The central Government initiated its policy of consolidation of banks into larger banks with:

2017: State Bank of India (State Bank of Bikaner and Jaipur, State Bank of Mysore, State Bank of Travancore, State Bank of Hyderabad, and State Bank of Patiala — along with Bharatiya Mahila Bank) followed by

2019:Bank of Baroda (Vijaya Bank and Dena Bank)

On April 01, 2020, the government further announced the merging of 10 Public Sector Undertaking (PSU) banks into four banks. This when completed would take the count of PSU Banks in the country from 27 to 12.

Consolidation through mergers, takeovers, and acquisitions has drawn the attention of the financial world
in the recent past. Narasimham Committee recommendations and BASEL conventions have also propagated the need for mergers and consolidations of the banking industry to bring synergic consequences. Mergers are not a very new phenomenon worldwide but in India, the speed with which it has taken entry into Indian banking is sufficient to raise doubts about need, implications, issues, and synergy in the financial system.

Should Indian banking take the experience from the past?

Should there be different models of consolidation of banking in the Indian context?

What will happen to beautiful small banks when big fishes gut their shares?

Rationale of Consolidation of Banks

Long term productivity and strengthening the competitive edge are core objectives of mergers.
Reduction in cost, efficiency gains, the economy of scale, enhancement of consumer base and innovations, and other objectives.

The logic is that rather than having several of its own banks competing for the same pie (in terms of deposits or loans) in the same narrow geographies, leading to each one incurring costs, it would make sense to have large-sized banks. This may be true especially in India’s bigger cities and towns.

It has also been argued that such an entity will then be able to respond better to emerging market trends and compete more with private banks. 

Also with the rising bad loans, the government has been compelled to infuse more capital in the PSU banks.  By reducing the number of banks to a manageable count, the government must be hoping that the demands for such capital infusion will be lower progressively.

Challenges of Consolidation of Banks

The biggest challenge of much talked about mergers of banks is the implication of consolidation on employment, profitability, market share, human motivation, and technology. The post-merger implications on the economy are listed below.

  • Prospect of resistance from staff and unions in the entities being merged; result in substantial job losses.
  • Directly impact the backroom operations and may reduce the face to face interaction along with the customers.
  • Efforts of big banks will be directed towards making more and more profits and less concentration on consumer’s grievances.
  • If the big institutions fail, this could hurt the government (bailout condition) and financial stability. (last seen during the 2007-08 crisis started in US)

Is consolidation the answer to the poor state of Indian Banks?

The creation of more large-sized banks will mean the RBI will have to improve its supervisory and monitoring processes to address increased risks. The RBI indeed has faced stiff challenges in dealing with big institutions. A case in point is the instance of IL&FS Group, which defaulted on repayments hitting many lenders and investors (September 2018). 

Ever since the Indian economy has been battling with a serious crisis of confidence and a severe liquidity crunch. The situation is worse for NBFCs (Non-Bank Financial Corporations) that provide more credit to small and medium scale enterprises than banks

Growing big is not always good as it invites bigger risks and challenges. The problem of rising NPAs is a ‘systemic’ one, it cannot be only solved by recapitalization or by even consolidation. In fact, if one has a cross-sectional analysis of the sector, the idea of consolidation raises more questions than answers.

The problem is structural and of governance, it does not matter whether the banks are large or small.

– Former RBI Governor Y V Reddy, in his D T Lakdawala memorial lecture (2017)

Way forward

Credit, Capital, and Consolidation are three dimensions in the new banking regime which is imminent in India. With the introduction of financial service convergence and competitions from outside and within, it is quite justifiable that to bring sound transparent, efficient, and effective and culture friendly banking practices should be on the anvil of the government as well as policymakers.

The post-merger implications of banks in the Indian context are still debatable and researchable issues. As a result the legal implications combined with the ethical and governance issues need to be redefined. And, mergers strategies should be designed to improve the financial and operational soundness of existing small and capital needy banks and these should not be focused merely to gut the beautiful entities

PPIN Staff

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