Bank Merger Proposal - Is It Only Make Believe?

Raman Swamy

It is better to do mergers when banks are healthy than when they are unhealthy.  That is considered the golden rule in global banking circles. 

Former RBI governor Raghuram Rajan made no secret of his skepticism of trying to bail out debt-ridden banks through the merger route.  In October last year he questioned the wisdom of the government's idea of amalgamating public sector banks which are deep in the red.  

Now after a year of vacillation, Finance Minister Arun Jaitley has apparently decided to disregard the danger signals and give the green signal to the merger of one weak bank (Dena Bank) with two comparatively strong banks (Vijaya and Bank of Baroda). 

The announcement late on Monday evening created a buzz in media and political circles, with some voices hailing the move as a step towards clearing the NPA mess and others expressing doubts and misgivings.

However, a few more alert observers were quick to note that the so-called announcement was neither a move in the right direction nor in the wrong direction. 

No decision has actually been taken - it is little more than a proposal or an exercise in loud thinking on the part of the government.   The merger process is long and time-consuming and will take nothing less than six months.   Even if all the procedures are completed and everybody agrees to go ahead with the three-bank amalgamation, it is unlikely to happen till after the next Lok Sabha elections.

All that has taken place so far is that a recommendation has been made by the ‘Alternative Mechanism’ set up last year to consider consolidation in the banking sector.   Alternative Mechanism is just another name for Panel of Ministers consisting of Nirmala Sitharaman, Piyush Goyal and Arun Jaitley himself.

As per the procedure, the Board of Directors of each of individual banks concerned will have to formally agree to the merger proposal.  

Even after the Board resolutions are passed the process does not end there.  A series of legal formalities have to be gone through.  Clearances have to be obtained from SEBI, the stock market regulator.   Negotiations have to be conducted with bank officers and employees’ unions and amicable settlements reached.  

Consolidation of the balance sheets of the three banks is a complex process – except that in this case it could be relatively less cumbersome because Dena, Vijaya and Bank of Baroda use similar technological platforms, which is probably one of the reasons why they were chosen by the ministerial panel.    

Yet, actual consolidation is by no means an easy task - it requires a great deal of time and effort by bank CEOs and bank managers throughout the system.  As Raghuram Rajan explained: “You have to merge IT systems, you have to merge cultures, you have to merge HR systems, you have to take sensitive decisions regarding seniority levels, organizational hierarchies and adjustment of pay and perks, including retrenchment where necessary.  All this involves a tremendous amount of work – and time".

Undoubtedly, the Finance Minister is fully aware of the complexities and knows how problematic the merger exercise is likely to be if the intention is to take it forward to the logical conclusion.   Most probably, the aim is simply to make a political gesture to give the impression that the Modi government is taking steps to address the banking crisis and the NPA calamity. 

Even otherwise, convincing answers need to be put forward for several disturbing questions.  One worry is whether the performance of Vijaya Bank and BOB will be dragged down by being burdened with the loss-making Dena Bank.

Of the three banks, Dena Bank is currently under the PCA or Prompt Corrective Action framework. It has been restrained from further lending.  It has an NPA ratio of 22 percent - among the highest across the banking sector. 

Vijaya Bank, on the other hand, is among the better performing public sector banks with a gross NPA ratio of 6.9 percent.  

Bank of Baroda, the largest of the three, has a bad loan ratio of 12.4 percent.

For Bank of Baroda, the merger could be a gain – in the sense that the bank will have a stronger presence in the western and southern regions.   For Vijaya Bank the downsides are likely to be more apparent – already the stock prices of the bank which is strong in the southern states like Telangana and Andhra have started declining. 

If the proposal does go through in another six months or more, the new combined entity will have a high current account savings account ratio and a well-diversified loan book - on paper it will become India’s third largest bank.   But in reality, it will take many years before the benefits of scale take effect. 

As of now, the announcement seems to be just another distraction.  In theory, the Modi government would like to reduce the number of PSU banks from 21 to 15 through consolidation – the logic is that higher economies of scale could be achieved.  In fact, last year the then Chief Economic Adviser Arvind Subramanian had even said that India should ideally have five to seven “reasonably large banks”.

The issue is that nine of the weakest banks reported losses of Rs 18,066 crore in FY 2016-17 and several are facing restrictions on expanding banking operations.

Even among the acquiring banks, junk assets of at least two banks are close to the regulatory trigger to imposing restrictions.  The so-called stronger banks are insisting on certain pre-conditions to merge with weaker banks.  

The acquiring banks are also likely to demand fresh capital from the government, particularly if the weaker banks have very large NPAs.  The merger route therefore may not avoid the recapitalization route.

Sep 18, 2018

Raman Swamy [email protected]

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