THE MERGER OF PSBs: WHAT COULD GO WRONG?
This piece has been authored by Parth Shrivastava, a second year student of B.A.LL.B (Hons.) at the Rajiv Gandhi National University of Law, Patiala.
The government in order to resurrect the Indian economy has fleshed out some initiatives recently. Mergers of Public Sector Banks (PSBs) is one of them. The government plans to merge ten PSBs into a pack of four to organize and structure the Indian banking system and also to create few but fortified strong global sized banks. All this has come under the wake of the recent slowdown in the Indian Economy. The GDP growth rate has reached a 23 quarter low of 5% which has taken a considerate gulp to the Indian Economy.[i] These mergers have brought down the total PSBs to 12 from 27 since last two years. This merger is not unprecedented at all, in-fact there has been two major mergers in the past. This merger has brought onto itself a fair share of criticism as well as praise.
BANKS BEING MERGED
The ten banks which are being merged are as follows:-
I. Punjab National Bank, Oriental Bank of Commerce, and United Bank with PNB being the carrier bank.
II. Canara Bank and Syndicate Bank, with Canara Bank being the carrier bank.
III. Union Bank of India, Andhra Bank, and Corporation Bank with UBI being the carrier bank.
IV. Indian Bank and Allahabad Bank with Indian Bank being the carrier.
The first set of banks will form the second-largest PSB, first being State Bank of India (SBI) with a business of 17.95 lakh crore and 11,437 branches. Following this would be the second set of banks which will cumulatively form a business base of 15.2 lakh crore and 10,324 branches adjudging it with the accolade of fourth-largest PSB of India.[ii] This initiative has been taken with the sole purpose of increasing the credit flow. Reserve Bank of India (RBI) has a ceiling limit on the weak banks, and now that the merger is on the cards, the weaker bank would eventually form a part of a larger bank and thus the ceiling would be lifted. This would help the Indian banking ecosystem.
THE BAD EFFECT OF BAD LOANS
One of the other major incentives for the merger was to limit the Non-Banking Financial Company (NBFCs) transactions. In recent times, the defaulters on the part of NBFCs has increased exponentially thus leading to high outgoing loan credit which has resulted in what the banking sector calls as Bad Loan. According to financial and economic moguls, India is slowly and steadily moving towards a labyrinth of banking breakdown catalyzed by the bad loans. A total of 2.4% of India’s entire banking loan system may be under stress on top of the 9.6% bad debt ratio as of June 2018, the highest among major economies.[iii] As per the CEIC report, India’s Non Performing Loans ratio has increased by 1.8% since last year. If we look at the numbers of 2008, it was a mere 2.5% and now it stands at 11.1%. A huge growth of 8.6%. Which is surely not good for the economy.[iv] This can be termed as the prolonged Shadow-Bank crisis which was also the main reason behind the greatest economic crisis of mankind in 2008.
The main indicator of a nose-diving economy is the going up of non-performing loans. This is the major reason behind the deceleration of an economy. What the Indian economy is facing right now, the Italian economy has been subjected to since the last decade. But, the Italian economy has been successful in curbing down its bad loans by almost half. India now needs to begin with what the banking world calls as the clean-up process. Bad-loans have been affecting every global economy in an extremely negative sense. It is perhaps the greatest modern impediment to a thriving, developing economy. Shadow crisis of the early 1990s was the central impetus behind the South-East-Asian crisis. This crisis led to the slowdown of Asian economies in the latter part of the 1990s. It must be noted that according to a Deloitte report, 23% of total Asian bank loans are bad loans amounting to a humongous debt of $640 billion, with India being the second largest contributor with $160 billion. Adding to our dismay is the fact that the stats show no signs of cooling down even in 2019-2020.[v]
RBI has not yet contemplated on the limit of exposure being given to an NBFC. It has said that the banks can themselves decide internally the individual lending limit or an aggregate exposure limit for all the NBFCs. The current exposure limit for a single NBFC stands at 20% of the bank’s tier-1 capital. But in practice, the limit ranges from 10-15%. This limit is also a part of banks risk management strategy. The merger neither directly affects the risk perception of the banking sector nor does it solve the lending problems. But it is hoped that it would help banks with credit appraisal, stress resolution, monitoring of sanctions and limiting the percentage of bad loans. Out of all the anchor merging banks, only Punjab National Bank (PNB) has an exposure limit below 10% of their total loans to non-banks. After the merger has full-fledged taken place, even the PNB’s exposure limit would rise above 10%.
As per RBI, 13.35% of total Indian loans are NBFCs loan.[vi] It is crucial to understand that this process of giving loans by NBFCs, creates a parallel banking ecosystem which is very complex to monitor and regulate. The bad loans arising out of lending by NBFCs are neither regulated nor watched, which makes this a grey area for the banking sector. This also multiplies the number of bad loans.
A TAKE-AWAY FROM THE HISTORY OF PSB MERGERS
At one side, where the government is having high hopes from the merger, the other side stands in darkness. Experts are skeptical as to what will be the outcome of the initiative and whether it would affect the Indian economy in a positive manner or not. Various analysts are of the view that the merger would take several years to potentially benefit our economy, and that too not spontaneously. The Narasimhan committee reported on the sensible banking reforms around a quarter-century ago. The committee specifically talked about the merging of strong, fortified banks and to stay away from the merging of weak banks, the government has certainly followed the second advice. As iterated by the banking history of the country, only the mergers of strong banks have had positive effects on the economy. Also, the magnitude of the bank shall be taken into consideration. Before this merger, most of the earlier mergers have been between state-level banks with not that great holding capacity. Which also decreases the probability of eventual crumbling-down of the economy as these banks, although are a part of the banking sector and the economy, they are not a potential contributor.
