Merger of Public sector Banks                                                 (GS PAPER 3)

• The government has announced a mega amalgamation plan of public sector banks.
• It merged ten public sector banks into four larger entities, alongside board level governance reforms.
• This step is aimed at improving their financial health and enhancing their lending capacity to support growth.
• The merger announcement was followed by an equity infusion move of Rs 55,250 crore in these banks to enable them to grow their loan book.
• This is third merger announced by the government. With these series of mergers, the number of state-owned banks is down to 12 from 27.

Which banks have been merged?

• Punjab National Bank, Oriental Bank of Commerce and United Bank of India to merge to form the country’s second-largest lender. These three banks are technologically compatible as they use Finacle Core Banking Solution (CBS) platform.
• Canara Bank and Syndicate Bank to amalgamate. It will create the fourth largest public sector bank
• Union Bank of India to acquire Andhra Bank. It will create India’s fifth largest public sector bank
• Corporation Bank; and Indian Bank to merge with Allahabad Bank. It will create the seventh largest public sector bank with strong branch networks in the south, north and east of the country.

Logic behind mergers

• Banks have been merged on the basis of likely operating efficiencies, better usage of equity and their technological platform.
• Main objective is to create banks of global level that can leverage economies of scale and balance sheet size to serve the needs of a $5-trillion economy by 2025.
• It will create banks of scale — there are too many banks in India with sizes that are minuscule by global standards with their growth constricted by their inability to expand.

Challenges

• Although It enables the consolidated entities to meaningfully improve scale of operations and help their competitive position
• However at the same time, there will not be any immediate improvement in their credit metrics as all of them have relatively weak solvency profiles.
• Current mergers may face more friction. In the present case, the mergers are mostly among larger banks, with absorbing bank not necessarily in strong health. However, given the merged banks are on similar technology platform, the integration should be smoother.
• Further initially there will be more focus on management streamlining, which would impact the loan growth and reduce focus on strengthening asset quality in the short term.
• While there may be some geographical synergies between the banks being merged, unless they realise cost synergies through branch and staff rationalisation, the mergers may not mean much to them or to the economy.
• Narasimhan Committee in late 1990s had recommended shutting down of the weaker banks and not merging them with the strong ones as is being done now.
• Along with merger the focus should be on adequate reforms in governance and management of these banks
• The key reforms to be made are at the board level, including in appointments, especially of government nominees. Professionalism in governance is a key to the success not just the size of the banks.
• It has been argued that a failure of a very large bank may have adverse impact on the economy as witnessed during the financial crisis of 2008. The 2008 crisis highlighted that presence of large financial institutions pose systemic risk to the economy and such institutions are "too big to fail".

Further, in event of any such crisis in future, the onus would lie on the government to bail out the institutions, thus posing a moral hazard.