Public sector bank consolidation: A painful journey ahead

The government has raked up the issue of merger between public sector banks, after a long gap. First, finance minister Arun Jaitley said in his budget speech that a roadmap for consolidation will be spelt out, which was followed up by the announcement to set up an expert panel to look into the issue of consolidation.

Consolidation among public sector banks was also in the agenda of the previous United Progressive Alliance government’s finance minister P Chidambaram but the then government wanted the proposal to come from bank board’s which never came. Merger between two banks would have cost the job of one of the chief executive, so one uttered the M word.

However, the stance of the present Narendra Modi-led Bhartiya Janata Party government has been vastly different. In first edition of Gyan Sangam, the bankers’ retreat organised by the finance ministry in 2015– government officials tested waters by floating the idea of consolidation. Bankers unanimous said time has not come for consolidation.

“After discussing the matter at length it was agreed that the current times is not the opportune time for consolidation and that the need of the hour presently is to strengthen the banks by empowering them with operational flexibility be it in the area of recruitment, or in differentiation on core capabilities,” minutes of the working group of Indian Banks’ Association which met to discuss consolidation in July last year, noted.

“Also it was envisaged that consolidation as and when the environment is congenial for the same is not going to happen through individual initiatives of the banks. The banks have to be driven towards the process though appropriate mandate by the major stakeholder i.e. government of India,”

The finance ministry got the clue, that the consolidation process has to be driven by the government.

So, the second edition of Gyan Sangam which took place earlier this month, the discussions was not if consolidation is needed. The discussion was how to consolidate, bankers who attended the retreat said indicating that the government’s resolve to push public sector bank mergers.

The need to have large banks cannot be over emphasised. No bank in the country features in the top ten banks in the country, in terms of asset size. State Bank of India – the country’s largest bank - is the only lender in the top 100 bank list. Given the huge large infrastructure needs of the country, large banks are required to finance it.

Consolidation will also increase capital efficiency, apart from improving the ability of banks to recover bad loans which are rising, experts said.

“There are two advantages of consolidation. One is that capital can be used more efficiently. The merged entity will have more leg room to raise capital,” said Ashvin Parekh, Managing Partner – Ashvin Parekh Advisory Services.

“At a time when NPAs are high, and banks are putting more effort in recovery, the ability to recover by smaller number of banks will be higher though a individual bank’s exposure may go up. This is because there are smaller number of voices … in the joint lenders’ forum today there are too many voices and each lender has a differential right with the borrower and they often not agree to a common recovery programme. With consolidation the recovery will be far more focussed,” Mr Parekh said.

Key for successful merger

Cost rationalisation is seen as one of key to make consolidation a success. This would result in cutting down branches, particularly in urban areas where there are too many branches of different banks in a same area, bankers said.

So, there is a view that banks from different geographies should be chosen for merger. For example, a south based banks should be merged with a north based bank. The recent acquisition by Kotak Mahindra Bank of ING Vysya Bank is a case in point, which primarily driven by the geographical synergies. Before the merger, 15 per cent of the Kotak branches were in south India, which improved to 38 per cent

Pratip Chaudhuri, former chairman of State Bank of India, however, feels public sector bank merger should be between by banks which are in same geographies.

“Lending, particularly to large corporate houses, is not the issue. The main objective is to get retail deposits. If a large bank from north India acquires a small bank from south India, then the merged entity’s south based branches will face difficulty in getting retail deposits,” Chaudhuri said indicating the importance of identity of a bank in a particular region.

When Mr Chaudhuri was the chairman State Bank of India (2011 to 2013), SBI merged one of its associate banks, State Bank of Saurashtra. “Customers of SBS was extremely disappointed. We have to cite example of how Sardar Vallabhbahi Patel had convinced all the princely states to accede to India,” he recollected. “This could lead to branch rationalization only in metro cities, but not in rural areas,” Mr Chaudhuri added.

The integration of human resources and their culture will also be easier if banks are merged from same geographies.

The other area is which should be the criteria for identifying banks for merger is the technology platform. Different banks have different technology platform which are developed by IT majors like Infosys and Tata Consultancy Services, to name a few. To merge two banks having different platform, could be a challenging task, bankers said.

