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Bank Consolidation
Why in News?
• The government has decided that Bank of Baroda, Vijaya Bank and Dena Bank shall be “amalgated” making the new entity India’s third Largest Bank.
Background
• Narasimham committee of 1991 had recommended a
Amalgamation vs Merger
• Amalgamation is the combination of one or more companies into a new entity (e.g. bank A and bank B combine to form a new bank C).
• In merger one company acquires the other companies. (e.g. bank B acquires bank C and D and eventually only bank B shall exist).
restructuring of Indian banks with 3-4 large banks that could be positioned as global banks and 8-10 smaller ones with a national footprint.
• The P J Nayak committee in 2014 suggested that government should privatise or merge some PSBs.
• In 2017, the government had approved the “merger” of SBI’s five associate banks and later of the Bharatiya
Mahila Bank (BMB) with SBI.
• Last year, the Government had constituted Alternative Mechanism Panel headed by the Minister of Finance and Corporate Affairs, Arun Jaitley to look into merger proposals of public sector banks.
o The proposals received from banks for in-principle approval to formulate schemes of amalgamation will be placed before the Alternative Mechanism.
o A Report on the proposals cleared by Alternative Mechanism will be sent to the Cabinet every three months.
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o Alternative Mechanism may also direct banks to examine proposals for amalgamation.
o Alternative Mechanism will receive inputs from Reserve Bank of India (RBI) before according in-principle
approval.
Arguments in favour of Consolidation
• Too many Public Sector Banks (PSBs): Currently there are 21 PSBs in India which often cannibalise into each
other’s businesses.
• Resolving the NPA issue:
o Reserve Bank of India expects the gross NPA ratio for state-owned banks to rise to 16.3% by March 2019
from 15.6% in March 2018.
o The consolidation is being seen as a way out of the NPA issue through the “strong” banks absorbing the
strain on the books of weaker banks.
• Increase in business: Consolidation will lead to substantial rise in:
o customer base
o market reach
o offering more services or products to customers
• Global banks: The consolidation will help create a globally stronger and competitive financial institutions.
Currently Indian banks are small when compared with their global peers.
• Cost cutting: Consolidation can lead to reduced operating costs for public sector banks as:
o All duplicate operations and redundancies are rationalised (e.g. shifting and closure of many overlapping
branches especially in urban areas).
o Excessive manpower can be shed off in the long run.
• Enhanced geographical reach: For example, Vijaya Bank has strength in the South while Bank of Baroda and Dena Bank had a stronger base in Western India. That would mean wider access for both the proposed new entity and its customers.
• Greater capital and liquidity:
o Merger will lead to a bigger capital base and higher liquidity which will help in meeting the norms under
BASEL III.
o It will also reduce the government's burden of recapitalising the public sector banks time and again.
• Enhanced human resource: Merger can lead to availability of a bigger scale of expertise and that helps in
minimising the scope of inefficiency which is more common in small banks.
• Employee welfare:
o The merger will not cause any job loss in any of these banks and no employee of the banks would have service conditions
that are adverse to their present one.
o The disparity in wages for bank staff members will get reduced and service conditions would become uniform.
Arguments against consolidation
• Setback to corporate governance perspective:
o The merger sends out a poor signal of a dominant shareholder (the government) dictating decisions that impact the minority shareholders.
o Forced mergers of the stronger banks with the weaker banks tend take a toll on the operations of the strong banks. For example: Bank of Baroda’s shares took a nosedive in wake of the announcement.
Recent banking reforms/steps taken:
• The Government in 2016 set up an autonomous body called Banks Board Bureau (BBB) to recommend for selection of heads of PSBs and Financial Institutions and help Banks in developing strategies and capital raising plans.
• The Insolvency and Bankruptcy Code (IBC) has made it easier for banks to recover through liquidation of assets.
• The government committed to Rs. 2.11 lakh crores capital infusion in PSBs.
• EASE - Enhanced Access and Service Excellence: It is a
reform agenda focusing on six themes of customer responsiveness, responsible banking, credit off take, PSBs as Udyami Mitra, deepening financial inclusion & digitalisation and developing personnel for brand PSB.
