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Bank Merger and Bank Amalgamation

Context:

Government of India decided to merge three Public Sector Banks namely – Bank of Baroda, Vijaya Bank and Dena bank into one single entity. Though termed Bank merger it being called as bank amalgamation. The resultant entity after amalgamation will be the third largest Public Sector Bank in India after State Bank of India and Punjab National Bank.

Difference between a merger and an amalgamation:
Amalgamation is the combination of one or more companies into a new entity. An amalgamation is distinct from a merger because neither of the combining companies survives as a legal entity; a completely new entity is formed to house the combined assets and liabilities of both companies.
NOTE: Bank Consolidation is a broad term used for bank mergers and amalgamations.

Historical Background of Bank Consolidation in India:

After the wave of economic liberalization, a committee under the chairmanship of MaidavoluNarasimham (13th Governor of Reserve Bank of India (RBI) was constituted in 1991 and again in 1998 to recommend reforms required in banking sector.

Narsimhan Committee 1991 Recommendation:

Structural Reorganizations of the Banking sector :

  • Actual numbers of public sector banks need to be reduced
  • Recommended mergers to form a three-tier structure
    • Three to four big banks including SBI should be developed as international banks
    • Eight to ten banks having nationwide presence should concentrate on the national and universal banking services.
    • A large number of Regional Banks focusing on agriculture and rural financing.
  • No further nationalization
  • Liberal entry norms for private and foreign banks

Narsimhan Committee 1998 Recommendation:

Strengthening Banks in India: It recommended the merger of strong banks which will have ‘multiplier effect’ on the industry.

Cases of Bank Mergers in India

  • Punjab National Bank (PNB) and New Bank of India (NBI) (1993-1994) – first ever merger between two nationalized banks.
  • Bank of Baroda (BoB) and Benares State Bank Ltd (2002) – another bailout in the form of a merger
  • Oriental Bank of Commerce (OBC) and Global Trust Bank (2004) – It was proposed in order to protect the interests of the depositors of GTB. The bank had suffered massive losses and its net worth wiped off.
  • State Bank of India and State Bank of Saurashtra (2008) – This was the first of the seven mergers between SBI and its associate banks. After the banking sector was opened to foreign banks in 2009, consolidation of SBI with associates was actively considered in order to increase its competency vis-à-vis entry of foreign banks.
  • SBI merger with associate banks and BharatiyaMahila Bank (2017) – As the largest lender, State Bank of India was already designated a systemically important institution. It became bigger after merging five associates and the BharatiyaMahila Bank. The merger helped SBI gain a spot among the top 50 banks globally.
  • Private Banks Merger – Kotak Mahindra Bank picked up ING Vyasa bank recently to increase its footprint in southern region. Similarly, ICICI bank had picked up Bank of Madura to get a rural footprint and increase its banking services.

Procedure of Merging

  • Bank mergers are regulated under (Banking Regulation) Act, 1949.
  • Any two public sector banking entities can initiate merger talks, but the scheme of the merger must be finalized by the government in consultation with the RBI and it must be placed in the Parliament.
  • Parliament reserves the right to modify or reject the mergers.
  • Alternative Mechanism Panel for PSBs merger– Recently, the government has put in place an Alternative Mechanism Panel headed by the Finance Minister to oversee merger proposal of PSBs. The other member of the panel are Railway Minister and Defence Minister.
  • It is made to fast-track consolidation process to create strong lenders.
  • The first proposal was the merger of Bank of Baroda, Vijaya Bank and Dena Bank. 
CAMELMODEL:
Financial performance of selected merged banks is analyzed and interpreted based on CAMEL parameters. For the purpose of analysis, data of both merging banks during pre-merger and financial data of merged bank during post-merger period is taken.
Based on CAMEL model in India, it is found that the private sector merged banks are dominating over the public sector merged banks in profitability and liquidity but in case of capital adequacy and NPAs, the results are contrary
Camel model is a supervisory rating originally developed in the U.S. to classify a bank’s overall condition.
CAMEL model were also developed in India by the Reserve Bank to provide a risk based summary view of overall health of individualbanks.
Certain important parameters were selected for rating the banks and grades were awarded on the basis of
a) Capital adequacy, (C)
b) Assets quality, (A)
c) Management Efficiency (M)
d) Earning Quality (E)
e) Liquidity and (L)

Why go for Bank Consolidation?

