CONSOLIDATION OF PUBLIC SECTOR BANKS

WHY IN NEWS:

• Government plans to consolidate 10 public sector banks into four bigger banks came into force on 1^st April 2020. With this, the number of public sector banks in India will come down to 12 from 27 in 2017.

NEED FOR CONSOLIDATION:

• India’s banks are disproportionately small compared to the size of its economy:
  • Although India economy is fifth largest in the world in terms of nominal GDP, the highest ranked bank - State Bank of India - is ranked 55th in the world and is the only bank to be ranked in the Global top 100.
  • Using international examples, the economic survey of 2020 estimates that in relation to the size of the Indian economy, we should have at least six banks in the global top 100.
• To reduce volatility:
  • Larger bank may be less risky than a smaller bank as the larger bank will have a more diversified portfolio resulting in less volatility in its earnings.
  • Consequently, a large bank may command higher credit rating than a smaller bank
• To cater to the needs of credit demand of a growing economy:
  • As Indian companies increase their business and become global in nature, their demand for large scale credit will become higher.
  • Banks also have to grow in size to meet the higher demand of credit. The banking system will be required to enhance its capacity to lend to larger companies and to larger projects
• To check twin balance sheet crisis:
  • Problem of credit lending, based on the twin balance sheet crisis, can be checked by the formation of bigger banks.
  • Mergers can also protect weak PSBs from loss - thereby securing customers and financial system.
• To minimise the chance of failure:
  • Bigger banks with diverse portfolios have lesser chances of failure since it is unlikely that different sector of an economy will face a crisis at a same time.

BENEFITS OF CONSOLIDATION

• For Banks:
  • Expand coverage:
    • PSBs, which are geographically concentrated, can expand their coverage beyond their outreach.
  • Innovative products and services:
    • A better and optimum size of the organization would help PSBs offer more and more products and services and help in integrated growth of the sector.
  • Increase professionalism:
    • Consolidation also helps in improving the professional standards.
  • Reduce unhealthy competition:
    • This will also end the unhealthy and intense competition going on even among public sector banks as of now.
  • Improving global presence:
    • In the global market, the Indian banks will gain greater recognition and higher rating.
    • Banks can gear up to international standards with innovative products and services with the accepted level of efficiency.
  • Saving cost and time:
    • The volume of inter-bank transactions will come down, resulting in saving of considerable time and cost in clearing and reconciliation of accounts.
  • Better pay structure:
    • The wide disparities between the staff of various banks in their service conditions and monetary benefits will narrow down.

• For Economy:
  • Funding for large projects:
    • Larger banks are in better position to fund projects with long gestation period
  • Decrease liquidity risk in the economy:
    • After merger, Indian Banks can manage their liquidity – short term as well as long term – position comfortably.
  • Improves ease of doing business:
    • Bank consolidation helps in reduction in the cost of doing business.
  • Economy of scale:
    • Synergy of operations and scale of economy in the new entity will result in savings and higher profits.
  • Better customer satisfaction:
    • Customers will have access to wider range of products at a lower cost

• For Government:
  • Reduced burden:
    • The burden on the central government to recapitalize the public sector banks again and again will come down substantially.
  • Better stability in banking sector:
    • Consolidation will also help in meeting more stringent norms under BASEL III, especially capital adequacy ratio.
  • Better regulation:
    • From regulatory perspective, monitoring and control of less number of banks will be easier after mergers

CONCERNS:

• Implementation challenges:
  • Integration of two different organisation cultures and technological platforms may not be a simple process.
  • The treatment of legacy issues, closure of redundant branches, redeployment of human resources and efficient allocation of capital post-merger are not straight forward decisions
• Neglect of local needs:
  • Bigger banks may follow monopolistic behaviour with increased market power – resulting in neglect of local needs.
• Transfer of risks:
  • A complex merger with a weaker and under-capitalized PSB would stall the bank’s recovery efforts as the weaknesses of one bank may get transferred and the merged entity may become weak.
• Larger the bank more the risk if it fails:
  • When a big bank books huge loss or crumbles, there will be a big jolt in the entire banking industry. Its repercussions will be felt everywhere.
  • Large global banks had collapsed during the global financial crisis while smaller ones had survived the crisis due to their strengths and focus on micro aspects.
• Issues in Human Resource Management:
  • There would be number of human resources issues such as difficulty in adapting to new emerging culture, discontent due to far-flung transfers etc.
  • Mergers will result in immediate job losses on account of large number of people taking VRS on one side and slow down or stoppage of further recruitment on the other.

WAY FORWARD:

• The Indian banking system is currently sub-scale compared to the size of the economy. A large economy needs larger and stronger banks to support its growth. Merger of smaller PSBs to create larger ones is a one strategy to attain this goal. However this should be carried out with right banks for the right reasons. PSBs are listed and their shares are held by diversified private institutions and individuals and interests of these minority shareholders need to be protected. Any plan for merger or acquisition has to be a Board led process in which all stakeholders have to be involved from beginning. Apart from this, we need to focus on certain other areas such as:

• Creation of a Fintech Hub For PSBs:
  • Challenges faced by PSBs such as high operating costs, disjointed process flows from manual operations and subjective decision making can be overcome by FinTech.
• Credit Analytics using Artificial Intelligence And Machine Learning
  • PSBs need significant investments to exploit the data-rich environment in India.
  • Analytics based on market data are capable of providing accurate predictions of corporate distress. Leveraging these data requires new data, analytics, and modelling skills

• Pooling of data:
  • PSBs will be able to enhance their efficiency by fulfilling their role of delegated monitors if all the PSBs can pool their data into one entity.
  • A GSTN like entity, called PSBN (PSB Network), to use technology to screen and monitor borrowers comprehensively and at length can be established.

• Employee stakes in PSBS:
  • Enabling employees to become owners in the banks would incentivise them to embrace risk-taking and innovation
  • A portion of the government stakes can be transferred to employees exhibiting good performance across all levels of the organization through Employee Stock Option Plans (ESOPs).

PRACTICE QUESTION:

Q. “Consolidation of Public Sector Banks helps in reducing the volatility of financial sector in India” Comment.