The Public Sector Banks (PSBs) holds about 70% of Indian banking industry and its profitability has been shrinking from last few years. The paper intends to provide the insights on the impacts of PSBs mergers on the Indian economy amid global coronavirus outbreak.
The worldwide economic slowdown due to Covid-19 crisis hasn’t left the Indian economy untouched with India’s GDP fall to lowest 5% in the last six years. With Indian economy at stake, the mergers of major public sector banks (PSBs) in India on 1st April, 2020 has set alarm bells ringing for the Indian government. The Punjab National Bank has been merged with Oriental Bank of Commerce and United Bank of India; Indian Bank with Allahabad Bank; Union Bank of India with Andhra Bank and Corporation Bank; while Canara Bank has amalgamated with Syndicate Bank. It has reduced total PSBs from 27 (in 2017) to 12 only. The Indian government is the majority shareholder in the PSBs so it becomes its responsibility to resuscitate the weak PSBs through infusion of capital in times of need to financially strengthen the PSBs.
Rationale Behind The Mergers
The financially-stricken PSBs in India have shown lessened credit-creation growth with waning lending capabilities in recent years. The huge pile of Non-Performing Assets (NPAs) and low asset qualities have hit badly their capital ratios with increased provisions for NPAs due to high risk weighted bad loans eroding their profitability. Rising bad debts has shrieked their exposure to big corporate lending like real-estate, steel and infrastructure with limited access to capital market.
The capital adequacy ratio is the ratio between bank’s capital and risk weighted assets and requires huge capital to meet it. The capital requirements under Basel III norms by Reserve Bank in India require minimum capital adequacy ratio to be 8% for banks to eliminate default risks. Expanding credit need in the economy also requires more capital for PSBs for lending purposes.
The Reserve Bank of India’s Prompt Corrective Action (PCA) plan for weaker PSBs to prevent default risks has constrained their lending capacities and requires more growth capital for them. The Insolvency and Bankruptcy Code,2016 also forces public sector banks in India to accept default payments lesser than the lending amounts. All these causes have forced the government to resort to mergers as the only viable option.
Government’s Vision Regarding PSBs Mergers
The Indian government is aiming to achieve USD five trillion economy in the coming years and considers amalgamation of PSBs as favorable move. It has proposed the mergers with the idea to improve operational efficiency of PSBs as the mergers will provide regulatory as well as growth capital.The mergers has been projected to create banks with stronger national presence and international reach. It will also improve their abilities to raise market resources with next generation banking technologies.
The move will help in reduction in lending cost and will help smaller and weaker banks to fulfill the Basel III capital requirements and will bring the merging weak PSBs out from the PCA framework. The Indian government has based its decision upon recommendations of Narasimham committee and PJ Nayak committee which suggested that India only requires few major banks than fragmented PSBs. The central bank, Reserve Bank of India has also proposed that the merger banks will become lenders of global scale through cutting edge technology and state of the art payment systems.
The Indian government is planning to increase the leverage ratio of public sector banks by augmenting their money creation powers. It aims to fulfill the objective to have multiplier effect on the Indian economy.It will result into manifold gains when loans by these banks will result into continuous cycle of consumption, production and income. But the repercussions of this move can’t be ignored and need proper assessment.
Impacts On The Indian Economy
The merging public sector banks in India exhibit varying financial strengths. The most profitable Indian bank among 10 PSBs with NPA of 3.2% has been merged with Allahabad bank with NPA of 5.2%. It will adversely affect the health of Indian bank’s profitability and efficiency. The share prices of Indian bank had also fallen down after the announcement of proposed mergers and the future efficacy of mergers is very plutonian in current economic conditions. By diluting the management of stronger banks, the forced mergers will be deteriorating for the whole banking industry in India.
The Indian government has claimed that no jobs of employees will be lost after the merger. Given this, it is very unlikely that efficiency of banks will improve by getting rid of redundant and underutilized labour as the government also fears severe strikes and protests by the bank unions’ employees. The claim is duping as closedown of many branches will result in retrenchment of many employees and will increase the cyclical unemployment rate in India.
PSBs mergers will not per se decrease the amount of their bad loans. It can improve only if banks improve their recovery processes or if loans are written off against balance sheets. Mergers do not address these significant structural problems as bad debts’ recovery process is slow due to inefficient judicial system in India and banks are unwilling to show them in balance sheets due to mounting losses.
