The good, bad and ugly of public sector bank mergers

The case for merger of two public sector banks is interesting as it appears to be high on the agenda of the government. At present, there are 26 public sector banks and there has been a call for SBI to take over its associates while other permutations are being worked out on the nationalised banks. What would this mean for the system as a whole and the banks that are involved in this process?

Our banking history has stories of weak banks (Global Trust Bank, Bank of Rajasthan, New Bank of India) being taken over by a stronger one through a merger or promoters selling out for various reasons (Bank of Punjab, Times Bank, Centurion Bank) in the private sector.

SBI has taken on two of its associate banks - SB Indore and SB Saurashtra. The large ventures involved the reverse mergers of DFIs into commercial banks with their own commercial bank outfits (ICICI Bank and IDBI Bank). This was more due to the viability of the DFI model in an open market system.

Two otherwise similar looking banks both owned by the government also have reasons to go in for a merger. The main reason for a merger is to build size.

Today the biggest bank in India has assets of around Rs 16-17 lakh crore, which would not be very large in global terms. Size is important mainly because it permits banks to have greater access to funds as well as expand its asset book.

The RBI has conditions on the maximum amount of exposures to companies and groups which are linked to capital. Intuitively through a merger one can increase this size and gain advantage of a larger loan book. In fact, wherever there is a net worth criteria, even in areas of overseas investment, mergers always help by adding to the existing dimension.

Second, as the two banks would have differing strengths, in terms of capital, a merger will make meeting capital requirements that much easier. Also the stronger bank which commands better valuation would then be better placed to raise capital in the market and hence shore up well for the purpose of capital adequacy.

As we are moving towards the gradual easing of public control in banks, some may not be able to fare well in the market. A merger will help in this case. Also the government will not have to provide additional support in terms of capital if the merger results in substantial increase in capital related to business requirements.

Third, a merger of banks with differing strengths or weaknesses would also do well in terms of the quality of assets as the NPA ratios would improve on a larger base.

Fourth, with synergies being attained, costs can be cut down. Today there are several instances of multiple branches of public sector banks in the same location. A merger would obviate the need to duplicate physical infrastructure and the same could be spread over a wider geography. The same holds for the staff which can be redeployed to enhance efficiency. With most bank branches under the core banking solution, physical interface has reduced as has the ledger practice. Hence, there is scope for several cost economies to be had through a merger.

Fifth, often all banks are not able to offer all banking products due to certain constraints bordering on size or expertise. Some PSBs are strong in home loans and others in say auto loans. A merger will help to offer the same to the customers and will be beneficial for both the banks and its customers.

Given that we are talking of two public sector banks, there will not be much change in the array and quality of services offered as at present the distinction is between old and new private banks, foreign banks and PSBs. The charges for services are almost standardised and the customers who bank with one will be comfortable with another, unlike a switch to a private bank where there are greater demands on customers with charges also tending to be higher if the account is not called ‘priority’.

There are arguments on the other side too which may counter some of these views. While mergers do help in sorting out the issue of capital to an extent, the real nature of the bank will not change as long as the government is the majority shareholder. Therefore, it may not really mean much in terms of operation where the management style as well as compensation and recruitment would be as per the prescribed norms. It would just multiply the size of the bank without quite changing the culture. Therefore, operations would not really change, unlike the case with the other mergers where a different culture comes in.

An even more difficult issue to resolve will be handling of staff when branches are closed down. While operational efficiency will be achieved through mergers, what does one do with surplus staff especially at the sub-officer level? Given that layoffs are not possible and the euphemistic voluntary retirement which works in the private sector cannot really be practised, this move will be a major logistical challenge for the HR departments that have to relocate staff while keeping an eye on issues like seniority.

Also while closing down branches looks theoretically sound, adjusting the same with customers would always be a challenge as unless branches are contiguous, it would be inconvenience them. Further, while all PSBs have different niches in terms of location and product offering, getting customers to adjust to a different bank can mean considerable adjustment. Several banks are strong in their states as the relation of the customers with the bank has come down the ages. Moving these customers to a new bank could be an issue.

The final question is whether or not shareholder value increases? Here there is not clear answer as there have not been too many experiences to go by. A failed bank being taken over is obviously good for the system and normally a gain for the acquirer as the bank comes cheap with the infrastructure and accounts. But for two otherwise similar banks with same ownership and practices, the ultimate impact is still unknown.

If issues of capitalisation is addressed and the main shareholder, the Government of India, is better off, then even though there will be several administrative adjustments to be made to the new situation, it should be better for the system. But it may not distinctly change the look and functioning of the merged bank from what they were earlier. In a way, this could be a Pareto optimal situation, where no one should be worse off and the government better off.

The author is Chief Economist, CARE ratings. Views are personal.