The earlier banking mergers came when the banks and economy were themselves in a good position. The earlier mergers were done with a motive to accelerate the economy and not to save it. Also, these mergers were gradual and successive and not sudden and spontaneous. We need to take into consideration this very fact of the underlying motives and intentions. The key to successful mergers is to flesh-out a decisive plan, to structure the course, to plan the outcome, to decide the incentive, and to contemplate the benefits.
The PNB merger of 1993 with New India Bank also speaks of the horrors of improper mergers. Even-though the merger did not affect the PNB in a grave negative manner, it surely did slow down its potential growth. The officials from various banks are talking of similar banking cultures amongst the merging banks is also not a great precedent to follow. In the PNB merger, the culture of both the banks was similar, but then also it did not restrict the bank to fall. It took several long years for PNB to recover from that merger’s ill-effects.
FINANCIAL CRISIS OF 2008: PARALLEL DRAWN
After the bleakest part of the worlds’ financial history took place, the one major lesson which we all learned was to never believe or trust big banks. It is even logical to understand that economy should never depend on a single sector. It needs to be understood that these big banks pose a great threat to the economy and the financing sector. It can be simply understood by the example of a house; when a building is being made, the most important part is the formation of foundation or base, if it is strong then it would last long and if it is weak, the entire structure will come crashing down. So, no country should ever rely on a particular sector to build its economy. Which was exactly the case with USA, the parent of 2008 crisis.
This crisis was a result of a gradually developing pothole in the foundation, which was the residence sector. In the early 1980s, the government had a pro stance of providing the Americans with homes to live. So it gave incentives to banks and to people as well to buy houses. This led the banks to give house loans on nearly no security and very low-interest rates. Due to this, a parallel system was formed which specifically focused on giving guarantees for such loans. The underlying faith behind this entire process was that why would a person default on the re-payment of house loans. This entire facade worked to nearly three decades but it started showing its signs by 2006.
In 2006, the housing prices fell which led the realtors to believe that the market of housing is finally stabilizing and the hype is going. But, they missed the fact that there was a majority of homeowners with questionably high credit. Banks even allowed people to take loans worth more than the value of their houses. Furthermore, the banks were allowed to trade profitable derivatives to investors which needed home loans as collaterals. So, this created a great demand for more and more mortgages. Hedge Funds majorly owned these mortgage-based securities. Even mutual funds, corporate assets, pension funds had securities. To maximize the profits, banks cut-down the real mortgages and resold them as tranches. Which made them impossible to price. This made these assets very risky. But, this did not stop pension funds to buy it because they thought that credit default swaps would save them. As not many were focusing over these pension funds due to other schemes available in the market, there were only a handful of companies selling swaps. So, when the derivatives lost value, there was not enough cash flow to honor all the swaps. This led the banks to absorb all the losses. So, the banks became reluctant to give interbank loans. This led the entire structure to fall.[vii]
The recent slowdown in the manufacturing sector is alarming. From an annual GVA growth of 12.1% last year, it has come down to 0.6% in the first quarter of this fiscal year.[viii] The merger of SBI with associate banks and Bharatiya Mahila Bank (2017), SBI and State Bank of Saurashtra (2008), OBC and Global Trust Bank (2004), Bank of Baroda and Benares State Bank Ltd (2002), can’t be taken into consideration as most of them were small banks as compared to the current banks. Most of them were regional banks. Also, none of the previous mergers came when the economy was in a deplorable state and none was done to resurrect the Indian economy. Indicators such as the share prices of Canara Bank, PNB and other banks went down after the announcement do alarm us about the skepticism of the investor in the market. Now, when the main task of the banks should be to get away with its bad loans, they would remain busy with these mergers. Although, as of now nothing can be ascertained, the merger may prove catastrophic.
[i] Banks mergers reflects govt resolve to address economic slowdown: India Inc, moneycontrol (Aug. 31, 2019, 8:46 PM), https://www.moneycontrol.com/news/business/banks-merger-reflects-govt-resolve-to-address-economic-slowdown-india-inc-4392331.html.
[ii] Bank unions across India protest centre’s bank merger announcement, India Today (Sep. 1, 2019, 12:01 AM), https://www.indiatoday.in/india/story/bank-unions-across-india-protest-centre-s-bank-merger-announcement-1593974-2019-09-01.
[iii] Bloomberg, World’s worst bad-loan mess set to worsen India’s cash crunch, The Economic Times (Sep. 8, 2019, 1:18 PM), https://m.economictimes.com/news/economy/finance/worlds-worst-bad-loan-mess-set-to-worsen-on-indias-cash-crunch/articleshow/71033073.cms.
[iv] India Non Performing Loans Ratio, CEIC Data (Mar. 2018), https://www.ceicdata.com/en/indicator/india/non-performing-loans-ratio.
[v] India’s Rs 11 lakh crore bad loan pile lures global investors: Deloitte, The Economic Times (Sep. 27, 2019, 8:08 PM), https://economictimes.indiatimes.com/markets/stocks/news/indias-160-billion-bad-loan-pile-luring-global-investors-deloitte/articleshow/71339290.cms.
[vi] RBI increases banks’ loan exposure limit to single NBFC, LiveMint (Sep. 12, 2019, 9:50 PM), https://www.livemint.com/industry/banking/rbi-increases-banks-loan-exposure-limit-to-single-nbfc-1568304974677.html.
[vii] Kimberly Amaded, 2008 Financial Crisis, The Balance (May. 11, 2019), https://www.thebalance.com/2008-financial-crisis-3305679.
[viii] Banks mergers reflects govt resolve to address economic slowdown: India Inc, moneycontrol (Aug. 31, 2019, 8:46 PM), https://www.moneycontrol.com/news/business/banks-merger-reflects-govt-resolve-to-address-economic-slowdown-india-inc-4392331.html.