PSU Bank Consolidation: Necessary But Not Sufficient 

Consolidation of Indian banking is an idea that dates back, at least, to 1991. Soon after liberalisation, then Finance Minister Manmohan Singh had appointed a committee under former Reserve Bank of India Governor M Narasimham to draw out a roadmap for financial sector reform. The committee was tasked with studying all aspects of Indian banking from structure to functioning.

When it submitted its report in December of 1991, the committee recommended a three-tier banking structure for government-owned lenders. It noted that the number of public sector banks need to be reduced; three to four big banks should be created and seen as international-sized lenders; another eight to ten lenders should have national presence; and local banks should be set up to service specific regions and communities.

In the 17 years since, the consolidation debate has stretched on in various shapes and forms.

On Monday, the government announced an intention to merge Bank of Baroda with Vijaya Bank and Dena Bank to create the country’s third largest lender by domestic assets. The merger announcement comes a little more than a year after the amalgamation of State Bank of India with its associate banks was concluded.

The announcement raises two questions:

• With two big bank mergers in two years, are we finally seeing some real consolidation?
• And will this consolidation help chart a stronger course for public sector banks?

Necessity Not Reform

Let’s consider the first question.

The amalgamation of State Bank of India with its subsidiaries was akin to the government dipping its toes into the consolidation waters. It was a no-brainer. SBI was the largest shareholder in each of these entities and they had many commonalities, particularly the technology platforms they functioned on. It went through smoothly, spearheaded by then chairman Arundhati Bhattacharya.

That merger emboldened the government. It signaled an intent to move ahead with PSU bank mergers in August 2017, when it set up an ‘alternative mechanism’ to process bank merger proposals. It was, however, left to individual banks to come up with a plan. Some did. Some did not. The energies of the banking sector were focused on the bad loan clean-up.

Twelve months later, the recognition of the stock of stressed assets is nearly complete, even though resolution is a distant dream. This bad loan recognition cycle, in turn, has helped separate the wheat from the chaff.

The merger announced on Monday fits into that mold well.

Dena Bank, which has been stopped from giving fresh loans, has been a trouble spot for some time, with no standalone solution in sight. Vijaya Bank is a small, healthy regional lender. But if it hopes to chart a brighter future, it needed to expand beyond its southern stronghold. As for Bank of Baroda, its size, scale and relative balance sheet strength probably meant that a leadership position was thrust on it.

The consolidation, however, will not solve any of the bigger problems of these lenders. It may help the government save a little bit of capital. It may take away the headache of figuring out what to do with lenders like Dena Bank. But the combined entity will hardly be a shiny new bank with a bright blue sky above it.

Be that as it may, if the deal between the three lenders is concluded relatively painlessly, the government will likely push for more such mergers. Particularly because there are 10 other lenders like Dena Bank who continue to be under the RBI’s prompt corrective action framework. The question is whether there are enough healthy banks around to absorb these weak lenders.

Bigger Problems On Hand

It must also be remembered that PSU banks have much bigger problems on hand. From the current problem of bad loans and weak governance to the more existential issue of retaining their relevance in their core business of lending.

Enough has been said above the former and the need for structural reforms needed to improve the functioning of PSU banks. It’s now time for the government — the owner of these banks — focus on the latter too.

Over the years, PSU banks—except SBI—have lost significant share of the large corporate business. Private banks have cherry picked the most profitable and least risky of businesses. Then came retail lending. The last three years have seen a strong retail credit growth cycle and private banks have led it. Now as the lending cycle is shifting towards small and medium enterprises, private banks and non-banks are rapidly gaining share there too, shows recent data released by credit bureau CIBIL.

In 2017-18, the share of the loan market held by PSU banks fell by 4 percentage points to 64 percent, showed data compiled by BloombergQuint earlier. Over the 12 month period between April 2017 and March 2018, only 24 percent of the incremental credit came from PSU banks, shows the data. The weakest of public sector banks saw a de-growth in their loan books.

The one advantage that PSU banks still have is their hold over household deposits.

Interestingly, while these lenders have lost credit market share and also market share in large corporate deposits, they have held on to their dominance of household deposits, according to data released by the RBI earlier this year. This may, partly, be inertia on part of depositors, but it also suggests that these banks retain the public trust that comes along with being sovereign-backed.

But to take that trust and build healthier and more efficient public sector banks, which can serve the economy well, is still a tall ask. With or without consolidation.

Ira Dugal is Editor - Banking, Finance & Economy at BloombergQuint.