Merger by region may help consolidation of PSU banks

If done methodically, it could provide a natural hedge against asset quality issues in the long run

The CNX PSU Bank index has been among the major gainers of the current rally, rising 18 per cent since January. An improvement in financial conditions of state-run banks has been recognised as a major factor for growth, among a host of other things.

Some of the major players, including the Punjab National Bank (PNB) and Bank of Baroda (BOB), along with smaller ones like Canara Bank and Syndicate Bank turned profitable in the fourth quarter, which ended March 31, after posting steep losses in the same quarter in the year-ago period.

Behemoth State Bank of India (SBI) and its smaller peers such as the Union Bank and Vijaya Bank saw a convincing improvement in operations. 

However, a few including the Dena Bank and IDBI Bank still have a long distance to travel. Nevertheless, the overall sentiment regarding PSU banks stocks is a lot more positive now, than what it was a year ago. Improved sentiments are also why now would be a good time for the government to pursue its mega merger plans agressively.  

Finance Minister Arun Jaitley was earlier quoted as saying that the government would go ahead with its PSU bank merger plan without much wait. 

In fact, there is a growing and urgent need for a stronger banking system, explains Vaibhav Aggarwal of Angel Broking, while adding that the objective of consolidation should not be to merely handle the issue of non-performing assets (NPA). 

“Merger of public sector bank (PSB) should be to create bigger banks with more synergy and ensuring capital adequacy”, he adds.

Earlier, the government shared a wish-list of potential mergers. It is believed that PNB could takeover Corporation Bank, United Bank of India, Dena Bank or Andhra Bank. While this may not be a bad idea, the process of merger should also not lose sight of the financials of the consolidated entity. Therefore, merger just by size or the aciquisition of smaller banks by larger ones,  may not lead to consolidation at all.

Unless the merger process effectively deals with the issue of manpower resources in the PSU banking system, the exercise is unlikely to produce the anticipated results.

The government, thus, needs to focus on consolidating the huge deposit available with the PSU Banks. India being a savings-focused banking system, a regional approach to consolidation of banks may be a fruitful exercise and could eventually address the issue of NPA in the long run. 

For instance, BOB, Central Bank of India and Dena Bank draw over 28 per cent of branch network from Chhattisgarh, Madhya Pradesh, Uttar Pradesh and Uttarakhand, according to data compiled by the Reserve Bank of India (RBI).

If these banks are merged, a bulk of the businesses in the central region will continue to be concentrated with the merged entity. This would firstly ensure more bargaining power and better room for negotiations with borrowers for the merged bank- a move that acts as a natural shield against asset quality concerns. Currently, the smaller PSBs follow larger banks in terms of prioritising lending without exercising adequate caution, and this partly explains why many smaller banks are faced with higher NPA troubles compared to the larger ones.

That apart, regional approach to consolidation may also tackle the issue of managing people, bank unions and other related aspects- a problem that has been the biggest hurdle for many bank mergers in the past and is likely to remain so, going forward. Regional approach ensures that the transfer of human capital is largely contained within the region. Further, historical trends suggest that 15-20 per cent of branch operations may shutdown post merger. If banks are consolidated region-wise, the post-merger rationalisation could reduce operating costs for the merged entity, without compromising on the deposit base. "Geographical synergies could be a key factor if region-wise consolidation is being explored. If executed successfully, operating expense ratios could come down,” said Krishnan Sitaraman, Senior Director, CRISIL Ratings.

Lastly, with a new format of banking emerging in the form of small finance banks (SFB) and payments banks, PSBs need to think of alternatives to retain and strengthen their deposit base. SFBs are expected to consolidate their presence as regional players in the next 5-10 years, and hence merging the PSBs region-wise may be a measure expected to guard against competition. "There is merit in having 5-6 large regional behemoths to get immediate synergy on consolidation. This could counter the potential threat from the upcoming differentiated banks that could be regionally more disruptive,” says Abhishek Bhattacharya, Director and Co-Head, Bank & FI Ratings, India Ratings & Research.