With a stroke of the pen, as it were, the government has reduced the number of public sector banks from 21 to 12. Ten PSBs will be merged into four. The rationale for the mergers has not been articulated clearly enough.
Discount the talk of creating banks of global size. The biggest bank that will result from the mergers announced—the one that will combine Punjab National Bank, Oriental Bank of Commerce and United Bank of India—will have total assets of Rs 11,98,400 crore or about $171 billion. That makes it less than one-third the size of the fiftieth largest bank in the world.
Size ≠ Efficiency
The correlation between size and efficiency itself is suspect, more so in the Indian context. The best-performing Indian bank over a long period, HDFC Bank, today has over Rs 12 lakh crore in assets and has world-class parameters of performance – net interest margin, return on assets, non-performing assets to total loans. It has had world-class performance parameters since the time it had Rs 1 lakh crore in assets. The price to book value of India’s behemoth, the combined State Bank of India and its former affiliates, is 1.2, way below HDFC Bank’s price to book value of nearly 4.
On other counts too, benefits may not be readily forthcoming. Bank mergers can potentially yield cost savings from elimination of surplus branches and of duplication in functions in such as back-office processing, call centres, etc. But such savings can be meaningful only if jobs are eliminated. Every PSB merger, however, carries with it the assurance that no jobs will be lost and that people will be redeployed where there is excess manpower.
No Culture Synergies
In planning the mergers, care seems to have been taken to ensure that the technology platforms are similar. But this is only one element in a merger. Mergers pose significant challenges when it comes to managing culture and human resources. The reason that a large proportion of mergers fail to enhance shareholder value is that the cost savings and synergies from mergers are overwhelmed by the problems in managing culture and human resources in the merged entity.
Punjab National Bank and United Bank of India have hardly anything in common in terms of culture. Or, for that matter, Indian Bank and Allahabad Bank or Union Bank and Andhra Bank.
The differences could not be starker if you were to merge two banks from different economies in the European Union.
For a merger to succeed, at least one entity in the merger should be financially strong and have management of high quality. In the PSB mergers that have been announced, none of the entities is particularly strong – it’s mostly a case of the weak merging with the weaker. Most PSBs have faced problems of depletion of senior management in recent years.
Four Possible Benefits
The mergers announced thus face serious odds. What, then, could be the rationale for the mergers? One can think of four potential benefits.
First, having too many PSBs makes serious demands on the Finance Ministry’s bandwidth. The appointments of chairmen, managing directors, executive directors, and independent directors are all time-consuming. In the very nature of government processes, such appointments tend to get delayed. PSBs suffer in consequence.
With fewer banks, it is possible for the ministry to better focus on the banks on its watch.
Secondly, the resolution of non-performing assets entails serious coordination problems among PSBs. Meetings among banks are attended by senior management who have to get back to their top management for instructions… followed by more rounds of meetings. Merging some of the banks should make the resolution of NPAs somewhat easier.
Thirdly, since the merged entities can make bigger loans, they will have pricing power vis-à-vis corporates. Corporates will find it difficult to play off one PSB against another as they do in the system of multiple banking.
Fourthly, with a larger network of branches, the merged entities can demand better commissions for the sale of fee-based products such as insurance and mutual funds.
The gains on these four counts must be weighed against the costs of greater complexity, which are rather difficult to quantify. The gains must be translated into projections of earnings per share at the merged PSBs. The projections must be made available to Parliament, the boards of the banks and to analysts and actual performance tracked against these. Only then can the claims of the benefits of merger be evaluated.
Important Governance Changes
The real news in the Finance Minister’s interaction with the media lay, not in the mergers, but elsewhere. One part had to do with the reforms in governance that were announced. The boards of PSBs have been given freedom to increase sitting fees for non-official directors – this should help attract better talent on to PSB boards. They are also free to hire a Chief Risk Officer, perhaps the most important function in banks today, at market salaries. They have been tasked with developing succession plans and individual developments at levels of General Manager and above.
Except at the State Bank of India, PSBs do not have a tradition of developing EDs and MDs from within – the appointees are invariably from outside and typically last for short periods. Appointing leaders from within and ensuring continuity at various levels would in itself be an improvement at PSBs.
Reforms at PSBs are often thought of in lofty terms; the measures required on the ground have to do with the unglamorous nuts and bolts of sound management.
The other big news in the interaction was what did not happen: the wholesale privatisation of PSBs. As we recently marked the golden jubilee of bank nationalisation, there was a terrific clamour among analysts and in the media for undoing bank nationalisation as part of ‘big bang’ reform in Modi-II. The government has signalled that this is not going to happen. It has opted for reform within the framework of government ownership. That the very analysts who clamoured for privatisation now hail the mergers announced as ‘structural reform’ shows that this government knows a thing or two about headline management.
TT Ram Mohan is a professor at IIM Ahmedabad.
The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.
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