Timing

But was the timing right? In last Gyan Sangam, bankers opposed the idea on ground that the health of their respective banks does not allow to takeover other banks. The situation has not improved in one year, rather it has further deteriorated if the Oct-Dec quarter results are considered. Many banks, including the likes of Bank of Baroda, IDBI Bank, Bank of India reported record losses.

“The overall observation that I will make is any time is a good time for consolidation. The real good time when consolidation should have happened is between 2005 and 2008 when the going was good. The issues that we are facing today that is of NPA and recovery, was not there then,” Mr Parekh said.

“Now what will happen is if you start focussing on consolidation then the focus on bad loans and recovery will get reduced. At that point in time the luxury was available. The other window that was available was between 2012 and 2014, when things started looking good. Today is the worst time,” Mr Parekh added.

Employee unions

One of the toughest challenges that the government will face while merging banks is from the employee unions and the employees who may fear identity loss. The unions have already started opposing the proposed privatization of IDBI Bank, in which the government said it would consider lowering stake below 50 per cent. The unions have called for a one day strike on 28 March to demand reversal of the government’s decision.

“What do we need? Big banks or good banks?” asked Vishwas Utagi, vice president, All India Bank Employees Association.

“We have always opposed consolidation among public sector banks. We have opposed it since 2004 when the then finance minister P Chibambaram talked about merger of Bank of India and Union Bank of India. At that time both the banks are profit making,” Mr Utagi said.

The Association said cleaning the bank balance sheet which the RBI has undertaken and the consolidation process that the government is planning, is a step towards privatizing the public sector banks.

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Banks need an autonomy stimulus

At a time when banks are in trouble globally, recent reported losses heighten the tendency to put Indian banks in the same basket. But global bank shares are falling because of an expected fall in bank earnings as interest rates become negative. In India, however, interest rates are firmly positive. In India, reported bank profits are soft because provisions are being made for weak assets. Tackling a problem at the root bodes well for the future. U.S. banks whose balance sheets were cleaned up are doing better than European banks where only cosmetic liquidity was provided.

Moreover, the asset quality problem affects only a part of the banking system, and only a particular type of loan. Non-performing assets (NPAs) that have stopped producing income are concentrated in public sector bank (PSB) loans to large corporates. Therefore the problem is limited in size and funds required to restore health are not excessive.

The sharp rise in emerging markets’ (EMs) corporate debt from 45 per cent of gross domestic product (GDP) in 2005 to 74 per cent in 2014 is a major source of global risk. It also rose in India, but is only 14 per cent of GDP. Debt is concentrated in large infrastructure firms, but even so average debt-equity ratios remain at around unity since they are low for other firms. Ignoring local detail leads to a blind echoing of global fears — a relative perspective diminishes India’s debt-related risk.

Caps on external debt reduced fluctuations in Indian interest rates compared to more open EMs. A mechanical sell-off of EM assets occurs in periods of rising global risk, as liquid portfolios are sold irrespective of a country’s own prospects. But the Indian experience in 2008, 2011 and 2013 is that they tend to return if prospects are robust. In the current cycle there are signs that domestic investors are using foreign exit to come in at a good price — a sign of maturing markets with a wider base. Indian restrictions on short-term debt have reduced chances of large cumulative cycles occurring as corporate bankruptcies create NPAs and stressed banks stop lending.

In addition, PSBs have demonstrated the ability to compete effectively and earn profits in the past. They did unexpectedly well after the 1990s reforms, and even overtook private banks on some parameters. They outperformed during and immediately after the global financial crisis. NPAs fell to 2.4 per cent in 2009-10 from 12.8 per cent in 1991. A similar recovery is possible now, even as gaps in reforms are closed.

Public and private banks

The problems of PSBs now are partly due to government interference but also to errors of judgment and to external shocks. The first two led them to participate much more than private banks in infrastructure financing. They came from a history of hand-holding large corporates in order to encourage development. The onus fell more on them after development banks were shut. They did not foresee the governance and administrative problems that delayed projects that were expected to be viable under high growth. Interest rate hikes, following the 2011 inflation peaks, also hit PSBs. A loan-based system is highly sensitive to a rise in interest rates.

Meanwhile, private banks concentrated on more lucrative and less risky retail lending. They did well in this period, and their market capitalisation overtook that of listed PSBs in 2011. But their diverse strategies did reduce risk for the Indian banking sector as a whole.

