All you need to know- Bank consolidation

• Last year we saw two new banks, IDFC and Bandhan Bank. 20 more new banks, 10 small banks and 10 payments banks will come up
• then in this credit policy in April the RBI (Reserve Bank of India) said that it would again explore the possibilities of giving differentiated banking, whole sale banks, custodian banks.
• It is complicated as on the one hand we say that we need more banks, different kinds of banks and on the other hand we say we need consolidation
• Particularly this time the trigger for consolidation is the high NPAs (non preforming assets) which is eroding, not the net worth but the profitability of many of the PSU (public sector undertaking) banks and the government of India is under pressure to capitalise… so in some sense that the trigger that how long can we keep on capitalising the banks.

Arguments in favour of consolidation

• At present, there are a total of 27 public sector banks (PSBs) in the country. Apart from the SBI, all the remaining banks are regional banks. Hence, consolidation helps in leveraging the benefits of economies of scale.
• India is the fastest growing major economy in the world. To sustain this growth, there is a need for mega banks that only will ensure investments into the large scale infrastructure projects.
• Cost rationalisation – Consolidation would result in cutting down branches, particularly in urban areas where there are too many branches of different banks in a same area.
• Other benefits – Risk diversification, scale and specialization would increase, improves ratings.
• Banking sector is suffering from non performing assets (NPAs) problem. To overcome this, the government is resorting to capital infusion. Consolidation will increase capital efficiency, apart from improving the ability of banks to recover bad loans.
• Consolidation will help in leveraging the synergies among the banks that have diverse portfolios, focus areas and coverage areas.
• At present, there is not a single Indian bank in the top 50 global banks list. The consolidation is expected to fill this gap, and, consequently, help build the ‘Brand India’ among international investors.
• As the government is the only common owner of all the PSBs, the process of consolidation is much easier and effortless.
• Indian companies are going global. Now we are home to many multinational companies that have presence in various sectors of the economy. Again this context, big-ticket Indian banks are the most proper platforms to deliver financial services to them.
• International experience is also favourable towards consolidation. Banks in Japan gained a lot as a result of large scale merger and acquisition process between 1990 and 2004.

Arguments against consolidation

• Experts argue that consolidation should take place in a positive environment. The present process of consolidation is not driven by the inherent strength of the banking system. It is resorted to escape from the problem of NPAs.
• There are apprehensions among the labour unions that the consolidation will lead to job losses.
• RBI has done an AQR (asset quality review) and it has proposed that balance sheets will get cleaned up by March 2017. Post 2017 (after balance sheets get cleaned up), on the basis of mutual consent by all stakeholders this model can be adopted.
• There are risks of creating giant banks – Global experience since 2008 has shown that large banks are not necessarily efficient banks.
• For example, four of the five biggest global banks in terms of assets are now Chinese. Few see them as paragons of financial stability. There is good reason to believe that the large Chinese banks are far weaker than what the official numbers say. The US too has seen that large banks are not necessarily efficient banks.

Obstacles for successful consolidation

• In PSU banks, the one will be cultural change—HR basically is the problem.
• Compatibility—how we decide mergers. It should not be forced mergers.
• There may be a few technology challenges.
• Beyond this we have see if we are merging two branches, two banks or two anything –there will be a gestation period of 18-24 months and this is a distraction. For nearly 24 months, owners are putting a pause button on growth because the senior management time will get deflected to this. For those two years, there will be challenges. The time it takes and the distraction it bring to the senior level should be worth doing.
• Integrating business processes. Processes in two banks are so different at times, it is very difficult to adjust and understand new systems and so on.
• When bank portfolios are uniformly strained, as they are today, mergers can accentuate the strains. i.e., Merger of two or more banks which have strained balance sheets can lead to a collapse.
•  At a time when PSBs need a razor focus on cleaning up credit portfolios, mergers will be very distracting and will bring the sector to a halt.
•  It will likely reduce competition—and without any major efficiency gains to the economy as a whole.

If we in principle agree that we need consolidation, how do we approach this?

• Need to look at complementarity. These are the building blocks for a successful consolidation process.
  • Look at branches as a factor. If one branch is in one place and the other one is in another region, it makes eminent sense to come together.
  • Then look at the businesses—some might have CASA (Current Accounts, Savings Accounts) others might have other businesses.
• Need to look at the regionalisation and getting scale in a particular geography. Each merger or consolidation given that India is so layered is considered. We are a very inch-wide mile-deep kind of country as opposed to mile-wide and inch-deep kind of country. We can scale this up with a large regional bank.
• There could be one geographical business based model. One bank could be aggressive in steel while other is aggressive in agriculture and so on. There could be 3-4 national level banks and then regional banks. We should have 3-4 national level banks, it will have all sorts of business presence to that, then there are regional banks, payments banks, they will continue on regional basis.

The key takeaway is that there are challenges of trade unions, technology, business model and HR. But we can overcome these, as none of this is unsurmountable. But there has to be a specific reason. There shouldn’t be a merger for merger’s sake or triggered by a sudden surge in bad assets. Will it be able to gain efficiency? Bring down costs? Serve our customers, etc. If the answer to all this is yes, then we should.