Bank Mergers: Missing Synergies
Hi Vivek,
This post is on the mega merger of 10 Public Sector Banks (PSBs) into four banks that was announced about two weeks back. In particular, I’ll focus on the Punjab National Bank and the Canara Bank mergers.
Punjab National bank (PNB) is being merged with the United Bank of India (UBI) and the Oriental Bank of Commerce (OBC). The merged bank will form the second biggest bank in the country. The merger of Canara Bank with Syndicate bank will make it the fourth largest bank in India.
The idea of the merger of PSBs was first floated in the Narasimhan Committee (1992) report on banking sector reforms. It suggests that healthy banks be merged and big stronger banks be created. The report also suggested winding up of weaker banks. Winding up of banks was anyway never going to be a suggestion that governments would take, given that thousands of jobs would be lost, customer inconvenience not much of a concern I suppose.
What is practical is the merger of strong and weaker banks, and let the bigger bank absorb the liabilities of the weaker bank. This, though for the health of the bigger bank isn’t good; offers a workable solution. Though it has to be properly balanced otherwise the whole new entity could become one sick company and cause a much bigger risk to the economy.
Initially, when I was thinking of writing on this, I was thinking of the synergies that can be derived from these mergers. No cost synergies mean the smaller bank eats into the health of the bigger bank without giving any benefits of reduced costs, thus increasing the risk of failure of the merged entity.
Though I look at the mergers as a practical workable solution to address the problem of underperforming PSBs, I am not a fan of the timing of it. The newly merged banks will come into existence from the next financial year. This year will be very hectic for the banks to work out the merger plans and so the current day-to-day lending business might take a back seat. Post-merger cultural, technological and human resource issues can prolong the time needed for the bank to function normally. All this while the economy is in urgent need of economic activity to stimulate growth. The issue of bulldozing over the minority stakeholders and the continued government ownership & hence political influence of banks are issues that at this point are more of theoretical and unimportant problems.
One of the first big mergers to happen a couple of years back that could act as a template was the merger of SBI with its associate sister banks. The merged entity had 24017 branches and about 2.8 lakh employees. Two years later, the number of branches has come down to 22010 with about 2.57 Lakh employees. It can be seen that the SBI was able to bring down employee numbers and optimise the number branches, thus bringing some cost savings.
Similar cost synergies may not be possible in the new mergers announced, at least not in PNB. The Finance Minister has said categorically that there will be no job losses due to the merger. SBI had made thousands to leave the organisation by making them take ‘voluntary’ retirement. PNB chairman recently dismissed that such measured will not be taken in the new merged bank. Also, on analysis of the P&L of PSBs, I saw that the rentals banks pay for the branches is much much smaller than the cost of employees to a bank. The employee costs were over 60% of operating costs for PNB in FY19 while rents were only 6.5% of the operating costs. Thus the cost analysis of the merger did not feel like a good source of synergy.
So I thought of looking at the metrics RBI uses to look at a bank’s health and to discipline them. For this, the RBI follows a ‘Prompt Corrective Action’ () framework. It uses five metrics with three thresholds for each of them to monitor the health of the banks. Even if one of the metrics breaches at least one of the thresholds, the RBI can step in to take corrective actions on the bank. I calculated these metrics for the Banks to see if the merged banks appear to be strong. The formulae and explanations for the metrics can be seen here.
Let’s start with the analysis of the PNB merger.
This is how the metrics pan-out.
Source: My calculations based on Annual reports(2018–19)
The Merged-2019 row indicates how the merged bank’s numbers look like. It can be seen that in 4 of the 5 metrics, the bank would breach the 1st threshold.
Here is the thing, I am sure the government did these calculations and knew the merger is problematic. So, the government announced recapitalisation of Rs. 16000 crores for PNB and Rs. 1600 crore for UBI.
To calculate the metrics by taking into account the infused funds, I assumed that the capital infused would be added to share capital on the liabilities side and on the assets side, are parked in the zero risk-based assets (as per RBI). This assumption has a bias against the NNPA calculations. But as capital adequacy is an important metric, I thought I’ll take the best-case scenario for that metric.
The row on ‘Merged + infused funds’ shows the results for the calculations. Still, two metrics breach the 1st threshold. A possible Big Bad bank. Highly possible.
I also looked at the merger of Canara Bank and Syndicate Bank, The calculations are as follows:
Source: My calculations based on Annual reports(2018–19)
The merged entity with the infused funds seems to be a stronger bank than the PNB merged bank. But it still took Rs.6500 crores to be infused in the bank this year. Syndicate bank received over 700 crores capital last year.
These are just 2 on the 4 mergers that were announced by the government. But here is the end result, even after pumping in Rs.70000 crores and forcing mergers, the end result is not all strong big banks, at least not in the next 2–3 years.
The government has pumped in almost Rs. 2 lakh crore in the last two years into PSBs. And all PSBs together have written off almost Rs. 4.5 lakh crores worth of bad loans in the last three years alone.
This is not the perfect solution to the problem of failing PSBs, maybe is even a bad idea. But given the weakness in our social and political discourse that do not make radical changes in govt entities probable, we have to pay a price. A price whose bill runs into the lakhs of crores, that the taxpayers bear.
Regards,
Disclaimer: All the views expressed above belong solely to the author, and do not represent those of the organization he works in.
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Bheem
Originally published at https://duologue.substack.com.
