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Bank mergers are not a smooth ride - Outside View by S.S. TARAPORE
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Bank mergers are not a smooth ride
May 4, 2015

Small banks merging with large PSBs does neither any favour. Narrow banking is the right option

Meeting the capital requirements of public sector banks has been of concern to the authorities for the past 25 years, but a sustainable resolution has been elusive. Official committees have advocated that the minimum 51 per cent government holding in PSBs be brought down. Governments of different political hues have considered reducing the minimum share of government below 51 per cent but the body politic has turned it down.

When the government recapitalised PSBs in the early 1990s it was felt this would be a one-time burden. This was belied, and year after year the government has had to recapitalise PSBs. The weaker the bank the larger the capital infusion. This has resulted in stronger and weaker banks growing at more or less the same pace.

The Basel III capital norms will require PSBs to raise equity tier 1 capital of about Rs. 2.4 lakh crore by March 2019. It is estimated that if the share of government in PSBs is reduced to 52 per cent, Rs. 1.61 lakh crore can be raised from the market. The government would need to provide only Rs. 79,000 crore, and net of dividends the requirements would be only Rs. 44,000 crore.

It would appear that an 'open sesame' approach has resolved the financing requirements of PSBs. The snag is that the stronger banks have already brought down the percentage holding of the government while those banks which still have a very high government proportion are invariably the weak banks which may not be able to access the market.

Merger of small banks

From time to time the government has mooted the merger of weak PSBs with stronger banks. The experience of the New Bank of India with the Punjab National Bank (PNB) in the 1990s was not without a massive drain on the exchequer besides a drain on the PNB which took years to recoup from this.

More recently, it is reported that the working group on consolidation and restructuring of PSBs has proposed that with a view to increasing profitability, PSBs could consider sharing infrastructure, including back office space, and IT and telecom contracts through shared services.

It is also stressed that PSBs should improve risk management, shift to profitability-linked performance metrics, leverage technology, and develop capital-light business models. Small PSBs are to exit from areas which are unprofitable, according to news reports. The target group of small banks (with less than Rs. 2 lakh crore loans plus investments) which need to be taken over are Andhra Bank, Bank of Maharashtra, Dena Bank, Punjab and Sind Bank, Vijaya Bank and United Bank.

The story so far

The stronger banks which have capabilities for taking over small PSBs include Bank of Baroda, Bank of India, Canara Bank, PNB and Union Bank. The working group rightly stresses that that any consolidation should be driven by market forces and the decision should be taken independently by the boards of these banks. But the way boards are presently constituted, their independence is a mere fig leaf. The track record is that voluntary mergers without strong intervention by the government just do not take place. Where the majority owner (government) is passive, unions can effectively block such mergers.

Mergers invariably involve bloodshed and the bank undertaking the merger expects compensation from the government; this is precisely what the government wants to avoid. As rightly pointed out in the editorial, 'Mix, but also match' (April 25), bank mergers in India have all along been used to bail out weak banks. Thus, voluntary mergers of weak PSBs with larger PSBs are unlikely to fructify.

Given the relatively small size of Indian banks and the increasing globalisation of finance, the merger of strong PSBs would be desirable. The Bank of India and the Union Bank did consider a voluntary merger but in the absence of explicit government support the proposal was aborted. The merger of strong PSBs would not resolve the government's financing problem of recapitalising weak banks.

At present, PSBs account for a little over three-fourths of the commercial banking system. If the government is willing to allow the share of PSBs to gradually decline to, say, 65-70 per cent, there could be a significant reduction in the burden of recapitalization.

A viable alternative

What could be considered is that government would restrict its capital injection into each PSB equal to the bank's dividend to government. Under such an arrangement, with a proviso that government's share would not fall below 51 per cent, the government should treat holdings in PSBs of public sector units as part of the government's 51 per cent holding.

Since the weaker PSBs would not be able to generate adequate profits they would have to ensure that their loan portfolio grows at a rate substantially below that of the system. These banks would restrict their lending to very safe lending, government securities and money market instruments such as commercial paper. Moreover, the weak PSBs should ensure that they raise deposits at the lower end of the deposit interest structure. In other words, the weak PSBs should be required to operate as narrow banks.

It is appreciated that at the present time neither the government nor the regulator are enamoured by narrow banking. It would be recalled that in the 1990s, a number of weak banks came out of the red precisely by resorting to narrow banking. The choices before the government are clear. Either the government accepts a continuing drain on the fisc of periodically recapitalising the weak PSBs, or the weak banks are directed to go back to narrow banking. A viable third alternative just does not exist.

This article was published in the Business Line print edition dated April 30, 2015.

This column, Maverick View is authored by Savak Sohrab Tarapore. Mr. Tarapore, is an economist and he runs his own Multi-Language Syndicated Column. Mr. Tarapore's other column, which appears in The Freepress Journal, is titled Common Voice.

Disclaimer:

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