B L Jalali
Finance Minister Ms Nirmala Sitharaman announced merger of 10 Public Sector Banks into 4 entities. Thus total PSBs reduced from 27 to 12. Before this merger exercise, in the recent past another 2 Public Sector Banks were merged with Bank of Baroda besides merger of 5 Associate Banks of SBI with SBI. The ten merger banks are Punjab National Bank, Oriental Bank of Commerce, United Commercial Bank, Canara Bank, Syndicate Bank, Union Bank of India, Corporation Bank, Andhra Bank, Indian Bank and Allahabad Bank. Banks which merged with Bank of Baroda are Dena Bank and Vijay Bank.
Two banks namely Bank of India and Central Bank of India are allowed to continue as it is.
Four banks viz Bank of Maharashtra, UCo Bank ,Indian Overseas Bank and Punjab & Sind Bank will continue to function within their regional areas.
Out of ten banks that the government has decided to merge to create four, nine have net NPAs( Non Performing Assets ) of over 5%. Only Indian Bank’s NPA as on March 2019 is below 5% at 3.75%.
Owing to the sharp deterioration in finances of state owned banks on the back of rising NPAs, 11 public sector banks were put under PCA in 2017, thereafter based on financials of FY 18, Seventeen Banks fell under PCA based on net NPA threshold alone and nine on ROA alone ( Negative for two consecutive years). Prompt Corrective Action or PCA is a framework under which banks with weak financial metrics are put under watch by the RBI. PCA framework deems banks as risky if they slip below certain norms on three paramteres i.e. Capital Ratios, Asset Quality and Profitability. It has three threshold levels ( 1 being the lowest and 3 the highest) based on where a bank stands on these ratios. Banks with CRAR( Capital to Risk Asset Ratio) of less than 10.25% but more than 7.75% fall under threshold 1).Those with CRAR of more than 6.25% but less than 7.75% fall in second threshold. In case a bank’s Common equity Tier 1( the bare minimum capital under CRAR) falls below3.625 percent, it gets categorized under the third threshold level. Banks that have a net NPA of 6 percent or more but less than 9 % fall under threshold 1, and those with 12% or more fall under the third threshold level. On profitability, banks with negative return on assets for two, three and four consecutive years fall under threshold 1,2 and 3 respectively.
As most bank activities are funded by deposits which need to be repaid, it is imperative that a bank carries a sufficient amount of capital to continue its activities. PCA is meant to alert the regulator as well as investors and depositors if a bank is heading for trouble. The idea is to proactively attend to the problems before they attain crises proportions. On breach of any of the risk thresholds mentioned above, the RBI can invoke a Corrective Action Plan. Depending on the threshold levels, the RBI can place restrictions on Dividend distribution, branch expansion and management compensation. Only in an extreme situation, breach of the third threshold, would identify a bank as a likely candidate for resolution through amalgamation, reconstruction or winding up.
If a bank in which we may hold deposits falls under PCA we need not to press the panic button. RBI’s and GOI’s ( being the majority share holder) Corrective measures will take care of the Bank. Moreover, as per Basel Committee on Bank Supervision ( BCBS) report, Core capital requirement for banks as prescribed by the RBI is 1% higher than what Basel III norm recommendations. Indian Banks as per RBI direction are required to maintain 5.5% CET1( Common Equity Tier 1) as against 4.5% required under Basel III framework. Several aspects of the Indian framework are more conservative than Basel framework. This includes higher minimum capital requirement and risk weightings for certain types of exposures as well as higher minimum capital ratios. RBI also applies certain restrictions to banking facilities through its prudential norms.
Consequent to opening of Indian Economy i.e. LPG (Liberalisation, Privatisation and Globalisation ) since 1990s , three major Committees were set up for Financial Sector Reforms in India who were tasked to study and submit their recommendations. These were: Narasimhan Committee Report 1991 : Objective : To promote healthy development of the Financial Sector. Recommendations :
* Establishment of 4 tier hierarchy for banking structure with 3 to 4 large banks ( including SBI) at the top and at bottom rural banks engaged in Agriculture activities.
* Capital Adequacy Norm – RBI fixed 8% by March 1996.
* Private Banks, 4 Local Area Bank, 5Access to Capital Market 6, Debt Recovery Tribunals etc
NARASIMHAN COMMITTEE REPORT II – 1998 : This is also called Banking Sector Committee. Objective: To review the banking reforms progress and design a programme for further strengthening the financial system of India. Focused on Capital Adequacy, Bank Mergers, Bank legislation etc .
NACHIKET MOR COMMITTEE: The committee on Comprehensive Financial Services for small Business and Low Income Households set up by RBI in 2013 was mandated with task of framing a clear and detailed vision for financial inclusion & financial deepening in India. Recommended six visions like Universal Electronic Bank Account (UBEA), Ubiquitous Access to Payment Services & deposit products, Affordable Credit, etc.
PJ NAYAK COMMITTEE – 2014: (Officially the Committee to Review Governance of Boards of Banks in India was set up by RBI to review the governance of the boardof banks in India. P J Nayak was former Chairman & CEO of Axis Bank): Some Recommendations are : Government must reduce its stake in PSB to less than 50%. .2 Establishment of Banking Investment Company. 3 Governance Reforms ( eg splitting of Chairman and MD) etc .
In view of the foregoing the bottomline for the merger of 10 PSBs into 4 entities is to create Banks of global level that can leverage economies of scale and balance sheet size to serve the needs of a $5 trillion economy by 2025.
Mergers are driven by synergies – in products, costs, business, geographies or technology and the most important , cost synergies. Unless they realize cost synergies between the branch and staff rationalization, mergers may not mean much to them or to the economy. This is where the govt strategy will be tested.
It was the Narasimham Committee in the late 1990s that recommended consolidation through a process of merging strong banks. The committee recommended shutting down of the weaker banks and not merging them with the strong ones.
The biggest plus of the mergers is that they will create banks of scale – there are too many banks in India with sizes that are minuscule by global standard with their growth constructed by their inability to expand. Yet this advantage of scale cannot be leveraged without adequate reforms in governance and management of these banks. To be sure, FM did announce a few measures to make managements better accountable to the board.
But the key reforms to be made are at the board level, including in appointments, especially of government nominees. These are often political appointees, with little exposure to banking. Such practices need to be curbed as the definition of global banks is not just about size but also professionalism in governance. The govt will also have to manage the fallout of unleashing four mergers simultaneously .
The benefits of Consolidation of banks are:
* Consolidated entities will have a higher capacity to lend .
* Second gain appears is strong national presence with better global reach.
* The third potential gain is the operational efficiency gains that reduce the cost of lending. This is one area where the entire operating model has to change. We now have retail banks, small finance banks, payments banks and more. Meanwhile , PSBs seem to be caught in the relatively outmoded loop of corporate banking while private banks are exiting the space due to asset liability management issues.
* The bigger banks have greater ability to absorb shocks, reap economies of scale as well as the enhanced capacity to raise resources without frequently depending on the exchequer.
* India will have 6 large Public Banks with 10 lakh Crore plus of Balance Sheet, two national bank and four regional banks.
Finally, though the merger of Public Sector Banks was overdue we must congratulate the present dispensation having taken this gubernatorial decision of merging 10 banks at a time which may help in motivating private sector to invest and boost the consumption demand.
(The author is former Asstt. Gen Manager and Head, State Bank Learning Center, Jammu)
B L Jalali