Government would do well to promote development banks to fund infrastructure projects and relieve public sector banks as experience amply demonstrated that PSBs are not cut for that job of funding long-term projects with short term resources
Recently, Gyan Sangam (Intellectual Confluence), the second one after the formation of the present government, discussed ways to revamp the banking system at Gurgaon. It has not offered any better wisdom than loud whispers of consolidation of banks. Is consolidation of banks the right solution?
The messy Indian banking at the moment due to huge pile up of non-performing assets (NPAs) in public sector banks (PSBs) in particular, caused by more of funding long term infrastructure projects through short term resources, trying to seek a bail out through mergers and acquisition route, history would not spare the government.
Reserve Bank of India (RBI) Governor Dr Raghuram Rajan rightly warned recently that the merger move is risky without cleaning up the beleaguered banks’ balance sheets. Finance Minister Arun Jaitley hinted at the consolidation of unwieldy and economically weak state-run banks even as he kept the door open for lowering the state's stake in them below 50%. He has also spread a red carpet to multi-national asset reconstruction companies (ARCs) providing scope for sale of distressed assets.
I recall what Thomas Koenig, Kansas City Fed Reserve President said on 8 September 2011 in an interview to Oklahoman – mega banks needed break up. He rightly felt that individual institutions should not grow to a size that would let the nation fail going by the experience of Penn Square Bank failure in Oklahoma. “The Oklahoma City bank's sketchy energy loans eventually led to the collapse of Chicago-based Continental Illinois, the largest bank failure in US history until 2008.” He did not at all support the theory of Fed Reserve ‘too big to fail’ in the aftermath of 2008 recession.
Banking Reforms Committee in India (Chairman M Narasimham, 1991), however, desired for creation of at least six mega banks in India. Attempts were made later to allow the size of ICICI Bank grew in the private sector and State Bank of India (SBI) in the public sector, grew through a few mergers and acquisitions. When there was a near run on the ICICI Bank in September 2009, the Government asked the SBI to pump in Rs400 crore and allow free operations on all the automated teller machines (ATMs) to give confidence to the customers and the RBI assured the economy that nothing went wrong with the Bank. The RBI in its Financial Stability Report (FSR) of June 2015 also identified these two mega banks as banks posing systemic risks along with four others.
Among the 38 mergers and acquisitions (M&A) since nationalisation of banks, a few posed severe problems. The inefficient New Bank of India merger with Punjab National Bank (both public sector banks) and takeover of the failed private sector bank – Global Trust Bank Ltd by Oriental Bank of Commerce, another PSB, took no less than a decade and over for makeover of balance sheets of the merged banks. In the case of former, human resource and cultural issues posed severe discomfort while in the case of the later, technology of GTB being the most sophisticated compared to that prevailing with the OBC the later took more than a decade to assimilate it.
Smoother among the takeovers was that of Bank of Madura Ltd with the ICICI Bank. Even the merger of a couple of associate banks with its parent, the SBI had problems in merger of hierarchy and scales of pay as also pension settlements for over a decade. No two merger formats had similarities.
In fact, the drivers of consolidation among banks should be synergies, efficiency, cost saving, and economies of scale. Proactive communication, organisation structure revamp, and appropriate human resource integration would smoothen the course to integration. Several Indian bank mergers in the recent past seem to belie these factors.
Some recent research studies into ICICI and SBI mergers 2008-10 point to least improvement in the share price on NSE and BSE, the return on assets, return on equity, earnings per share and net profits. Indian banks did not secure new customers post merger in most cases.
Quite a few of the PSBs, aping the west, went in for universal banking and incentivised cross-selling as a major business strategy. The incentives for such cross-sold products were so attractive that several executives could care little for the regular banking products and customer service.
Amidst domestic pressures, politics playing spoilsport on the PSBs, due diligence took a beating and global impacts added fuel to the fire in creating NPAs of over Rs6 lakh crore by the end of December 2015 requiring recapitalisation to a degree of Rs1.18 lakh crore. Government chose to pump in a meagre Rs25,000 crore in its latest Budget. This gave rise to the expectation of mergers and acquisitions as a possible route to come out of the capital vows.
It is not size that is the solution to the problems as much as good governance and the government maintaining arm’s length distance from the governance and management of PSBs. By the time, the Bank Board Bureau starts functioning, it may be six months from now.
Cleaning up the boards and balance sheets would depend upon the Bankruptcy Act’s effective implementation. It is past experience that such Acts requiring rules to be framed would take another minimum six months after receiving the President’s assent. Speed of action has always been a casualty in Indian governance and regulatory mechanisms and this shall be the key area of focus of the government.
It is also important that the big banks start becoming humble and learn lessons instead of becoming conglomerates of unwieldy nature. Banking basics and customer service can hardly be bargained. Government would do well to restart the Development Banks to fund infrastructure projects and relieve the PSBs from this window as experience amply demonstrated that they are not cut for that job well due to their funding long-term projects with short term resources.
Simon Johnson, a former chief economist of International Monetary Fund (IMF) arguing in his Project Syndicate column on ‘the End of Big Banks’, strongly supports Kashkari’s view point that the time has come for review of ‘too big to fail’ theory and breaking big banks would hold better financial stability in a fragmented world.