  • Lower return on the capital employed by the government: All the PSBs have a government sharing upward of 53.81%, they are doing same business and compete to serve similar customers. It meant a lower return on the capital employed by the government which has competing demands for funds, and growing competition.
  • Reduced Recapitalisation Burden– With a larger capital base and higher liquidity, the burden on the central government to recapitalize the public sector banks again and again will come down substantially.
  • Cutting Cost and Acquiring Efficiency – Several banks that are majority-owned by the government, virtually doing the same business, and competing for the same pie of customers wasn’t a sensible strategy. Since financial stability is not threatened and depositors are not running the risk of losing money (as long as the banks have government backing), the primary logic for consolidation should be cutting cost and acquiring efficiency.

There are multiple expected ways in which this can be achieved.

  • Weaker bank sells its assets
  • Closes loss making branches
  • Entail sale of real state where branches are redundant
  • Manage headcount – providing voluntary retirement schemes
  • Multiple senior management posts will be abolished bringing in financial prudence.
  • To increase the risk taking ability-The aim of the government is to increase the risk taking ability of the banks.Banks will not be reluctant to approve big loans to averse the risk.
  • To reduce government holding-The government owns majority stakes in 21 Public Sector Banks (PSBs) virtually doing the same business and competing for the same pie of customers.
  • Bad loans problem-Ever-rising NPAs have created the urgency for bank consolidation. Big banks can absorb shocks and have capacity to raise resources without depending unduly on the state exchequer.

Implications of Bank Merger

For banks● Economies of scale can be reached – more capital and more customers
● Reduced cost of doing business
● Risk taking ability will increase
● Rationalization of banks and branches
● Variety of services delivered can be increased
● Indian banks will gain greater recognition in the global market
● Volume of inter-banks transactions will come down cutting the clearance and reconciliation time.
● Employee welfare as the wide disparities between the staff of various banks and their service conditions will narrow down.
For government● Basel III requirements can be met mainly through Capital Adequacy Ratio.
● Burden on the exchequer to recapitalize can be reduced
● Regulatory ease: Ensure easy and effective monitoring
For economy● Robust banking system with global presence
● Help in solving bad loans issue
● Credit availability in the economy
● Government expects NPA problem will be cured
For minority stakeholders● Immediate effect of merger announcement has brought volatility in stock prices. For example: Investors in Bank of Baroda and Vijaya Bank have lost 14% and 12% in market value.
● Shareholders may experience dilution of voting power due to increased number of shares.
● SBI’s recent merger saw customers of associate banks opting to move their business to rival lenders as result of a lack of comfort in banking with the larger parent
For general people● Prices of products or services will decrease
● Quality of products or services will enhance
● Customer satisfaction may increase/decrease depending on the circumstances
● There might be a change in accessibility to their customary banking institutions.
For financial inclusion● The objectives of financial inclusion and broadening the geographical reach of banking can be achieved better with the merger of large public sector banks and leveraging on their expertise.
● Increased accessibility of financial services at affordable cost
● Recent announcement of third phase of consolidation of Regional Rural Banks(RRBs) will further enhance capital base and area of operation. It will provide credit and other facilities to small farmers, agricultural labourers and artisans in rural areas.

Disadvantages of Bank Merger

  • In India most of the merger has been a consequence of compulsions like NPA, inefficiency which has only led to failure in objectives in 90% of cases.
  • The move towards consolidation is contrary to the initial focus on regional banking requirements.
  • Different global financial crisis have seen large global banks collapsing while smaller ones had survived the crisis due to their strengths and focus on micros aspects.
  • With the merger, the weaknesses of the small banks are also transferred to the bigger and healthier bank.
  • So far small scale losses, recapitalization could revive the capital base of small banks. Now if the giant shaped SBI books huge loss or incurs high NPAs as it had been incurring, it will be difficult for the entire banking system to sustain.
  • Shifting and closure of many branches- for example, 20% SBI branches  are closed after merger
  • Large banks are not necessarily better banks as seen in SBI merger case.