• RBI has introduced prompt corrective action (PCA) framework as a measure to check banks' financial health. Under the PCA, banks are prohibited from distributing dividends and remitting profits, expanding their branch networks, maintaining higher provisions, etc.
• The government had formed the Sunil Mehta Committee to look into the faster resolution of stressed assets. It has suggested five-pronged strategy to resolve stressed assets called Project Sashakt.
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• Meaningless without implementing governance reforms: The new entity will face similar problems unless significant reforms take place in the overall functioning of public sector banks. Merger could only give a temporary relief but not real remedies to problems like bad loans and bad governance in public sector banks.
• Setback to financial inclusion:
o Consolidation may lead to large scale shutting down of overlapping branches of the entities being merged.
o Many banks have a regional audience to cater to and merger destroys the idea of decentralisation.
• Systemic risks: There is a global consensus that banks that are “too big to fail” are sources of serious risk to
financial stability and consolidation might lead to such a scenario.
• Protests: Addressing the concerns of unions and shareholders can prove to be a major roadblock.
• Varying work culture: Aligning contrasting HR practices will also pose a challenge to the new management.
• Harmonization of Technology: It is a big challenge as various banks are currently operating on different technology platforms.
Way Forward
• Clear rationale:
o The consolidation process among banks should be driven primarily by synergies, efficiency, cost saving, and economies of scale.
o It is essential to evaluate the merger of banks by assessing the benefits such as cost rationalization, additional business, etc. against the likely future costs.
• Non-Imposition:
o Mergers must happen on commercial considerations and must not be politically imposed.
o While PSBs are promoted by the government, they are run by their respective professional boards, which
should take such decisions.
• Twin-fold Governance reforms:
o Independence from political interference
o More regulatory power to RBI over PSBs
• Creating a healthy entity: It should be ensured that these mergers do not create an entity that is weaker than the original pre-merger strong bank.
• Training for HR: Human resource from the smaller bank should undergo training programs to get acquainted with the new processes, technology and environment.
• Allow “non risky” failures: Failures are the essence of free market so sometimes we also need measures that allow banks to fail safely without causing systemic shocks.
Bank Consolidation
Why in News?
• The government has decided that Bank of Baroda, Vijaya Bank and Dena Bank shall be “amalgated” making the new entity India’s third Largest Bank.
Background
• Narasimham committee of 1991 had recommended a
Amalgamation vs Merger
• Amalgamation is the combination of one or more companies into a new entity (e.g. bank A and bank B combine to form a new bank C).
• In merger one company acquires the other companies. (e.g. bank B acquires bank C and D and eventually only bank B shall exist).
restructuring of Indian banks with 3-4 large banks that could be positioned as global banks and 8-10 smaller ones with a national footprint.
• The P J Nayak committee in 2014 suggested that government should privatise or merge some PSBs.
• In 2017, the government had approved the “merger” of SBI’s five associate banks and later of the Bharatiya
Mahila Bank (BMB) with SBI.
• Last year, the Government had constituted Alternative Mechanism Panel headed by the Minister of Finance and Corporate Affairs, Arun Jaitley to look into merger proposals of public sector banks.
o The proposals received from banks for in-principle approval to formulate schemes of amalgamation will be placed before the Alternative Mechanism.
o A Report on the proposals cleared by Alternative Mechanism will be sent to the Cabinet every three months.
25
o Alternative Mechanism may also direct banks to examine proposals for amalgamation.
o Alternative Mechanism will receive inputs from Reserve Bank of India (RBI) before according in-principle
approval.
Arguments in favour of Consolidation
• Too many Public Sector Banks (PSBs): Currently there are 21 PSBs in India which often cannibalise into each
other’s businesses.
• Resolving the NPA issue:
o Reserve Bank of India expects the gross NPA ratio for state-owned banks to rise to 16.3% by March 2019
from 15.6% in March 2018.
o The consolidation is being seen as a way out of the NPA issue through the “strong” banks absorbing the
strain on the books of weaker banks.
• Increase in business: Consolidation will lead to substantial rise in:
o customer base
o market reach
o offering more services or products to customers
• Global banks: The consolidation will help create a globally stronger and competitive financial institutions.
Currently Indian banks are small when compared with their global peers.
