Public Statement | New Delhi, September 18, 2018

The Merger of Banks: Harmful, Ill-timed and Avoidable

The decision of the government to merge Bank of Baroda, Dena Bank and Vijaya Bank yesterday (September 17, 2018) is harmful to public sector banks (PSBs) and is a precursor for privatising the PSBs. The stated objective of the government as reported in the media is “Aspirations of the fastest growing economy have to be supported by stronger and globally competitive banks”.

The plan to merge the existing 21 Public sector Banks (PSBs) to form a few megabanks has been in the making for years now. The NDA government got cabinet approval for the merger in August last year, following which RBI was asked to give suggestions before Alternative Mechanism for possible consolidation and amalgamation of banks. Earlier, Minister of State in the Ministry of Finance, Shiv Pratap Shukla informed in Rajya Sabha on July 31, 2018, that presently there is no proposal before the Alternative Mechanism for its consideration. Hence, the decision of merging the three banks have come after subverting the parliament the same way as it was done in the case of Demonetisation.

The much-touted merger of India’s largest bank with its associates and Bharatiya Mahila Bank only resulted in it accumulating the bad assets of associates, costing its profit. Even SBI’s operating profit came down from Rs. 124 Billion Q3FY17 to Rs. 118 Billion Q3FY18, not to mention the first-ever loss in over a decade after accounting for provisions. The merger was not only a commercial failure, but it also resulted in closing down branches, reduction of staff and administrative hassles even though the merger was within associate banks.

While the government argues that the merger of one weak bank with two stronger banks will help to mitigate the burden of bad loans and further increase the lending capacity of the amalgamated entity it hides the fact that it would also necessitate more provisions by the new bank. Further, the new bank lending to the same large borrowers, without recovering existing bad loans will only result in more loss for the bank. A clean balance sheet by the merger of banks is the first step towards privatisation.

Not just commercially unviable, but a three-way merger among banks with the different administration will only result in administrative chaos. To merge many banks to make 4-5 big banks have been on the cards since this government came to power, believing they will be ‘too big to fail’. It is paradoxical that this merger is proposed just on the 10th anniversary of the fall of Lehman Brothers, the fourth largest investment bank in the United States.

When the lessons of SBI merger is clear as daylight, and when global experiences of big banks are glaring bright, it puzzles why the government is rushing to merge more banks. Why is the government pushing for this without initiating a public debate? Why are account holders not consulted and taken for granted? If not the government who would protect the depositors’ rights?

The need is not for big banks but good banks. The banking sector is facing an unprecedented crisis, but it can be solved through changes in lending policies, stringent recovery for corporate defaulters, proper due diligence for large-scale lending and penalising wilful defaulters and recapitalisation of Banks. Transparency and accountability at all levels need to be the hallmark of a genuine effort to cleanse the banking system. But, when the aim is to destroy the public sector bank to hand over to private players, then everybody loves a good crisis.

3 Comments, RSS

  • Himanshu Damle

    “A clean balance sheet by the merger of banks is the first step towards privatisation” — not necessarily. China never privatized their banks (the big four) despite mergers and ejections. If the ARCs are capitalized its equities from the MoF, and they pay for their purchase of the bad loans by borrowing from the RBI and issuing low-coupon bonds that the banks themselves purchase, then at least the bad loans can be acquired at face value. I know this is a circularity, but then mergers bring forth this circularity to be effective, with the only caveat being ARCs should not wind up as early s they seem to be, only because they are yet to yield dividends to their creation. But, mergers leading to privatization, though a distant possibility, is a policy paralysis and the handiwork of constructing dissenting news from the social justice warriors.

    • CFA

      Priya Dharshini responds:
      In the Indian Context, mergers leading to privatisation could have been a distant possibility at the beginning of the 90s. Seeing the trajectory taken by the PSBs post liberalisation and the current context right now, one can see the distance reducing with every policy change (big and small). I don’t really think it is a purely cause-effect question, hence to say mergers in China didn’t lead to privatisation hence mergers in India would not lead to privatisation doesn’t hold true. When there have been attempts over a quarter century to privatise PSBs, the social justice warriors are justified in their projection that These mergers proposed by the Indian government Will and IS one more step closer to Privatising Banks.

