The Big Bank Merger – A move to Boost Growth?

- Taarini (B.A. (Honours) Economics, Panjab University)

In the wake of economic slowdown, the new government appears to bring with it every day
a new package of ‘reforms’ or policy announcements to revive the economy.
On August 30, 2019, Finance Minister Nirmala Sitharaman announced the amalgamation of
10 public sector banks into four entities as a big bang response to arresting the slowdown.
This is a step forward to fulfill the Prime Minister’s aim of creating a $5 trillion economy by
the year 2024. “We want to create next-generation banks,” said Nirmala Sitharaman. Last
year, the government proposed a merger of Vijaya Bank and Dena Bank with Bank of Baroda
(third largest bank of India). Earlier in 2017, State Bank of India was merged with five of its
associate banks making it the largest lender of India. Now, the number of state-owned
banks has slashed down to 12 from 27 in 2017.
The ‘Big Bank Theory’ of the government is both an acknowledgment and statement on the
severe condition of India’s economy. According to the report of first quarter of the 2019-20
financial year, India’s gross domestic product (GDP) grew at 5% - the lowest in the last 25
quarters. Last time the economy faced such a situation of slow GDP growth was in the
fourth quarter (January to March) of financial year 2012-2013. The growth rate of the
manufacturing sector has dramatically fallen down from 12.1% in FY19 to just 0.6% in FY20.
‘Slowdown in GDP growth is due to endogenous and exogenous factor’ said Chief Economic
Adviser K V Subramanian after the release of GDP data. The highly damaging impact of
demonetization in November 2016 and the poor implementation of the GST, barely after
seven months of demonetization, worked as a fuel in the burning economy. The Automobile
sector, moving in the slower lane, is facing the worst crisis in the last 20 years. State-owned
banks have been suffering from bad loan crisis from years now. Last September, the IL &FS
group, the infra-finance operator, collapsed. Ever since that incident, the Indian economy is
battling with a serious crisis of confidence and cash crunch. More bad loans will come
through as we’ll approach the IL&FS group meltdown anniversary.
At this juncture of the Indian economy, when the threat of economic slowdown is looming
large, the number of measures is taken including the merging of state-owned banks. As per
the proposed plan, the largest of the mergers announced by the finance minister is that of
Punjab National Bank with Oriental Bank of Commerce and United Bank. The amalgamated
entity formed will be the Nation’s second-largest state-owned lender with the total business
of Rs17.94 lakh crore after the State Bank of India with the business of Rs 52.05 lakh crore.
The second merger announced is that of Canara bank with Syndicate bank, giving it a
combined business of Rs 15.2 lakh crore and ranking it at the fourth-largest public sector
bank. Union Bank will amalgamate with Andhra Bank and Corporation Bank, which will make
it the fifth-largest public sector bank with a business of Rs14.6 lakh crore. Indian Bank will
absorb Allahabad Bank giving it a business of Rs.8.08 lakh crore. [Source: The Economic
Times].
Perspective behind the ‘Big Bank Theory’
Every policy has a perspective and purpose. Bank becomes bigger when merged. According
to the government, large banks will be able to lend more money and help resuscitate the
slowing economy. The government has also announced the infusion of Rs70,000 crore to
help these merged banks to extend more loans to the customer. Credit flow will increase in
the economy which is considered important to achieve the goal of creating India a $5 trillion
economy. Big banks with enhanced capacity, strong national presence and global reach will
emerge from this step. It is believed that the latest consolidation move of the government
will be able to save costs of operation and lead to increase in the efficiency by way of
economies of scale such as centralized bank office processing, elimination of branch
overlap, better manpower planning, optimum funds management and other fixed costs.
“The merged entities would have a high CASA and lending capabilities, and cost-cutting
branches would be realized with those branches that are overlapping,” Sitharaman said.
Reduction in the cost of operations of banks will lead to a reduction in lending costs as well.
The major challenge that the government faces is that of overstaffed banks. There is also
some overlap in branch networks such as in the case of Canara-Syndicate Bank merger in
Karnataka and other southern states. The All India Bank Employees Association has already
raised the red flag by taking out protest rallies and wearing black badges to work. But it is
being assured by the Finance Minister that no jobs will be harmed. But this is seen as a mere
compromise to avoid any trouble from the bank employees association by many.
But would a merger help in making the banks stronger?
The Narasimhan Committee in the late 1990s was the first one to recommend
amalgamation of strong banks. The committee was not supportive of the idea of merging
strong banks with the weaker ones as is being done now. If one weak bank is merged with
the strong bank, the resultant bank will be less strong. Indian Bank which is considered to be
financially stronger than the other 10 banks, has a net NPA ratio of 3.8% while that of
Allahabad bank is 5.2%. So, the impact of the merger will be intense on Indian Bank. Indian
Bank and Punjab National Bank are stronger than the other eight banks that they are being
merged with. Secondly, big banks become too big to fail. If a large bank fails, it brings down
the entire financial sector. For Example, the collapse of Lehman Brothers in 2008 triggered
the global financial crisis. The Big Bank Merger announcement has not gone down well with
the investors. The banks have lost about 9-12 percent of shares on the first day of trading
after the major announcement. This move has already scraped away the government’s
holdings in Public sector Banks by Rs 6500 Crore. But the worst may not be over yet, stock
prices of these merged Banks may fall further, hurting investors in the coming months. The
present merger per se will not decrease the size of bad loans. The structural problem can
only decrease if banks manage to improve the band loans recovery.
Conclusion
So far, the history of government dealing with the banks and their lending process has been
dreadful. The merger of Bank of Baroda with Vijaya Bank and Dena Bank in 2018 was not
appreciated by the market. There was no significant fall in the Credit Cost. According to a
BIS paper, “empirical evidence on gains from merger is often weaker than the claims of the
merging institutions and some economies of scale could be exhausted at relatively low
levels.” A study that 20 years of amalgamating banks in developed countries found
“beneficial up to a relatively small size, but there is little evidence that mergers yield
economies of scope, or gains in managerial efficiency.”[Source:
“https://www.thehindubusinessline.com/opinion/is-there-much-to-gain-from-bank-
mergers/article29385214.ece”] But still, many experts feel that this big bank merger may
face manpower and other hiccups in their short run, but if implemented well, this move will
enable Public sector Banks to compete more effectively nationally as well as globally.
Adequate reforms in governance and management of Bank, along with the government
consolidation move may help to address the bad loan crisis and help kick start economic
growth. Of course, the impact of government’s mega move would crucially depend upon the
future course of these banks. The future will colour the past.