The raison d’être for having a bank merger is to bring about economies of scale to the company so that it becomes globally competitive. The Narasimham Committee-I of 1991 had recommended that the system finally should move towards having a handful of national level banks which can compete globally. Looking at the way things have turned out, one is not sure if this is the motivation behind the present idea of bank mergers considering that while it is nice to have large banks, Reserve Bank of India is ironically trying to move banks out from large exposures. The thrust is on moving these large borrowers to the corporate debt market, which is a prudent move in the light of the asset-liability management (ALM) challenges that banks face. However, the curious thought here is that any discussion on bank mergers does not involve protagonists with large sizes. It is more a case of the strong absorbing the weak to make the combined entity more respectable. The sense one gets is that it is more to address the health of weaker banks that mergers are being considered and the motivation is definitely not to create mammoth sized-banks.
Since the talk is of having two public sector banks merge, is there any a priori justification from the point of view of the business of banking? Or is it just a way of adding the weaker numbers to the stronger ones? This would effectively tantamount to a mathematical summation of two balance sheets to make the final picture more digestible. One way out is to look at whether or not such a merger improves the usual yardstick of CAMEL (Capital adequacy, assets, management capability, earnings, liquidity) stronger for the merged entity?
To provide some flavour of numbers to such a process, two banks have been considered here—one which is the largest in terms of the size of assets in FY16 and the other is one of the smallest banks with some distinct stress on the quality of assets (see accompanying table). These are selected at random and could just be any two entities. Capital is always a factor which is critical in banking. The ratios of 13.18% and 10.08% are both above the statutory requirement. Adding two banks’ balance sheets can improve the ratio if the capital to risk (weighted) assets ratio (CRAR), of the weaker bank is lower.
But most Indian banks are adequately capitalised, at present, and such an addition may not materially change the position of the combined bank. For the system, the amount that can be lent will not change. In fact, what is important is whether or not this new bank can raise capital from the market by virtue of its new strength? As it is a summation of two banks, the overall ability will get constrained by the net effect on profits thus affecting valuation. Besides, if the combined bank remains owned by the government, it would not matter as the bank will still operate as a PSB which will not matter materially for an investor.
How about asset quality? Here, the ratios were 5.1% and 9.0% respectively, which will come down in the case of a merger to somewhere between the two numbers. This is a play with numbers because the non-performing assets (NPA) ratio can be lowered by increasing the denominator which is what several banks did in the past. Mathematically, a larger denominator through a merger can accommodate a higher numerator. But fundamentally, this does not resolve the NPA problem (the numerator) though it improves the ratio and the gross NPA quantum remains unchanged.
Management is an important aspect of the CAMEL model. Here again, it does not matter as both the banks have similar management personnel which are shuffled often by the government. As long as the business ethic does not change, swapping heads may not be have limited impact. PSBs have long been subjected to government pressure by virtue of the ownership to complying with all the policies which have political overtones. This ranges from loan decisions including the loan melas to waivers to opening Jan-Dhan accounts. No discernible change would accrue on account of this merger. In fact, there would be cultural issues that require concerted assimilation as surprisingly the operating practices and systems in various PSBs are different and adjustments would have to be made.
Operating platforms may be different necessitating concerted effort at integration. Earnings are the next factor that should get enhanced to improve the CAMEL model. When a merger takes place normally there are synergies to be harnessed. This could be in terms of say CASA deposits, retail asset portfolio, branches, location advantage, ATMs, etc. The present concept of a merger would only mean rationalisation of staff (through voluntary retirement if acceptable) and closing down of branches. Looking at these two banks, the wage component of the cost bill is similar.
The staff composition is stronger for officers in case of the smaller bank though rural and semi-urban penetration is slightly lower in terms of branches—which should not matter today given that this job is now with small and payments banks. While the cost of deposits and return on advances vary, the net interest margins (NIMs) for the two banks are close to one another at 1.81-1.84%. Hence, staff and branches are the two props that are there to lower costs. Liquidity, which is the last parameter, would normally not be an issue as weaker banks tend to hold on to more government securities, as they have moved to narrow banking. The investment deposit ratio is higher for the smaller bank at 38.4% which reduces the liquidity risk in case of adverse times.
The table gives a hypothetical case of a merger between one of the biggest and smallest banks in the country as of FY16 where the latter was also stressed with NPAs. Some of the ratios are interesting when compared. Looking at the table closely, it does appear that it is possible that when trying to map two such banks it could mean similar structures with the differentiating factor being the NPAs and future capital.
The objective of creating a larger bank is definitely not the point here, and hence may be construed as being myopic in scope. Using a merger to raise resources will be an attempt to use these combined numbers rather than providing a new model to investors. Interestingly, all bank mergers in India were results of either failures or loss of interest by promoters in the private banking space or non-viable models. Attempting such moves when balance sheets are clean may be more convincing than in the present conditions.