Banking Sector Reforms

Explained: Mergers of public sector banksExplained

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Read the attached story

Mains level : Merger of PSBs and various prospects associated



  • The Centre announced a mega amalgamation plan, the third in a row, that merged ten public sector banks into four larger entities.
  • With these series of mergers, the number of state-owned banks is down to 12 from 27.

About the merger

  • There are four new sets of mergers — Punjab National Bank, Oriental Bank of Commerce and United Bank of India to merge to form the country’s second-largest lender.
  • Canara Bank and Syndicate Bank to amalgamate; Union Bank of India to acquire Andhra Bank and Corporation Bank; and Indian Bank to merge with Allahabad Bank.
  • The biggest merger out of the four was Oriental Bank of Commerce and United Bank merging into Punjab National Bank to create a second largest state-owned bank with Rs 17.95 lakh crore business and 11,437 branches.
  • These three banks are technologically compatible as they use Finacle Core Banking Solution (CBS) platform.
  • The merger of Syndicate Bank with Canara Bank will create the fourth largest public sector bank with Rs 15.20 lakh crore business and a branch network of 10,324 branches.
  • Andhra Bank and Corporation Bank’s merger with Union Bank of India will create India’s fifth largest public sector bank with Rs 14.59 lakh crore business and 9,609 branches.
  • The merger of Allahabad Bank with Indian Bank will create the seventh largest public sector bank with Rs 8.08 lakh crore business with strong branch networks in the south, north and east of the country.

Why merge PSBs?

  • According to the government, banks have been merged on the basis of likely operating efficiencies, better usage of equity and their technological platform.
  • But the move marks a departure from the plan to privatize some of the banks or bringing in a strategic investors to usher in reform in the sector.
  • The government, after consultations, decided that amalgamation is the “best route” to achieve banking sector scale and to support the target of achieving a $5 trillion economic size for India in five years.
  • The amalgamations will help banks to meaningfully scale up operations but will not lead to any immediate improvement in their credit metrics.

Logic behind the move

  • For years, expert committees starting from the M Narasimham Committee have recommended that India should have fewer but bigger and better-managed banks to ensure optimal use of capital, efficiency, wider reach and greater profitability.
  • The logic is that rather than having several of its own banks competing for the same pie (in terms of deposits or loans) in the same narrow geographies, leading to each one incurring costs, it would make sense to have large-sized banks.
  • This may be true especially in India’s bigger cities and towns.
  • It has also been argued that such an entity will then be able to respond better to emerging market trends or shifts and compete more with private banks.
  • The proposed big banks would be able to compete globally and improve their operational efficiency once they lower their cost of lending and improve lending.
  • But none of India’s banks including the largest, SBI, figures in the list of the top 50 global banks. So that may be a long way away.

How does it help the government?

  • For over decades starting from 1992, the government as the biggest shareholder of over 25 banks had to provide capital for them.
  • To grow and lend more, the banks often need a higher amount of capital to set aside also for loans that could go bad.
  • With the government not willing to lower its equity holdings and with a large slice of the capital being set aside to cover for bad loans, the burden of infusing capital rests on the majority shareholder.
  • This means marking a large amount of money almost every year during the last few years in the Budget for capital infusion at many banks at a time when there is a huge demand for social sector.
  • By reducing the number of banks to a manageable count, the government hopes that the demands for such capital infusion will be lower progressively with increased efficiencies and with more well capitalised banks.
  • It will also help that the government can focus now on fewer banks than in the past.

How have previous bank mergers fared?

  • Last year, the government had merged Dena Bank and Vijaya Bank with Bank of Baroda, creating the third-largest bank by loans in the country.
  • The government said this merger has been “a good learning experience” as profitability and business of the merged entity has improved.
  • Earlier, the State Bank of India had acquired its associate banks.
  • Indian Overseas Bank, Uco Bank, Bank of Maharashtra and Punjab and Sind Bank, which have strong regional focus, will continue as separate entities.
  • The government said profitability of public sector banks has improved and total gross non-performing assets have come down to Rs 7.9 lakh crore at end-March 2019 from Rs 8.65 lakh crore at end-December 2018.

More thrust on RBI

  • The RBI keeps monitoring large institutions whose potential failure can impact other institutions or banks and the financial sector, and which could have a contagion effect and erode confidence in other banks.
  • A case in point is the recent instance of IL&FS Group, which defaulted on repayments hitting many lenders and investors.
  • The creation of more large-sized banks will mean the RBI will have to improve its supervisory and monitoring processes to address increased risks.

Will this help improve the performance metrics now?

  • While the announced consolidation of PSU banks is a credit positive as it enables the consolidated entities to meaningfully improve scale of operations and help their competitive position.
  • At the same time, there will not be any immediate improvement in their credit metrics as all of them have relatively weak solvency profiles.
  • While asserting that bank consolidation is a good move towards improving efficiency of the PSBs, he said “it is possible that the current mergers may face more friction than the last one with BoB, Dena and Vijaya.
  • In that case, a large, well-capitalised strong bank absorbed two much smaller entities.
  • In the present case, the mergers are mostly among larger banks, with absorbing bank not necessarily in strong health.
  • However, given the merged banks are on similar technology platform, the integration should be smoother.
  • Also it is likely that management attention and bandwidth of the entities being merged could get split impacting the loan growth and reduce focus on strengthening asset quality in the short term.

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