Was the Merging of PSBs a good move?

Created on 27 Sep 2019

Wraps up in 3 Min

Read by 2.4k people

Updated on 12 Oct 2020

On the eve of August 30, 2019 when the abysmal GDP growth figure of 5% was announced, there was another press conference by the Finance Minister N Seetharaman. The press conference detailed on how some Public Sector Banks (PSB) would be merged with some other Public Sector Banks. While some called it a banking reform, the market perhaps did not seem convinced. Here is the story of unfolding of the Indian PSBs merger.

The Minister Speech

The Minister views this as an attempt to reduce the number of banks and instead create fewer, but larger banks. One may assume that this merger is not the last one.

In addition, she said that larger banks would be of larger capacity and will be able to lend more and hence, economic revival would be quicker. She also believes that mentorship under larger banks would improve practices in the smaller banks being merged. This would help in creating next-generation banks with a global outreach.

This all appears to be convincing but is it?

In Numbers

The 27 PSBs today will remain only 12 after the merger. The mergers would be as follows:

Therefore, the ten banks consolidate into four.

Problem with Indian Banks

The economic growth is slowing down. The banks should facilitate the loan disbursement to support the economy by increasing the demand. However, the banks have not much capital left with them to loan out. For every Rs. 100 bank take it in deposit, they have to keep a CRR of Rs. 4 with RBI and an SLR of Rs. 19 with themselves. Therefore, the maximum amount banks can loan out is only Rs. 77. Now, what if I tell banks have already loaned out Rs. 76.3! Banks are running short of capital and banks need more money so they may lend ahead. The merger is no solution; rather it has aggravated the problem.

What have you done!

The government seems to have mistimed some of its reforms. See it from Demonetization, GST, the Budget provisions, or even the corporate tax cut. They operate the head for stomach-ache.

Now let us understand this step (it is no way a reform) assuming two banks. Bank A is a large one. It follows all norms and standards. It loaned out Rs. 1000 while its NPA is only Rs. 50 (5%). While there is another small rogue bank B. It lends RS. 300 but NPA is Rs. 90 (30%). When the smaller bank merges into the bigger one, the final bank would have loaned out Rs. 1300 with an NPA of Rs. 140 (10.8%).

This has ultimately ruined the balance sheet of the first bank. It cannot loan enough as it used to. It has been rather punished for working better while other bank just gets to go away.

What went wrong?

The worst part of it is that in case of Indian economy Bank A itself has an NPA over 15%. Merger of two sick banks would only lead to a larger sick bank. The problem only aggravates.

The government should have waited for its previous decisions to fructify. What happened to SBI after its merger with its five associates and Bhartiya Mahila Bank? The NPA of SBI jumped from 6.9% to 10.9% just within FY2018 to FY 2019.

Are mergers bad?

No, mergers are not bad. Around the world, companies acquire another company. Banks are no different. However, in the case of Indian PSBs, the merger is imposed instead of being strategically planned by the bank’s management. The companies should merge when they look forward to enhanced profits while PSBs only look after the increased liability. The government is only using healthy PSUs to buy sick PSUs ultimately hurting the healthy PSU. Losses reported by LIC and ONGC are the evidence.

Secondly, the timing of merger is important. The mergers have taken place earlier as well but one has to understand that circumstances were different. The economy was bullish. Banks were profitable. Merging good bank with a good bank gives a larger good bank. Merger of SBI and State Bank of Indore did the same.

If I could shorten the entire script to one line, “An omelette mixed of a good egg and a rotten egg would taste bad even if all the ingredients were right.”

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Ayushi Upadhyay

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A Keen Learner. Tiny, brainy, and studious, this quiet one stays in her zone until she pops. And once she does, boy, are her comebacks snappy! There is no financial question that she can't answer through her magical blog-writing. 

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