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Merging 3 PSU banks a bold step by Modi govt, can set path for future mergers

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The announcement of merger of three public sector banks — Bank of Baroda, Dena Bank, and Vijaya Bank — took everyone by surprise. While the general talk of consolidation of PSU banks has been going on for a while, no one expected such a specific announcement. Analysts and observers of public sector banks (PSBs) suffering from a general malaise due to the non-performing asset (NPA) situation, have suddenly found something exciting to discuss.

We should welcome this announcement. This is the boldest move that any government has made about PSBs since they came into being. This merger could deliver several very positive benefits not just for these banks but also for the broader banking and finance sector and indirectly for the Indian economy.

First, it reduces the governance challenge for the government, in that it has two fewer banks to find good CEOs for, two fewer boards to appoint, and two fewer entities to audit. In the past few years, we have seen many PSBs with long spells without a CEO and inadequate boards highlighting the challenge government faces in making appointments. Setting up of the Banks Board Bureau appears not to have had much impact on this process. So, having to make fewer appointments will be a relief for the government.

Second, it creates a larger bank. Banking business has sizeable economies of scale and larger banks tend to me more efficient that smaller, sub-scale banks. The Indian banking sector is excessively fragmented where even the largest of the Indian banks are puny by global standards. Among the large economies, India has the third most fragmented banking sector behind the United States and Germany.

Economies of scale will continue to increase with increasing investments in technology. A more consolidated banking sector with fewer and larger banks is also likely to be more resilient. It is interesting to note that in the global financial crisis, two developed economies whose banking sectors were least impacted were Australia and Canada, both of which have consolidated banking sectors with a few dominant, large banks along with a number of much smaller specialist banks.

Third, this merger will help these banks deal with the large-scale retirement of senior management that they are going to face in the next few years. Pooling of the managerial talent in the combined entity would allow more efficient deployment over larger businesses and operations thereby easing the challenge presented by retirements.

Fourth, it will reduce the urgency of capitalisation of financially the weakest of the three banks (Dena). Relatively healthier balance sheets and capital levels of the other two banks would effectively eliminate the immediate need for any capital infusion on part of the government. In a year where government finances are already stretched, even a small relief on this count is welcome.

Fifth, there are potential synergies that can be realised in a merger. There could arise from economies of scale and scope, cross-selling products of one bank to the customers of the other, rationalisation of the branch network, etc. The extent and the sources of synergies will have to be carefully worked out and a programme developed to realise them as the banks are integrated.

While there are clearly benefits in this merger, it is important to also note that the mergers of this kind is not a panacea for all the challenges facing PSBs. The most pressing one, the problem of NPAs, will not be solved by just merging these banks. It will require fixing deeper institutional weaknesses. However, if the number of PSBs reduces from the current 21, then there will be fewer entities to be fixed.

Any merger is challenging, even for privately-owned and managed companies who regularly engage in mergers and acquisitions. All the stakeholders — employees, customers, vendors, shareholders, regulators — have to be carefully managed through the process. Communication is crucial. Synergies that seem obvious on paper are harder to realise in practice. On the other hand, a poorly-managed integration can impose costs and business disruptions. The integration process requires skilled and careful management. This is a merger of three entities, each with a long history, culture, tradition, and a large organisation (together over 85,000 people) which will be even more complicated than more common merger of just two entities.

PSU banks have not had any experience in this area and hence will have to find skills in managing the integration. The process will also require regulatory support — the merging banks may need temporary exemptions from single borrower exposure norms, approvals for consolidating branches within close proximity, etc. PSU banks are governed by the Nationalisation Act, which means that this merger will also requires approval from both houses of the Parliament.

Overall, this is a good move for the banking sector and if executed well can set the path for future mergers among PSU banks which will strengthen the banking sector in India. We should all hope for a conspicuously successful merger.