• Cost cutting: Consolidation can lead to reduced operating costs for public sector banks as:
o All duplicate operations and redundancies are rationalised (e.g. shifting and closure of many overlapping
branches especially in urban areas).
o Excessive manpower can be shed off in the long run.
• Enhanced geographical reach: For example, Vijaya Bank has strength in the South while Bank of Baroda and Dena Bank had a stronger base in Western India. That would mean wider access for both the proposed new entity and its customers.
• Greater capital and liquidity:
o Merger will lead to a bigger capital base and higher liquidity which will help in meeting the norms under
BASEL III.
o It will also reduce the government's burden of recapitalising the public sector banks time and again.
• Enhanced human resource: Merger can lead to availability of a bigger scale of expertise and that helps in
minimising the scope of inefficiency which is more common in small banks.
• Employee welfare:
o The merger will not cause any job loss in any of these banks and no employee of the banks would have service conditions
that are adverse to their present one.
o The disparity in wages for bank staff members will get reduced and service conditions would become uniform.
Arguments against consolidation
• Setback to corporate governance perspective:
o The merger sends out a poor signal of a dominant shareholder (the government) dictating decisions that impact the minority shareholders.
o Forced mergers of the stronger banks with the weaker banks tend take a toll on the operations of the strong banks. For example: Bank of Baroda’s shares took a nosedive in wake of the announcement.
Recent banking reforms/steps taken:
• The Government in 2016 set up an autonomous body called Banks Board Bureau (BBB) to recommend for selection of heads of PSBs and Financial Institutions and help Banks in developing strategies and capital raising plans.
• The Insolvency and Bankruptcy Code (IBC) has made it easier for banks to recover through liquidation of assets.
• The government committed to Rs. 2.11 lakh crores capital infusion in PSBs.
• EASE - Enhanced Access and Service Excellence: It is a
reform agenda focusing on six themes of customer responsiveness, responsible banking, credit off take, PSBs as Udyami Mitra, deepening financial inclusion & digitalisation and developing personnel for brand PSB.
• RBI has introduced prompt corrective action (PCA) framework as a measure to check banks' financial health. Under the PCA, banks are prohibited from distributing dividends and remitting profits, expanding their branch networks, maintaining higher provisions, etc.
• The government had formed the Sunil Mehta Committee to look into the faster resolution of stressed assets. It has suggested five-pronged strategy to resolve stressed assets called Project Sashakt.
26
• Meaningless without implementing governance reforms: The new entity will face similar problems unless significant reforms take place in the overall functioning of public sector banks. Merger could only give a temporary relief but not real remedies to problems like bad loans and bad governance in public sector banks.
• Setback to financial inclusion:
o Consolidation may lead to large scale shutting down of overlapping branches of the entities being merged.
o Many banks have a regional audience to cater to and merger destroys the idea of decentralisation.
• Systemic risks: There is a global consensus that banks that are “too big to fail” are sources of serious risk to
financial stability and consolidation might lead to such a scenario.
• Protests: Addressing the concerns of unions and shareholders can prove to be a major roadblock.
• Varying work culture: Aligning contrasting HR practices will also pose a challenge to the new management.
• Harmonization of Technology: It is a big challenge as various banks are currently operating on different technology platforms.
Way Forward
• Clear rationale:
o The consolidation process among banks should be driven primarily by synergies, efficiency, cost saving, and economies of scale.
o It is essential to evaluate the merger of banks by assessing the benefits such as cost rationalization, additional business, etc. against the likely future costs.
• Non-Imposition:
o Mergers must happen on commercial considerations and must not be politically imposed.
o While PSBs are promoted by the government, they are run by their respective professional boards, which
should take such decisions.
• Twin-fold Governance reforms:
o Independence from political interference
o More regulatory power to RBI over PSBs
• Creating a healthy entity: It should be ensured that these mergers do not create an entity that is weaker than the original pre-merger strong bank.
• Training for HR: Human resource from the smaller bank should undergo training programs to get acquainted with the new processes, technology and environment.
• Allow “non risky” failures: Failures are the essence of free market so sometimes we also need measures that allow banks to fail safely without causing systemic shocks.
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