest net interest margin as well as capital adequacy ratio. The other 3 banks have largely similar numbers as their merging banks.

PNB’s CASA ratio is lower and cost to income is higher than its merging bank – United Bank of India while net NPAs are higher, Net Interest Margins and Capital adequacy ratio is lower than that of Oriental Bank of Commerce. Similarly, Canara Bank’s CASA ratio and Net Interest Margins are lower than its merging bank – Syndicate Bank. On the other hand, Indian bank is better than Allahabad Bank (its merging bank) in every aspect except CASA ratio. Hence, these amalgamations look more like mere consolidation than strategic mergers.

Further, in one of her statements, Finance Minister mentioned about the Bank of Baroda merger as success and took that as a base for announcing the current big bang merger drive. Though it is too early to comment on the performance of the new Bank of Baroda (post-merger) based on only one quarter’s result and would be worthwhile to look at any directional change in key operating parameters in the long term. Based on Q1 2019-20 report, most parameters have deteriorated post-merger. There is an approximately 2.4% decline in its total business, 35 bps (basis points) dip in CASA ratio, 13 bps fall in NIM and 29 bps increase in net NPA. Hence, at least its Q1 performance numbers do not give any sign of success yet instead signals further stress on profitability and asset quality.

In a nutshell, while the government’s ultimate aim of creating bigger banks is to fuel the economy and improve the asset quality of PSBs, however, the timing seems ill timed. Mergers, during this phase of economic slowdown, will simply divert the management’s attention away from credit growth and NPA reduction while not providing the much-required instant boost to the economy. Further, with the merging banks themselves ailing, their amalgamation will also add up their NPAs, which might result in weaker balance sheets post-merger. Hence, even though the objective behind this significant movement in the history of Indian banking system is to provide impetus to the slowing economy, however, we maintain a cautious view about its impact at least in the short to medium term.