Bank consolidation: Merger by size no quick fix

However, if done methodically, with an eye on regional presence, it could provide a hedge against asset quality issues in the long run

After months of languishing on the bourses and recording new lows, the NSE PSU Bank index, has gained a little over 15 per cent since March, outperforming the benchmark Nifty (up 9.5 per cent).

Analysts attribute much of the post-Budget rally in stocks of public sector banks (PSBs) to the government's capital infusion and consolidation plans. Also, that some part could be on account of bottom fishing. The recent formation of the Banks Board Bureau, meant to select heads of state-run banks, help improve their governance and develop innovative financial methods to raise capital and other measures, has added to the sentiment.

Investors, however, need to be cautious. The fundamentals of PSBs haven’t changed meaningfully since the December ’15 quarter. Nor will merging these purely on the basis of size (bigger bank acquiring smaller peer) lead to significant gains.

Take Punjab National Bank (PNB). In the December quarter (Q3) of 2015-16, it saw a 93 per cent slip in profit due to Rs 3,775 crore of bad loan provisioning. Going by the government’s wishlist, PNB is to take over either Corporation Bank, United Bank of India, Dena Bank or Andhra Bank. If so, its financials might become more stressed, as these banks face equal or more asset quality pressure. The merged entity might look no better.

Likewise with Bank of Baroda (BoB), where much cleaning was done in Q3. If it was to take over a smaller bank, the purpose of undertaking the massive clean-up exercise might be defeated. While there is a growing and urgent need for a stronger banking system, Vaibhav Aggarwal of Angel Broking says the objective of consolidation should not be to only handle the issue of non-performing assets (NPAs). “Mergers of PSBs should be to create bigger banks with more synergy and ensure capital adequacy,” he adds.

In that case, as India is largely a savings-focused banking system, a regional approach to consolidation might be fruitful and could eventually address the NPAs issue. For instance, RBI data indicates BoB, Central Bank of India and Dena Bank draw 28 per cent of their branch network from the central region (Chhattisgarh, Madhya Pradesh, Uttar Pradesh and Uttarakhand). If these banks are merged, the bulk of business in the central region remains concentrated with the merged entity. This would ensure more bargaining power and better room for negotiations with borrowers for the merged bank, a natural shield against asset quality concerns. Currently, the smaller PSBs follow larger banks in terms of prioritising the lending, without exercising adequate caution. partly why many smaller banks are faced with higher NPA trouble than the larger ones.

That apart, a regional approach to consolidation might tackle the people management (and bank unions) aspect, an issue which has in the past and is still likely to be the biggest hurdle in any merger. A regional approach ensures transfer of human capital is largely contained within the region.

Further, historical trends suggest 15-20 per cent of branch operations might be shut after a merger. If banks are consolidated region-wise, the after-merger rationalisation could reduce operating costs for the merged entity, without compromising on the deposit base.

Says Krishnan Sitaraman, senior director, CRISIL Ratings: “Geographical synergies could be a key factor if region-wise consolidation is being explored. If executed successfully, operating expense ratios could come down.”

And, with the new format of banking, such as the emergence of small finance banks (SFBs) 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 five to 10 years. So, merging the PSBs region-wise might guard against the competition.

“There is merit in having five-six large regional behemoths, to get immediate synergy on consolidation. This could counter the potential threat from the upcoming differentiated banks, which could be regionally more disruptive,” says Abhishek Bhattacharya, co-head, bank & financial institution ratings, India Ratings & Research.