Why Bank-Mergers Continue to Remain a Bad Idea - Vivek Kaul's Diary
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Why Bank-Mergers Continue to Remain a Bad Idea

Jun 5, 2018

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Yesterday's edition of the Mint newspaper reports that the government is planning to merge, the Bank of Baroda, IDBI Bank, Central Bank of India and Oriental Bank of Commerce, to form one big bank.

If the plan goes through, the new bank will be the second largest bank in India, after the State Bank of India, the paper reports.

How will this help, other than creating a bigger bank? As the Mint newsreport points out: "With the merger, the government hopes to help stem the rise in bad loans in their books at a time when poor asset quality has crippled the lending ability of some of them."

The point being made here is that the merger is likely to improve the overall situation. Is that likely to be the case?

Let's take a look at Figure 1, which basically lists the advances (i.e. loans) made by these banks, along with their non-performing advances or bad loans, as on March 31, 2018. Bad loans are basically loans which haven't been paid for a period of 90 days or more.

Figure 1:
Name of the Bank Gross Advances (as on March 31, 2018) Gross Non performing advances (as on March 31, 2018) Gross Non Performing Advances (in %)
 Bank of Baroda 4,60,744 56,480 12.26%

IDBI Bank 1,98,853 55,588 27.95%

Central Bank of India 1,77,484 38,131 21.48%

Oriental Bank of Commerce 1,48,206 26,134 17.63%
Total 9,85,287 1,76,333 17.90%
Source: Investor presentations of banks.

What does Figure 1 tell us? It tells us that Bank of Baroda is by far the biggest and the best performing bank among the four banks. But even then it's gross non performing advances ratio or simply put the bad loans ratio, is at 12.26%. This basically means that for every Rs 100 that the bank has lent out, loans worth Rs 12.26 are not being repaid.

In case of other banks, the situation is much worse. In case of IDBI Bank, the bad loans ratio is close to 28%. This basically means that the bank has lost more than one out of every four rupees that it has lent out. Why is this bank in the business of banking at all, is a question well worth asking?

If these banks had been merged as on March 31, 2018, the new bank would have lent close to Rs 10 lakh crore (Rs 9.85 lakh crore to be precise). It would have had bad loans of Rs 1,76,333 crore and a bad loans ratio of 17.9%.

The question is how does creating a new bank with a bad loans ratio of 17.9%, genuinely help anyone? What it does is that it sweeps under the carpet the bad state of IDBI Bank and the Central Bank of India. So, the government has two fewer problems to publicly deal with.

Nevertheless, it also pulls down the performance of Bank of Baroda, which is by far the biggest of the four banks and is not in as bad a state as the other public sector banks are. Given this, it needs to be treated with slightly more respect.

As the Mint newsreport further points out: "The merger will also allow the weak banks to sell assets, reduce overheads and shut money-losing branches."

This is being naive at its very best. When was the last time, the government of India shutdown anything where people are still working? It continues to operate a company called Hindustan Photo Films, despite the fact that the company has barely done any business for many years, and faced losses of close to Rs 3,000 crore, in 2016-2017.

The 'real' situation of the merger of different public sector banks, was best summarised by R Gandhi, a former deputy governor of the Reserve Bank of India, in a speech he made few years back: "Merger of a weak bank with a strong bank may make combined entity weak if the merger process is not handled properly. The problems of capital shortages and higher non-performing assets (or bad loans) may get transmitted to stronger bank due to unduly haste or a mechanical merger process."

This is precisely what will happen. In fact, it is surprising that the government is even thinking of a plan like this, after seeing what has happened to the performance of the State Bank of India, after its five associate banks and the Bhartiya Mahila bank, were merged with it.

We recently wrote about this. The overall bad loans ratio of the the State Bank of India as of March 31, 2018, was at 10.9%. The corporate bad loans ratio was at 21.9%.

The interesting thing is that the State Bank of India wasn't in such a precarious position up until March 2017. Yes, it had its share of bad loans, like other public-sector banks, but it wasn't in the mess that it currently finds itself in.

As of March 2017, the bad loans ratio of the bank was at 6.9%, against the current 10.9%. Further, the corporate bad loans ratio of the bank was at 13.7%, against the current 21.9%. What has changed between March 2017 and March 2018? Five associate banks of the State Bank of India and the Bhartiya Mahila Bank, were merged with it. Over and above this, the Reserve Bank of India has also cracked down on banks harder and forced them to recognise their bad loans as bad loans.

And this pulled down the performance of the State Bank of India. Having been through this, the government is thinking of making a similar mistake and merging four public sector banks. When you have a problem, you isolate it and solve it. You don't mix it with more problems and create a bigger problem.

That should be the logic with which the government should be operating. But as we have seen time and again in the past, good economic logic and government, rarely go together. And why should this time be any different?

Postscript: Last week we wrote about the interest rates going up and that has started to happen, with banks increasing their home loan rates for starters.

Regards,

Vivek Kaul
Vivek Kaul
Editor, Vivek Kaul's Diary

PS: For over 16 years, members of the exclusive Bombay Investing Society have received safe stock recommendations that generated double, even triple digit returns! This society is currently accepting new members. Click here to find out how you can join...

Vivek Kaul is the Editor of the Diary. He is the author of the Easy Money trilogy. The books were bestsellers on Amazon. His latest book is India's Big Government - The Intrusive State and How It is Hurting Us.

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4 Responses to "Why Bank-Mergers Continue to Remain a Bad Idea"

BP Nagoji

Jun 7, 2018

Merger does not mean mere adding up of balance sheet. There are whole of other things gets merged. Yes initially there might be problems. The merger is also the recommendation of Narasimham Committee. The need of the hour is bigger banks which can stand shocks. The banks have already factored the repo effect, thus your post script may not come true.

Like (2)

SHAKTI PRASAD MAHAPATRA

Jun 5, 2018

May be it's a bad idea to merge a strong bank with weaker banks in short term as per your point of view and research but in a long term once bad loan and NPA problem subsidise we can see a better future for the banks.

Like (3)

SHAKTI PRASAD MAHAPATRA

Jun 5, 2018

May be it's a bad idea to merge a strong bank with weaker banks in short term as per your point of view and research but in a long term once bad loan and NPA problem subsidise we can see a better future for the banks.

Like (2)

Avinash B Ketkar

Jun 5, 2018

Today's banking mess is the direct result of politically motivated decisions intentionally ignoring economic considerations. Political leaders for their own selfishness, including Indira Gandhi right from 1969 bank nationalisation. Social goals were set and profit motive was a sin. After 1991 near bankruptcy situation, globalisation,privatisation,liberaisation. Were new mantra. Total confusion, politically motivated loan weaver schemes. Court decisions delayed indefinitely and this was supposed to be a system. Today Congress is 100% responsible for today's nonsense .Judiciary is also committed to ex Congress rulers and trustworthiness is doubtful. In this situation Adhar linking is opposed due to selfishness only. 70 years sins cannot be washed out in 4 years.british,mogals,Congress looted India and therefore we are suffering today. People deserve the government and they get it.In Solapur 100 cracked buses purchased,money looted and public is fooled. In such situation bank mergers is a must ,costs will have to be controlled and recovery must be very sturn .

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