Good for banks, but the system? January 6, 2010 Financial Express

The McKinsey-EY Report on consolidation of public sector banks is timely because this is the time when RBI should have been opening up the sector to foreign participation. With more foreign banks entering the country and capital account convertibility around the corner (though everything has been delayed by the financial crisis), there is evidently a need to seriously debate the issue of consolidation among banks. Is consolidation an answer to future competition? The answer is a shoulder shrug, even though consolidation would help banks become more competitive. Consolidation helps organisations attain scale. A bigger balance sheet makes it easier for a bank to raise capital against the background of Basel II requirements. Further, such alliances bring about synergies for an organisation, especially across geographies and businesses. A bank focused on wholesale banking and another on retail can merge to create a monolith that provides complete banking solutions. A bank with a strong branch network and another with technology can merge to emerge stronger. Similarly, a bank based in the North can work with one with base in the South. All this helps in diversifying risk, which makes consolidation a viable proposition. So far, in India, mergers involving public sector banks have been restricted to rescuing failed banks. In the case of private banks there were different reasons such as survival (universal banking), weakness of a partner or plain loss of interest by the promoter. When it comes to public sector banks, the issue is more ticklish. To begin with, the ownership is with the government for all the entities. The management is professional with its appointment following the same procedures. The culture and quality of staff of these banks would also tend to be the same, since the recruitment process is standardised. In terms of profitability and other financial indicators there would be significant differences, which can make consolidation a worthwhile proposition. However, one needs to examine the rationale for creating these many public sector banks. All these banks tend to be stronger in various regions while there are some, like SBI, that have an all-India presence. Under these circumstances, the objective was to reach out to a larger cross-section of society and make banking more inclusive. The same could have been done by just having SBI stretch out, but multiple organisations made sense from an administrative point of view. While consolidation would be a sound idea today in a world where size matters, we would have to unwind these structures. The two areas of concern would be the branches and workforce. With the growth in banking, there has been a tendency for banks to open branches in common centres, which makes them redundant when one goes in for consolidation. The other is workforce. While some have been nimble-footed like Corporation Bank, others could have legacy issues that have to be ironed out. Are we in a position to close down these branches and downsize? The answers to these questions must be juxtaposed with other fundamental questions behind the consolidation debate. Have our banks exhausted the route to organic growth? They are well-capitalised today and have scope to go into non-fund based activities like the private banks. Therefore, there may not prima facie be major advantages in such like-minded banks merging. The second is, are we prepared for concentration in this sector? New private banks have already merged and there are probably three major ones that will continue to dominate the scene in future. Consolidation on the rationale of size would germinate the process of concentration. Third, how real is this threat of competition? Foreign banks operate under unequal regulatory conditions in terms of, say, priority sector lending, but have limitations when opening branches. The performance of public sector banks is almost on par with that of foreign banks. Therefore, prima facie there may be little justification to think that they have a major competitor to tackle. Globally, our banks are still too small, with only SBI making a mark with a domestic share of around 30%. Hence by having a merger that accounts for 7-8% of the system, little can be achieved even in terms of making a global mark. Therefore, before deciding on a roadmap for bank consolidation, we need to be sure of our objectives. As long as they are state-owned, capital should not be a problem unless we are ideologically inclined towards privatisation. Size building is good for leveraging synergies and diversifying risks, but the costs of technology, physical infrastructure and workforce redundancy have to be balanced. There is hence a necessity to have a serious discussion on the issue.