SBI merger: A test case

Without a hands-off approach, PSU mergers won't work

State Bank of India’s (SBI’s) merger with its five associates and Bharatiya Mahila Bank will be worth careful observation. SBI hopes to complete the formal merger in three months. The real task of extracting cost savings and building positive synergies will take longer. The most obvious cost savings will come from eliminating duplication. Savings are estimated to amount to about Rs 2,700 crore per annum starting 2018-19, though there will be higher costs in this financial year.

Some 1,500-1,600 branches can be shut, and commensurate employee strength downsized.  In addition, the treasury departments, information technology (IT) systems, vigilance etc,  can be merged. This should lead to more cost reductions and higher efficiency. The combined entity employs about 280,000 personnel and it could downsize a significant percentage. A start has been made with 2,800 employees of the five associate banks accepting the voluntary retirement scheme (VRS).  About 12,500 employees of the associate banks are eligible for VRS under the current offer. However, bank unions oppose downsizing on principle. That could mean stumbling blocks. 

The merged entity will be No. 44 on the list of the world’s largest banks. It will have an asset base of about Rs 37 lakh crore and branches across 36 countries. It would be almost five times the size of the next-largest Indian bank (HDFC Bank and ICICI Bank both have around Rs 7.5 lakh crore in assets). SBI has, by far, more reach in terms of branch footprint. The website generates huge online banking activity. 

The combined balance sheet will bear the brunt of gross non-performing assets (NPAs) at about 8.7 per cent of combined advances and a provisional coverage ratio of about 59-60 per cent (that is, only 60 per cent of NPAs are covered by profits that are set aside). The NPA ratio of five associate banks was worse, at 9.14 per cent in June 2016, versus SBI’s own NPA ratio of 6.94 per cent (June 2016). This would mean an initial deterioration in combined asset quality. The capital adequacy ratio is also likely to fall, since the capital adequacy ratio of the associates are all lower than SBI’s.

The silver lining is that SBI’s processes should lead to higher efficiencies and NPAs falling. The combined entity will probably need less recapitalisation than the separate entities would have required. SBI also has a lower cost to income ratio and SBI’s treasury operations are better managed with higher treasury margins. The accounting would also be more transparent, allowing for clearer judgement. In terms of scale, the merged entity will hold over 22 per cent share of all banking loans and deposits. Even in “side” businesses, it will be No. 3 in terms of life insurance premiums and it will also be among the largest of mutual fund houses, with about eight per cent of total assets under management. 

A bank which controls over 10 per cent of banking assets is generally considered “too big to fail”— since failure could affect the entire banking system. The US has legislation to prevent large banks triggering systemic risks. The merged SBI is over twice the trigger-size, so that’s a red flag. 

To avoid NPAs spiralling up, the merged entity must be allowed the freedom to operate according to commercial considerations. This goes beyond synergies and cost-cutting. Like every public sector bank, SBI suffers from major political interference. Loans are made and bad debts are forgiven on the basis of political expediency. The risks of such interference in the merged SBI would be higher. This is a crucial test case. If it does work, other public sector banks (PSBs) can be merged to create larger PSBs. But if it doesn’t work, the risks of bank failure would increase; the larger the entity, the more damage a crash could cause. 

It’s a positive sign that the government is willing to let PSBs try going the merger route. If growth continues to be reasonable, the NPA situation should improve. However, bank credit remains at multi-year lows and that is not a good omen. The merger must be backed up by more policy action. Every PSB desperately needs to be allowed to do its due diligence and operate without interference and this is crucial for SBI, in particular.  Unfortunately the recent massive write-off of farm loans in UP indicates that it may not happen. But without a hands-off attitude, PSB mergers cannot work in the long run.