Case Study – State Bank of India merger with its associates and Bhartiya Mahila Bank. 

PositivesNegatives
Consolidation helped in better monitoringCombined loss of associate banks shadowed the profits of SBI in 2017-18
Customers were able to avail lower interest on loansBad loans of the associate banks can drag the performance of strong bank SBI
increased efficiency of the consolidated bankOfficials of associate banks are upset over the change in their career prospects as a result of the merger
Provided for better capital adequacy ratio of the consolidated entity20% of the branches have been closed

Key Challenges

  1. Integrating different cultures– Integrating the cultures of two merging banks remains a major task as even SBI has not been able to escape the pain of merging its associates with itself.
  2. Identity loss- An enforced merger will lead to identity loss for the staff and its large clientele. For example- Vijaya Bank may face identity loss after its merger with Bank of Baroda.
  3. Human Resource management– Merger announcements trigger confusion, anxiety and insecurity in staff.
  • There will be staff surplus requiring relocation or enforced retirement.
  • Ensuring that no employee will face adverse service conditions as a consequence of the amalgamation.
  • Rationalisation of work procedures between merging entities
  • A process of confidence building among the officials is needed and this is in its nature a time-consuming exercise.
  1. Operational autonomy– operational autonomy for senior management must be ensured for new entity formed after merger.
  2. Governance and regulatory structure – Governance structure and regulatory structure of the consolidated bank remains in a grey area.
  3. Too big to fail– The global financial crisis of 2007-08 had established that when institutions are too big, regulatory intervention would get diluted.

Steps to be taken

  1. Consultation with stakeholders– Vinod Rai, former chairman of Bank Board Bureau (BBB) had underlined the need that various stakeholders need to be engaged before bank consolidation is effected, to ensure the entire process is least disruptive. For example: in the recent merger, heads of the banks are not consulted before making the decision to merge these entities.
  2. Divesting the shares– There is large headroom for divesting and creating new owners to share the burden of capital infusion.  For example- currently, government holdings in PSBs range from 100% in IDBI bank to 61% in Allahabad and Andhra bank.
  3. Clean the bank before consolidation– The need is to first clean the banks then consolidate the weak bank with the strong bank.
  4. Strengthening regulation– The need is to strengthen the Banking Regulation Act, 1949 to give the regulator enough teeth to regulate state-run banks.
  5. Other measures to control bad loans problems:
  • Insolvency and Bankruptcy code
  • Bank Board Bureau
  • Appointment of chiefs of PSBs
  • Tenure of chiefs of PSBs
  • Measures to ensure accountability
  1. 4 R’s– The Economic Survey 2015-16 had proposed 4 R’s- Recognition, Recapitalization, Resolution  and Reform to deal with challenges of PSBs. The recent move of merging banks is the implementation of this fourth R i.e. reforms in PSBs. The recognition and resolution of stressed assets is expected to improve asset quality.

Way Forward

  • Public sector banks should not be merged mindlessly to create a few bigger banks. Prudent selection of banks based on market forces is the need.
  • Raghuram Rajan, has, in his note to the Estimates Committee of parliamentspelt it out clearly: “improve governance of public sector banks and distance them from the government” and “delegate appointments entirely to an entity like the Banks Board Bureau.”
  • We need a mix of efficiently run PSBs and private banks to serve both development goals and social justice.
  • Promoting saving culture among the masses, reducing the gender gap in accessibility of financial services, promoting digitization should also be the priority of the lenders.
  • Forced mergers should be avoided and should not become a means to imbibe issues that deeply stall our financial institutions and needs to be addressed separately.
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