Merger of Banks: Need & Challenges

Note4Students:

The talk of bank mergers is thicker in the air now, than never before. Government has started with merger of SBI and its subsidiaries. This merger has initiated a debate with some economist calling it a landmark decision while others believe that it will make the financial system more risky.

Context:

Recently The boards of State Bank of Bikaner & Jaipur (SBBJ), State Bank of Mysore (SBM), State Bank of Travancore (SBT), the unlisted State Bank of Hyderabad (SBH), State Bank of Patiala (SBP) and Bharatiya Mahila Bank approved the scheme of merger with State Bank of India.

Background

  1. The various committees appointed by the Government of India have advocated consolidation They argue that we need to have three to four large nationalized banks in order to improve the operational efficiency and distribution efficiency. The Narsimhan committee ii has specifically emphasized the need to have Indian Banks which are comparable in size with global leading banks.. The Narsimhan committee proposed a three-tier banking structure in India with around 3-4 large banks to take a stand in global scenario,8-10 banks to provide national coverage and rest to take care of local coverage.
  2. Most of the mergers in the pre-reform period have been forced ones. The post-reform era has witnessed both forced and voluntary mergers. The forced mergers have been caused by the financial ill health of the acquired banks. Banks witnessing erosion in net worth, huge NPAs and decline in capital adequacy ratio have been forced by the regulatory authority to undergo merger. Oriental Bank of Commerce’s acquisition of Global Trust Bank is an example of forced merger. Voluntary mergers have expansion, diversification and growth as the main motives. HDFC’s acquisition of Times Bank and ICICI’s acquisition of Madura Bank are a few examples of voluntary mergers. India has also witnessed cross- border acquisitions in the recent past. SBI’s acquisition of a Mauritian bank is one such example.

What is bank consolidation?

  1. Bank consolidation occurs when two or more banks become one bank. Bank consolidation can lead to expansion for the newly merged institution. Banks consolidate for multiple reasons, including to mitigate competition, gain capital power both domestically and internationally, to compete with larger banking institutions or to expand the services that the newly merged bank can provide both internally and geographically by decreasing overall operating costs.

Why do we need Consolidation of Banks?

  1. Economies of scale: Assocham Survey has found that size of Indian banks in terms of their assets stands very small to make optimal use of their capacities to raise funds at internationally competitive rates. Combined assets of top ten banks constitute less than 60 per cent of the GDP unlike the banking system of European economies, where even after the global financial turmoil, assets of only top five banks has grown to four times of GDP.
  2. Indian Banks are too small: Even as India is the second largest growth market for banking services after China in terms of the number of wealthy households, the ASSOCHAM Chief said, only two Indian banks, State Bank of India at the 64th position and ICICI Bank Ltd at 81st, figure among the global top 100 by tier I capital – a core measure of a bank’s financial strength that consists largely of shareholders’ capital.
  3. Similarly, in terms of assets, India’s largest bank, SBI is now the world’s 70th largest bank. On the other hand, ICICI Bank Ltd, the largest private sector lender has attained the 148th position. None of the other Indian banks features among the top 200 banks in the world-in terms of size of assets.
  4. Many experts in Banking field feels that hampered by the fragmented nature of the banking industry, Indian banks are not able to compete globally in terms of fund mobilisation, credit disbursal, investment and rendering of financial services. The balance sheets of top 10 Indian banks suggest the greater scope of consolidation to reap the benefits of large sized globally competitive Indian banks
  5. Merger will increase Capital efficiency: Consolidation will also increase capital efficiency. Merged entity will have more leg room to raise capital.
  6. Would decrease NPA: 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 focused. Thus consolidation could decrease NPA in India.

Advantages of merger of SBI with associate banks

  1. SBI will have global presence among top 50 Banks, bringing confidence, investment and greater lending.
  2. SBI can become one of the anchor banks to finance large infrastructure projects like dedicated freight corridor, solar energy, Sagarmala etc.
  3. It will increase networking of SBI all over India, thus better services of SBI compared to its associate branches will be able to reach remote locations.
  4. It will reduce duplication as SBI and its associates target the same clients with similar products.
  5. It will consolidate resources and infrastructure, reducing the cost on operations, human resource and technological solutions, overlapping bank branches, reduce inter-bank transaction cost etc.

Disadvantages of merger

  1. Presently these banks have huge NPAs thus merger should be planned after sufficient capital is injected.
  2. Banking competition may be affected, as SBI is likely to be five times larger than its nearest competitor.
  3. RBI has declared SBI as Domestic Systemically Important Bank (D-SIBs) and its failure can shock other parts of financial system.
  4. Past example of large banks and their failure with financial crisis in Japan, USA, etc.
  5. Workers resistance from associations like AIBEA calling for strikes
  6. India has poor financial inclusion, thus needs variety of banks and differentiated services.

Suggestions

  1. The govt should not rush through the process – all stakeholders must be involved in the process
  2. In the event of further divestment, the govt. share shall not fall below 51% in any case
  3. Acquiring bank shall not dominate the smaller ones- good practices of both should be combined; conscious and organized efforts to synthesize the differences must be made.

Conclusion

Bank consolidation is a tricky issue. While it is said that the long-term benefits of consolidation outweigh the short-term concerns, it must not be made a general policy. It is only to be done with right banks for right purpose with proper safeguards.

(Q) What do You Understand by Bank consolidation? Do Indian Banking sector need banking consolidation? Highlight Pros and cons.

(Q) Examine various implications of proposed merger of the State Bank of India with its five associate banks and the Bharatiya Mahila Bank.

 

 

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