The move also doesn’t deal with the problem of political interference in the management of PSBs – a major cause for increasing bad loans. The banks are forced to extend loans to big businesses without securing any payment guarantee.It will impede the goal of financial inclusion by the government to reach the unbanked poor. Minority shareholders will be more affected than dominant shareholders i.e. the government as it has also other revenue sources.
The credit growth has deteriorated drastically in India and post- mergers, the banks will face severe challenges related to staff integration, synchronizing accounting, bad loans’ recognition policies, rationalization of branches and culture compatibility. For instance, the Punjab National Bank (PNB) who is grappling with 16% NPA can’t be expected to revive the weaker Oriental Bank of Commerce and United bank in India,.
The government has initiated the idea that through recapitalization of PSBs through mergers, credit deployment would increase but the credit flow also depends upon economic environment and bankers’ propensity to take risk. So the increased financial health may be necessary but not the only sufficient step for reviving the credit crunch in the economy.
The government fiscal deficit gap is already increasing and recapitalization funds for mergers will further aggravate the problem. Instead of multiplier effect, the deficit will compel government to more borrowings and this will lead to crowding out of private investments. The Indian government debt will rise up and it would only be intergenerational transfer of funds without yielding optimistic results.
The sole criterion used for classifying banks into recent mergers was selecting banks operating on common banking technology solutions. This would ease integration but it can’t be the only rationale for merging banks. The infusion can temporarily solve the problem but will not address deep structural woes faced by the PSBs.
Through mergers, instead of the strong banks lifting the weak PSBs, the weak ones may sink the strong. Past mergers of weak banks with strong ones have not shown riveting results in India. The merger of Punjab National Bank with the New Bank in 1993 failed to create any significant cost synergies. The State Bank of India‘s merger with its associate banks also affected the SBI’s credit growth after the merger with depressed operating performance and reduced share prices. Last year, the strong Bank of Baroda was merged with the weaker Vijaya Bank and Dena Bank, but post-merger performance showed little improvements and its share prices has also collapsed from Rs 150 a year ago to Rs 92. The weaker banks also suffer as Dena bank’s share swap ratio was much lower than expected by their shareholders.
The government has based its whole justification upon the success of the State Bank of India (SBI)’s merger. But the same effect can’t be expected from recent mergers as the SBI merger was only internal reorganization exercise as associate banks enjoyed common identity with SBI for long and SBI also had operational control over them from inception. The banks were operating under the same information technology platform so the merger had more positive impacts. While SBI had more trained employees’ pool and larger capital resources, managing 2-3 banks would be nightmare for other current PSBs as economy is already facing recessionary problems.
In previous PSBs mergers, anchor banks had better asset qualities and strong capital stocks but major banks under recent amalgamation plan are themselves not in good health. Like, both gross bad loans and net bad loans for PNB and Union Bank of India are at over 15% and 7% of assets. So, further strain from weaker banks would prove detrimental for the major banks.
The PSBs in India have also previously shown lending bias to big corporate businesses and venturesome customers only. The mergers will add fuel to this problem rather than healing it out. It is more likely that consolidated bigger entities would use their pricing power to push for greater credit to big businesses than needy small customers. The Marginal Costs of Lending rate (MCLR) of merged bank is decided by the anchor banks only and the inclusion of weak banks in operations becomes minimal. The consolidation of banks may lead to the monopolistic pricing behavior of large banks and will left out the regional banks.
The current Indian economy requires instant remedy solution but the new mergers will have more long run impacts than near-term growth. The meaningful cost synergies from banks are unlikely in the short run as they would focus more on integration and restructuring of their banks rather than lending more funds.
This merger will be a short-term reprieve and only structural change will prevent public sector banks from sliding downhill again.
As PSBs are foundational for growth of Indian economy, the analysis of this government move becomes necessary. The researcher opines that based on previous merger repercussions and current state of Indian economy, the mergers will not be healing but detrimental to Indian banking industry. It is only short term relief measure intended to distract the attention of people from the slumping economy. For achieving expected merger benefits, the corporate governance through Banks Board Bureau needs to be emphasized. The government should develop more infrastructure development banks to relieve existing PSBs from infrastructural bad loans. The PCA framework also needs to be administered efficiently.