Public sector banks merger is not a reform

On 30-8-2019 Finance Minister Nirmala Sitharaman announced a mega plan to merge 10 public sector banks into four as part of plans to create fewer and stronger global-sized lenders as it looks to boost economic growth from a six-year low. After the mergers, the country will have 12 public sector banks, including State Bank of India and Bank of Baroda.

• Except PNB, all anchor banks had exposures of over 10% of their loan book to NBFCs.
• Merging of two weak banks into another weak bank is a decent  idea, under normal economic conditions. But to pass it off as a major reform on a day when the economy hit a six-year-low in growth (~5%) rings hollow.
• Given the limited flexibility on restructuring and rationalization, meaningful cost synergies from PSU bank mergers are unlikely. Core profitability for these banks is likely to remain weak and hence they will continue to depend on external infusions.
• Until the year 1995, the best candidates from IITs and the best universities wrote IAS exams, State Bank entrance exams and the national recruitment exams of the PSBs. But after the liberalization of the Indian economy in 1991, private sector companies grew aggressively and  attracted away the cream of the talent. 
• In the face of this competition, the PSBs with their moribund processes and stagnant salaries have attracted mediocre talent. Any bright spark, despite these service conditions was usually poached by private banks and NBFCs.
• In 1992,  the government realized it doesn’t have the money to capitalize them and started listing them so that they may raise funds from the capital market. But the design of the Act is still intended to serve government goals and not compete on commercial lines.
• True reform will require what financial sector giants like YV Reddy and PJ Nayak have long recommended: Abolish the Banking Companies Act, bring PSBs under the Companies Act, so that clauses like section 49 (ensuring truly independent directors) apply to PSBs as well. This will fix governance somewhat. Then as soon as the capital markets permit, government stake in these PSBs needs to be brought below 50%. This will enable them to recruit competitively and run on market-based principles.  That’s what you call reform.
• For now the PSBs are going to be completely immersed in their integration issues. Past experience showed deep gashes in the merged banks for few quarters after merger. The merging banks have barely recognized the bad loans created before 2013, when a new wave of bad loans created after 2014 started emerging. Instead of tackling  this continued onslaught, every senior banker in the merging PSB will be more worried about what will be his or her place in the new hierarchy. Each branch manager will worry about how to tackle customers of the erstwhile competing bank. They will worry about  repainting their billboards and printing new stationary. 
• And all this chaos with no change at all in governance standards. And at a time when the best PSBs have a net NPA of 6% and capital that just makes it to Basel grade. And at a time when the economy is giving you that sinking feeling.

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