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An Ill-timed Intervention

Merging public sector banks that are in need of capital infusion will only exacerbate problems.

At a time when India’s public sector banks (PSBs) are laden with debt that companies are unable or unwilling to repay because of their own stressed balance sheets (also called the twin balance sheet problem), the union cabinet chose to announce an “alternative mechanism” to hasten the merging of PSBs last month. This will entail providing in-principle approval to proposals received for mergers from bank boards. Such a policy proposal cannot be more ill-timed. The most important concerns for the banking sector in India today are to find ways to recover the amortisation and interest payments due from companies, and to mobilise capital so that their capacity to lend is restored, thereby facilitating investment in the economy. A quicker mechanism to merge PSBs will serve no purpose. Worse, any such move at this time runs the risk of merged banks gaining little, except a higher concentration of stressed assets.

Successful mergers entail, among other things, good timing. Merging two stressed assets-laden banks will mean not just a larger balance sheet, but could also mean a higher proportion of stressed assets. It is unclear how the merged entities will be in a better fi nancial position, other than having larger combined balance sheets, which is no indication of improvement. How will concentrating the stressed assets help at this time? More importantly, how will this reduce the amount of additional capital needed to recapitalise banks?

For instance, look at the merger of State Bank of India (SBI) with its associate banks this year. Their combined balance sheet became larger, but the proportion of bad assets went up substantially. This particular consolidation of associate banks with SBI has been under consideration since 1991 when the Narasimham Committee proposed the gradual merger of SBI and its seven associate banks (which were set up by princely states and were nationalised post-independence). It would have been in SBI’s interest to wait for a time when its associate banks had lower non-performing assets (NPAs). SBI’s net profit in 2016–17 was lower than the combined losses of the five associate banks that were merged with it. Other PSBs may not withstand such costs of mergers, because none are as large as SBI. This was a special case, and not as complicated as the possible merger of two unconnected banks.

The SBI group shares a common logo and branding, and uses the same information technology infrastructure. It already had a centralised governance structure with the SBI having a say in key matters concerning associate banks. Even so, the potential advantages of scale that this merger promises will only be realised once staff and branch networks are deployed productively. That will be a long wait. Organisational cultures also need to be addressed, and all these are difficult issues that need time and attention. Moreover, mergers of PSBs, and banks in general, in the post-1991 period, have not always resulted in more efficient merged entities.

The twin balance sheet problem has often been framed in a way that primarily implicates PSBs and their managements for being corrupt and inefficient. This explanation might have a grain of truth. Most of the ventures that PSBs financed were not unviable to begin with, but did badly because of reasons outside the control of banks. Certainly, there were cases of malpractice and corruption, but that was not the primary reason. Commercial banks began filling in for development finance institutions (DFIs), the term-lending institutions of the past that used to finance large projects. By the early 2000s, most DFIs ceased lending, closed, or converted into commercial banks. This was a result of financial deregulation. Commercial banks entered long-term project financing. They debt-financed the boom of the mid-2000s. But the result now has been eroded profits and large and growing NPAs.

To be fair, there have been efforts by individual banks to recover and restructure debt. In many cases of default, the time-bound Insolvency and Bankruptcy Code, 2016 processes are underway. The Reserve Bank of India’s advisory to banks to proceed against specific loan accounts promises some recovery, but these processes will be long drawn. Some debtors chose to take legal recourse to avert their bank’s attempts to take control of their assets. In the meantime, the government will have no option left but to allocate more to recapitalise PSBs.

What has the government done so far? In March 2014, gross non-performing advances (GNPAs) as a percentage of total advances was about 4% for scheduled commercial banks (both private banks and PSBs together); by March this year it was 9.5%, or ₹7.28 lakh crore. “Mission Indradhanush,” which the Narendra Modi government announced in August 2015 as “the most comprehensive reform effort undertaken since banking nationalisation in the year 1970,” was supposed to provide some respite. Two years on, it clearly has not. The main focus of the mission was recapitalising banks, and establishing independent processes for appointments to PSB managements. The phased allocation of ₹70,000 crore over four years has not been enough, as many had feared when it was announced. The Ministry of Finance did express its intention to allocate more this year (“Indradhanush 2.0” some called it), over and above the ₹10,000 crore allocated so far, in order to meet the PSBs’ requirements. The government must realise that it is not a question of if new allocations need to be made for recapitalisation, but when. And that time is now.

Updated On : 11th Sep, 2017


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