  • himanshu damle

    Thanks Priya for the response. I was increasingly beginning to feel like being considered as a troll and was in all seriousness contemplating stopping responding on this site for lack of counters 🙁

    Credit deposits ratio of public sector banks has been falling over the years. As on March 31, 2013, the credit deposit ratio of public sector banks had stood at 77.8%. This basically meant that more than three-fourths of the deposits had been given out as loans. As on March 31, 2018, the credit deposit ratio had fallen to 69%. This means that banks are not able to carry out enough lending against all the deposits that they have raised over the years. over the years the total amount of credit given by public sector banks against the deposits raised, during the course of a year, has come down dramatically. In 2012-2013, more than 80% of the deposits raised were given out as credit. In 2016-2017, not a single new rupee of loans was given. In fact, the total outstanding credit of public sector banks, actually contracted. In 2016-2017, the banks raised Rs 5,90,604 crore of deposits, without giving a single rupee of a new loan, on the whole. This was primarily on account of demonetisation. This meant that the maturity transformation model of banking totally collapsed for public sector banks. In 2017-2018, the banks have been able to reverse it and lend close to 75.5% of the deposits raised during the year. Nevertheless, in absolute terms the overall lending was a very low Rs 1,40,118 crore. In comparison, the public sector banks had lent Rs 6,28,209 crore, during 2013-2014. Of course, over the years, a lot of lending carried out by public sector banks has gone bad. Having said that, if these banks are to be in the business of banking (and make no mistake, banks are in the business for business!!), they need to be able to lend money. There is no point in raising money from people in the form of deposits, and then not lending it or simply investing all the money in government bonds (something that the government would love, but will hurt the overall economy). What does not help that 59.4% of deposits of public sector banks as on March 31, 2018, were term deposits, on which banks pay a higher rate of interest in comparison to current and savings account deposits. Hence, giving out loans is important. Or at least allow some of the smaller PSBs to give out only retail loans, which too is not being approved by the government or governments. Moreover, the incremental credit deposits ratio for private sector banks is significantly higher than the public sector banks. All of this does not sound too good for public sector banks, and thus the rationale to merge under-performing banks with a better one (now, what is better is again subjective, no?).

    Coming to the Chinese model…India is following on lines of its northerly neighbour in banking reforms, especially taking cues from how China managed to tackle their NPAs (China prefers calling it the NPLs), and that being to administer Asset Management Companies, which we prefer calling ARCs. Bad Bank was mirrored on Chinese model, though is yet to take any steam. Given the enormous size of China’s banking system, loans from private banks in China represent less than one percent of the total universe of loans. Additionally, private banks face restrictions on growth into other business areas and geographical locations. These banks may never grow to the size of China’s large state-owned banks, but they can have a significant impact on the banking system. Financial inclusion is one possible benefit. New private banks are targeting areas that are under-served by traditional banks, such as lending to small and medium-sized enterprises and consumers. And all of this with new private banks being set, though with constrained regulatory adherences.

    This juxtaposed with the Indian model has growing strands of similarity, if not congruence, from the southern to the northern geographies, that is. So, why do I say social justice warriors are not justified in their dissent? It is because of the technicalities (the complexes of banking sector financial inflows and outflows + reserve requirements + asset valuations + over-reliance on government bonds etc. etc.) involved in the banking sector, are hardly reflected into, or strived to be understood as an analyzing tool. These technicalities are then fused with political mileage at the policy-maker tier for centralized government control levels. Any breach to such a contract (call it social contract, for we are referring to nationalized banks) would beg the question: who would want to undertake political careening by toying with public sector banks, when all you could do is step up via mergers?

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