Merger Of Public Sector Banks

• Capacity Enhancement: These bank mergers, and the ones already carried out, will lead to the creation of big banks with an enhanced capacity to give credit. Previously, the government has already merged SBI with its affiliate banks, and Bank of Baroda with Vijaya Bank and Dena Bank.
• Global Competitiveness: These big banks would also be able to compete globally and with private banks post consolidation. There will also be increase their operational efficiency by reducing their cost of lending. Post-mergerIndia will have a total of 12 PSBs, half of which (Punjab National Bank, Canara Bank, Union Bank of India, Indian Bank, SBI, and Bank of Baroda) will be able to compete at a global level.
• Efficient Resource Utilisation: These banks have been particularly chosen for the mergers as they run the same or very similar platforms which would ensure that there is no disruption in the banking services, and that the banks should benefit from increased CASA [current account savings account] and greater reach. Rationalization of costs across many areas including branches, people, technology, etc. and creation of stronger institutions will thereby lead to efficiencies of scale and stronger balance sheets.

• Ability to Compete Globally Doubtful: The bank mergers announced by the government are still not large enough in size to be able to take over global competitors. For example, even after the merger the PNB would be about one third the size of the 50th largest bank in the world.
• Correlation between Size and Efficiency is Disputable: As per analysts, size-efficiency link has a positive correlation only until the size is quite low (around $ 10 billion) and not beyond that. Even in India large PSBs underperform in relation to private banks, which are much smaller. The price to book value ratio of HDFC Bank is close to 4, whereas the price to book value of SBI is around 1.25.
• Management Still a Challenge: Almost all the banks being merged suffer from managerial inefficiency. When the existing management is not able to deliver the performance at the existing level of assets, how can management make a success of a much bigger and more complex entity?

Apart from bank consolidation today the banking sector needs comprehensive reforms covering management, privatization and operational changes:

• Making Banks Independent: The P.J Nayak Committee recommended a path to greater independence for PSBs. Eventually PSBs should be independent and accountable, and allowed to choose bank’s CEOs.
• Government Run to Board Run: Making bank managements accountable to professional boards instead of the political leadership by strengthening the Bank Boards, reducing government ownership to 50% of the bank’s paid-up capital etc.
• De-Risking Banking: Banks lend to NBFCs who further lend to housing projects and during default the risk is transferred to banks. To prevent this, NBFCs must be able to raise money directly from markets.
• Reducing Government Mandates: Uncompensated government mandates (for example, opening Jan Dhan accounts, mandatory purchase of SLR bonds, rural lending targets and loan waivers) for PSBs makes them uncompetitive and are against the interests of minority shareholders. These free banking services should be compensated, reduced and paid out of budgetary resources.

Thrust on better governance, a more liberal approach to the composition of boards, succession planning on a par with private sector peers, and competitive executive compensation would determine whether the reforms provide independence and ensure accountability at these banks.