Banking on consolidation

SBI merger is a good start but the real challenge lies ahead

The merger of State Bank of India (SBI) with five of its associates will create an entity that will be one of the 50 largest banks in the world with an asset base of Rs 37 lakh crore and a presence in 36 countries. It will have over 500 million customers and an employee strength of over 270,000. The merged entity will be almost five times the size of India’s second largest bank. The combined balance sheet will bear the brunt of a poor bad loans ratio with gross non-performing assets (NPAs) at 8.7 per cent of combined advances and a provisional coverage ratio of about 60 per cent (profits are set aside to cover only 60 per cent of NPAs). But the accounting will be more transparent, allowing for clearer judgements about financial health. As it stands, SBI will need large sums for recapitalisation to meet Basel-III prudential standards. However, it is an open question whether it will be a more efficient entity, with better operational dynamics and sounder financials. That will depend on the ability to cut redundancies and downsize manpower surplus to requirements. It will also depend on the merged entity being allowed the freedom to operate on purely commercial considerations.

Major cost savings and synergies could result as and when treasury operations are merged and streamlined, along with audit processes and assets like physical offices and the information technology infrastructure. The branch strength is to be “right-sized” to 22,500 branches from the current combined total of about 23,900 branches. Manpower is also to be whittled down. But the merger is sure to run into rough weather as it will be opposed by the unions, which have formed a nine-union united front to block the process. That has to be sorted out because without redundancies being reduced quickly and in a cost-effective fashion, the merged entity will be bloated. Like every other public sector bank, SBI also suffers because it is not entirely free to act as a commercial entity without political interference. This is the primary, oft-unstated cause underlying poor non-performing ratios of public sector banks. The risks of such interference in the merged SBI are higher since it controls a larger share of assets.

A rule of thumb indicates that a bank which controls over 10 per cent of banking assets is “too big to fail”. Indeed, the US has legislation to prevent entities of such size undertaking mergers and acquisitions to prevent them becoming even larger and triggering systemic risks in the event of failure. The merged SBI will be well over that limit and, thus, require very stringent oversight and supervision. Such worries apart, this merger will serve as a test case; if it works, and it does generate efficiencies, other public sector banks could be merged in a similar fashion. That will help to create a sector which has three or four larger and more efficient banking entities. However, it should not be forgotten that this merger is akin to plucking the low-hanging fruit as the merger of other mid-level banks is likely to be trickier. Such banks have far greater variation across parameters than what exists among SBI and its associates. As such, it is their merger that will be the true test of the government’s resolve to bring about consolidation in the public sector banks. To that extent, this merger cannot provide the real blueprint for consolidation. The government will need to spell it out separately.