SBI merger with associates: Why there is a danger in letting the elephant grow bigger

The government’s plan to merge State Bank of India (SBI)’s five associates and the Bhartiya Mahila Bank (BMB) with SBI has all the signs of a forced merger. Till recently, SBI chairman, Arundhati Bhattacharya wasn’t too sure about the merger plan as a priority item on the agenda. This is what Bhattacharya said in August last year. [caption id=“attachment_2656422” align=“alignleft” width=“380”]  SBI chairman Arundhati Bhattacharya. Reuters[/caption] “I don’t think this is the right time. Because today there are a lot of challenges and those challenges are more immediate than merging banks. The conversion to digital that is happening at such a fast pace, that’s a very big challenge. The fact that we have so many other layers coming in like payments banks, universal banks, licence on tap, disintermediation happening through the crowd funding platforms, crypto currency popping up here and there, so, challenges are multi-fold today,” Bhattacharya said. “Even if I merge them, my balance sheet will not go up, the group balance sheet remains the same. And therefore, the valuation I get will remain almost the same. Only thing that will happen is, I can bring about greater efficiency. But I can do that even without merging,” she said. So what has changed since then to say now that time is right for the grand merger? None of the elements Bhattacharya listed above has suddenly become a non-challenge. They are still around, may be even bigger in nature. So, that leaves us with the assumption that the merger idea has come from the government, the owner of India’s public sector banks (PSBs) including the SBI family. Now, why would the government want SBI to merge all its associates and BMB? The only reason could be to create a big-size bank (SBI is the largest in India by assets but not so big if seen globally) that can compete with global banking giants. Bhattacharya told CNBC TV18 in an interview last evening that SBI’s total balance sheet size will go up to Rs 37 lakh crore from Rs 28 lakh crore presently post merger. It would also mean the next big bank will not have even one-fifth of its asset-size (Bank of Baroda with total asset size of Rs 711,532.88 crore as on September 2015). But, this raises another key question. Is SBI, often dubbed as the elephant among Indian banks, growing too big in relation to its competitors? This is something former RBI governor, D Subbarao had highlighted in August, 2013. “Presently, (there is) significant skewness in the size of banks. The second largest bank in the system is almost one-third the size of the biggest bank. This creates a monopolistic situation,’ Subbarao said. The problem has grown even bigger since then. The concern of policymakers worldwide about the ‘oversized’ financial institutions is justified since if something goes wrong with them, this can have serious ramifications on the whole financial system. This is something that prompted the US federal reserve to finalise a rule in November, 2014 that prohibited any financial company from acquiring another, if the resultant entity’s liabilities exceeded 10 percent of the total liabilities of the financial services system. The rule - Section 622 of the Dodd-Frank Wall Street Reform and Consumer Protection Act - says once a particular entity reaches the specified concentration limit, that bank cannot acquire control of another entity. Logically, the new rule intends to shield the US financial system from the foibles of ’too big to fail’ banks, which could then spark a crisis like the one in 2008 following the collapse of Lehman Brothers, which triggered a global financial meltdown. That meltdown showed that when banks become too big, they can bring down the whole financial system when they lend or invest imprudently. There is no comparison between US and Indian banking systems in terms of size. But, the concerns apply here as well. In July, 2014, the central bank released a framework to identify domestic systemically important banks (D-SIBs) and later classified both SBI and ICICI as systemically important banks. SBI has five remaining subsidiaries - State Bank of Bikaner and Jaipur, State Bank of Travancore, State Bank of Mysore, State Bank of Hyderabad and State Bank of Patiala - of which first three are listed. The bank merged two of its subsidiaries State Bank of Saurashtra and State Bank of Indore during Bhatt’s time, in 2008 and 2010, respectively. In SBI’s case, given the enormous size of the bank compared to its domestic peers, there is an obvious concentration risk that is building up. This is what the RBI has to monitor. If anything goes wrong with SBI, it would have repercussions not only for the bank, but the whole financial system. In a worst case scenario, if a major crisis grips the domestic banking system, a fiscally-constrained government may find it difficult to capitalise SBI, especially if it keeps growing its book at least as fast as the economy. Considering its size and appetite, the elephant is not easy to feed. Even now, a rapid growth in bad loans coupled with higher capital requirements under Basel-III norms, will call for additional capital of Rs 2,50,000 crore by 2019. The government plans to infuse Rs 70,000 crore in PSBs and wants them to fend for themselves to make up the rest. Yet again, Subbarao’s caution assumes importance. “We don’t need monopolies, instead we need four-five banks of big size, as large banks can become too-big-to-fail, leading to moral hazard problems.” As for BMB is concerned, the idea was a failure form day-1 since creating bank for women and by women assumed that the so-called weaker section would always remain weak and can’t be accommodated in the mainstream. The bottom line is this: There is merit in debating about controlling the steep growth in SBI’s size through the associate- merger and instead think of growing 4-5 large banks which can compete in global space. As former SBI chairman, O P Bhatt pointed out before, it would have made more sense to delink SBI’s associates with the parent since they are doing good on their own. Letting the elephant grow too big can make it much difficult to control.