Will Reserve Bank Of India Walk The Talk On Bank Consolidation

Talks on consolidation in Indian banking have been going on for almost two decades. A seminal report on banking reforms, authored by a panel headed by former Reserve Bank of India (RBI) governor M. Narasimham in 1998, recommended merger of banks to make them strong. In fact, it was in favour of a three-tier banking structure with three large banks with international presence at the top, eight to 10 national banks at tier two, and a large number of regional and local banks at the bottom.

There have been several rounds of discussions on mergers and consolidation of state-run banks in India at periodic intervals. Till recently, the logic for such mergers was building scale and strengthening the risk-taking ability of such banks but at this point, the trigger for revival of the decades-old discussion is ballooning bad assets in the Indian banking system.

The public sector banks roughly have a 70% market share and many of them are hugely stressed. In the past too we had seen stress in certain banks but at that time, the banking regulator was in favour of making them “narrow banks”—directing the stressed banks not to give fresh loans but continue to accept deposits and invest those deposits in zero-risk sovereign bonds.

There seems to be a radical shift in the RBI’s approach.

First, it withdrew the protective ring around the public sector banks and opened up the industry by allowing new banks—small finance banks and payments banks—to come up. Till this happened, the banking regulator was in favour of letting the public sector banks gather strength to withstand competition and delaying the entry of new players. But, by opening up the sector, it has exposed the public sector banks to competition which will definitely erode their market share. Now, it has started talking about mergers and consolidation and also allowing the weakest ones to die. It is in line with what the Narasimham panel had said—the weaker banks should be closed down, if they cannot fend for themselves.

Early last week, RBI governor Urjit Patel flagged off the issue when he said India could be better off if some public sector banks are consolidated and we have fewer, but healthier, entities. Delivering a lecture at Columbia University, New York, Patel said that public sector banks need to raise private capital from the market and not rely on “government largesse”; raising private capital will “restore some market discipline and get the banks and their shareholders to more seriously care about management decisions”. He also appreciated the fact that the weaker banks have been losing market share and the stronger banks are gaining market share, particularly the private sector banks.

A few days later, his deputy Viral Acharya, in Mumbai, echoed the same sentiment and looked for some “creative solutions” to address the problems of the public sector banks—some of which are laden with so much stressed assets that they have lost their right to live. Starved of capital, they may not be giving fresh loans but since they are state-owned, the depositors are always happy to keep their money with such banks. Essentially, as long as they have the crutches of deposit insurance (under law, up to Rs1 lakh deposit is insured) and government support in the form of continuous infusion of capital, they will remain in business.

The key question is: Do we need them? Such banks, according to Acharya, give two kinds of loans—first, “ever-greening of existing bad loans” or throwing more money after the bad to help the borrower repay past loan; and, second, risky loans that give banks high returns, in a last-ditch attempt to make some money (“doubling up bets in a casino when first round of gambling has all gone sour”).

Acharya is prescribing merger of certain banks. We do not need so many banks, particularly when we have cooperative banks and microfinance institutions for community-level banking or the third tier of banks, as recommended by the Narasimham panel. He is also in favour of private capital raising by the relatively healthier public sector banks. This will lighten the government’s burden of recapitalization and, at the same time, the private shareholders’ presence will make these banks more accountable for their lending decisions and governance. He is also recommending sale of assets—the loan portfolios as well real estate (branches, guest houses) and the subsidiaries involved in the so-called non-core businesses such as insurance and capital markets.

Finally, those banks which are not in the best of health should be merged with others. Incidentally, in February too, Acharya had made similar suggestions while addressing a seminar of lobby group Indian Banks’ Association. Will the regulator walk the talk? It won’t be able to unless the government, the majority owner of these banks, is on the same page. Repeated assertions by Acharya and endorsement of his statements by Patel encourage us to think that there will be concerted efforts by the Reserve Bank and the government to resolve the problem of the banking system’s growing bad assets in the world’s fastest growing major economy through mergers and even privatization of some of the state-owned banks.

In 1930, there were 1,258 banks registered under the Indian Companies Act, including loan companies and the so-called nidhis, which were in the business of borrowing and lending money but by 1947, the year of Independence, the number of scheduled banks had come down to 82. Since economic liberalization, barring a handful of cooperative banks, no bank has been allowed to fail. The Reserve Bank always “found” a suitor for a troubled bank to protect the interest of depositors and avoid any systemic crisis. In 1993, New Bank of India was merged with Punjab National Bank—the last instance of a state-owned bank being merged with another.

The merger of associate banks with the State Bank of India which has catapulted the nation’s largest lender into the league of the top 50 banks globally in terms of assets is a family affair, driven by the objective of achieving scale and not rescuing some the associate banks. Merger of the weak public sector banks will be a far more challenging task. Who will merge with whom? Certainly three or four weak banks cannot be merged to create a larger weaker bank; similarly, merger of a weak bank with a strong bank will pull the relatively stronger bank down.

Of course, synergies in technology, loan portfolios and profiles of borrowers and branch locations could bring down the cost of mergers and sale of real estate can generate income. Employee separation schemes can also be used to get rid of excess staff and bring in a younger, digitally savvy talent pool into these banks. Incidentally, the Narasimham panel was in favour of closing down the weak banks and had said the big banks should be merged with equally big and strong banks.

Nothing will happen overnight but the fact that the Reserve Bank has started talking about consolidation, mergers and privatization of public sector banks is a great beginning. The banking regulator is preparing itself for the last rites of some of the state-owned banks which have lost relevance.

They have been on a life support system (periodic capitalization by the government and the deposit insurance) for too long and it’s time to pull the plug. Of course, before the last-rite rituals are performed, the government and the banking regulator need to ensure that their organs in terms of branches, other real estate assets, subsidiaries, borrowers, and even the employees are “donated” and successfully “transplanted” into other banks. This will be the best way to make the mergers painless and beneficial for all the stakeholders.

To read the writer's earlier columns, log onto www.bankerstrust.in

Tamal Bandyopadhyay, consulting editor at Mint, is adviser to Bandhan Bank. He is also the author of A Bank for the Buck, Sahara: The Untold Story and Bandhan: The Making of a Bank.

His Twitter handle is @tamalbandyo.

This column first appeared in www.livemint.com