Subir Roy: Why merge public sector banks?

The problem of public sector banks (PSBs)'s non-performing assets (NPA), far from easing, seems to be getting worse. In the last financial year (2015-16 or FY16) their gross NPA ratio rose to 9.5 per cent, compared to five per cent in the previous year (FY15). It is, therefore, not surprising that new ideas are being thought up to seek a way out. The latest is Banks Board Bureau Chief Vinod Rai airing the notion that two large Mumbai-based PSBs could be merged after they had cleaned up their acts, that is, balance sheets. Then, once this merger had been digested, another weak bank could be merged with this new entity.

Mr Rai has not mentioned which banks he has in mind, but the media has speculated that they might be Bank of Baroda and Bank of India. Now, the former is one of the best run among all PSBs, a particularly bad lot of course. Its strength is a positive public perception of it as a brand and a reasonably competent management cadre. But even such a bank has reported a loss in the March quarter with gross NPAs going up to as high as 9.99 per cent, sharply up on the previous year's 3.72 per cent. The deterioration of financial health is also evident in the bank going into a sizeable loss (Rs 5,396 crore), compared to recording a profit (Rs 3,398 crore) in the previous year. If this is the condition of the stronger of the two, then how will it pull up the weaker?

Merger is about the only solution that the government seems to be capable of thinking up in seeking to get the PSBs into some degree of health. Earlier, the government had approved the merger of State Bank of India, the biggest and arguably the strongest among PSBs, with its associate banks. Now what this merger of all the associate banks in one go is supposed to achieve is not at all clear. Earlier, particularly weak associate banks were being merged on a sort of case by case basis. What is the point in merging, for example, State Bank of Travancore and State Bank of Hyderabad with SBI, when in FY16 the two associate banks' gross NPA ratios were in fact lower than that of SBI?

If a smaller bank has extensive local knowledge and a good brand image, and runs reasonably well, then it will be counterproductive to merge it with a big structure that could well reduce the speed of decision-making for operations that were part of the smaller entity. Merging of weak and strong only makes sense if the weak entity needs to be rescued. But in the process the merged entity becomes weaker than what the standalone stronger entity was. Private sector mergers most often result in an overall reduction of management positions and cost saving. One will have to only wait and see if this happens in the case of SBI and its associates.

If the idea of a merger is to have a large balance sheet which causes a national bank to rise higher in global league tables, then one way of achieving that without changing decision-making processes on the ground is to have a holding company and publish a consolidated balance sheet. Mergers by themselves do nothing to address the issue of poor governance resulting in poor asset quality, except for the owner (in this case the government) being able to say that instead of, for example, 10 weak banks we now have five, the better banks having been made to swallow the weaker ones.

It is also equally pointless to create a bad bank, so to speak, in the nature of an asset reconstruction outfit, to which all the bad debts of all the banks in trouble can be transferred so that they can start with clean slates. That will take care of the stock problem (the legacy of stressed assets). If there is no change in the quality of management and the political masters' way of dealing with PSBs, then over time the banks will again pile up assets of poor quality.

Now that a respected person of known efficiency and integrity like Mr Rai has been put in charge of selecting top bank managers, it will over time lead to PSBs being headed by a more able lot. But it will take far more action and years to change the culture prevailing in these banks. Creating a Banks Board Bureau like the present one will only marginally improve the quality of decision-making in the banks in the medium term.

The only way for the government to stop bleeding (periodic recapitalisation) is to privatise the banks. Unfortunately, there will be no takers for most of them. The developmental role of nationalised banks is long over. They have singularly failed to take forward financial inclusion in a meaningful way. The poor will be well served by microfinance institutions and small finance banks. So policy should encourage their growth.

As for the legacy PSBs, what the government needs to do is work out a strategy to give a decent burial to all but a few of them. Less than a handful can be left in public ownership to perform as national companies in emergencies. Banks were nationalised by Indira Gandhi foremost for political reasons. It is hard to see why the Bharatiya Janata Party government should be so timid in ending her legacy.

subirkroy@gmail.com