NPAs were expected to come down as the economy revived. But external shocks and domestic political logjams continue to delay recovery. Capital adequacy regulation should ideally be countercyclical with buffers built up in good times. But recovery is taking too long. Moreover, loan growth from PSBs is the slowest, possibly because of a larger share of stressed assets. Therefore it is necessary to clean up bank balance sheets. The onus is on the government as the largest shareholder. The Budget has made a contribution towards refinancing PSBs. There is little risk for depositors or of systemic spillovers.

The Indian taxpayer has, however, for long subsidised government and large private investment. Earlier this was through loss-making public sector undertakings and development banks whose loans were rarely repaid. The 1990s reform closed some of these channels, and sought to bring in a larger role for market forces. But private infrastructure investment was inadequate. So PSBs were persuaded to step in again. Even if losses are due to external causes, promoters have poor incentives when they can escape liability. A readily refinanced bank does not choose projects carefully. Moreover, relationship lending easily degenerates into corruption or gives in to pressure from powerful connections.

Onus on the government

Therefore, refinancing must be accompanied by reforms that build proper incentives. These should increase PSBs’ independence, and force promoters to share risk and potential losses, while making it easier to change management and allow equity infusion to keep viable businesses going. If loans are written off, a business can become viable as fresh equity and new promoters are more likely to come in. Banks with clean balance sheets are more willing to lend.

The problem is banks tend to stop lending to companies whose assets are declared to be NPAs. If an asset is recognised as an NPA, provisions must be made for possible losses. Therefore, before imposing an asset quality review in end 2015, the Reserve Bank gave banks new tools to make restructuring easier. It remains to be seen if these are adequate to provoke the mindset change required to aggressively revitalise projects and lend more.

Even so, it is time for change, for arbitrage-free systems with greater transparency. The government can subsidise industry if it is necessary, but this must be done upfront with the correct share of risk allocated to promoters and minimum discretion. The political system has too often taken taxpayers for a ride, with small benefits masking large hidden costs. They have the right to know what they are paying for. The SC has already asked for information on large defaulters. Stronger boards and improved governance mechanisms can ensure that PSBs make independent decisions on purely commercial grounds.

Appropriate structural change makes some monetary stimulus feasible, both to reduce the pain and in response to the global slowdown. Many negatives need positive counters.

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Student loans dry up as bad debts climb at banks

An increase in non-performing assets have led several public sector banks to go slow on educational loans, latest data complied by the Finance Ministry shows.

“Banks have achieved 50 per cent of the disbursal targets of the year 2015-16 up to 30 September,’’ according to a note circulated among chief executives of the public sector banks before Finance Minister Arun Jaitley met the bankers on Monday. “`However, banks namely the Corporation Bank, Dena Bank, IOB , UCO Bank, SBI, State Bank of Patiala, State Bank of Hyderabad and the State Bank of Travancore have not achieved proportionate targets,” the note said.

Banks were given a target of 20 per cent growth in disbursement and 15 per cent growth in accounts for the current financial year.

Reserve Bank of India Governor Raghuram Rajan had, earlier this month at the Delhi Economic Conclave, raised a red flag over the increase in non-performing assets in education loans and said such loans should be devised in a flexible manner, providing options like automatic moratorium if borrowers were under a period of unemployment. He wanted guidelines on know-your-customer (KYC) to be made easier.

“There are lots of NPAs in the education sector. They have been rising in the last few years. It's a matter of concern,” Mr. Rajan said.

A student, under the educational loan scheme, can borrow up to Rs.10 lakh for domestic education and Rs.20 lakh for studying in foreign colleges. Borrowers need not pay during the tenure of the course and for an additional year. The repayment period is five to seven years.

For loans up to Rs.4 lakh, banks cannot demand any collateral. According to bankers, the maximum number of bad loans are in this segment.

Due to rising bad loans, the finance ministry, at the request of bankers, has created a credit guarantee fund for education loans. The Ministry of Human Resources has transferred Rs.351.09 crore to the corpus fund and Rs.112.05 crore may be transferred in the next week, according to the Finance Ministry.

It has also asked banks to integrate with the Vidya Lakshmi portal – which is a first of its kind portal providing a single window for students to access information and submit applications for educational loans to banks and for government scholarships.

While 24 banks have registered, only eight have integrated their system with the portal for providing loan processing status to the students. “All the remaining banks are requested to take steps to integrate with the portal,” according to the note.

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