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Economic Concerns: Affects of Bank Mergers

Published on 11-Sept-2019 – Affects of Bank Mergers

How will mergers affect public banks? (Affects of Bank Mergers)

Approx Read Time: 4 minutes

In News (Affects of Bank Mergers):

  • FM Mrs. Sitharaman recently announced that 10 banks owned by the Government of India will be merged into four larger banks, thus the total number of state-owned banks in the country will have come down from 27 (in 2017) to 12.
  • Punjab National Bank will be merged with- Oriental Bank of Commerce and United Bank of India.
  • Canara Bank with Syndicate Bank.
  • Union Bank of India with Andhra Bank and Corporation Bank.
  • Indian Bank with Allahabad Bank.

News Summary:

  • The government announced an infusion of ₹55,250 crore to help these newly merged banks extend more loans to their customers and meet crucial regulatory norms.
  • Last year, the government proposed the merger of three banks namely Vijaya Bank and Dena Bank with Bank of Baroda, to create a larger bank.
  • Earlier in 2017, State Bank of India, the country’s largest lender, was merged with five of its associate banks.

What is a merger?

  • A merger is simply the combining of two business entities to form a larger one but with no explicit change in ownership.
  • One business entity takes ownership control over another by paying for the ownership privilege in cash, stock, or other means.

Why are so many state-owned banks being merged?

  • In the case of state-owned banks, where the government is the majority shareholder, there will be no change in ownership but merely a restructuring of how these banks are organized.
  • Various reasons cited by the government for its decision to merge state-owned banks are:
    1. Large banks will be able to lend more money.
    2. It will help revive the slowing economy.
    3. Increased credit growth is essential in order to achieve its target of growing India into a $5 trillion economy in the next few years.
    4. The merger will lead to increased operational efficiency that will help these banks lower their costs, thus enabling them to lower their lending rates.
    5. State-owned banks have been reeling under a bad loan crisis for years now.
    6. Bank mergers in the past have been carried out simply to bail out struggling banks.

Note: According to the government, the size of gross nonperforming assets of state-owned banks stood at ₹7.9 lakh crore, as of March 31, 2019. Although the government has not projected the present merger as a measure to tackle bad loans.

Will the move help make banks stronger?

  • The banks that have been merged by the government exhibit varying financial strength.
  • Banks such as Indian Bank and Punjab National Bank are stronger than the smaller banks that they are being merged with under the plan.
  • Indian Bank, which is considered to be the strongest financially among the 10 banks, for instance, has a net NPA ratio of 3.8%; it is 5.2% for Allahabad Bank, so the merger is expected to adversely affect the health of Indian Bank.
  • Private businesses typically merge their operations when they believe that the merged entity will help increase their profits.

Concerns:

  • The shares of Indian Bank and other relatively strong banks witnessed a steep fall on the first day of trading (Tuesday) after the announcement of the merger (Friday).
  • If the reaction of investors on Tuesday is anything to go by, it seems quite unlikely that the merger of state-owned banks will create any significant value for shareholders.
  • Managers of efficient banks have to share the burden of weaker banks, many fear that there will be fewer incentives for managers to manage well.
  • It seems unlikely that state-owned banks will be able to become more efficient after the merger by getting rid of redundant labour which may lead to unemployment.

Will it address the bad loans crisis and help kick-start economic growth?

  • The merger of banks per se will not lead to a decrease in the absolute size of bad loans in their books.
  • The size of bad loans in bank books can drop only if banks manage to improve the recovery of these loans, or if these loans are written off their balance sheets.
  • The bad loan recovery process remains slow due to the inefficient judicial system and the unwillingness of the banks to write off their bad loans.
  • Mergers do not address these serious structural problems.
  • The stated purpose of the nationalization of banks in 1969 was to use bank credit to fund the various development goals of the government.
  • Towards this end, over the years, various state-owned banks have been forced to extend loans under political pressure even though such loans did not always make business sense.
  • This is in contrast to private banks that are allowed to operate simply as pure businesses seeking profits. FM announced some governance reforms, such as strengthening the power of bank boards, but not many really believe that they will effectively address the fundamental issue of political interference in state-owned banks.
  • Finally, when it comes to funding the growth needs of the economy, large banks may be able to lend more money than smaller banks due to the size of their capital base.
  • Companies themselves might prefer to seek funds from multiple sources.
  • Infusion of additional capital by the government can temporarily help banks troubled by bad loans to extend loans more confidently without the fear of going bankrupt due to their precarious capital position.

Conclusion (Affects of Bank Mergers):

  • The merger does not really address the root structural causes behind the woes facing state-owned banks in the country.
  • Large banks may not really be essential when it comes to funding big-ticket business projects. In the past, several smaller banks have come together to extend large loans.
  • It remains to be seen whether the operational benefits that the government believes will come about through the merger will compensate for the deterioration in the financials of the stronger banks.
  • Merging of healthy banks with weak banks may not really improve the health of the banking system as a whole.
  • By diluting the management of strong banks, forced mergers may lead to a significant deterioration in the overall health of the banking system. This can further negatively affect the long-term performance of state-owned banks.
  • The present merger does not address the issue of political interference in the management of state-owned banks that is at the root of the bad loan crisis.

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