Merger and consolidation is needed before money is injected into banks

By committing Rs 2.11 lakh crore over two fiscal years for recapitalisation of public sector banks (PSBs), the government has done what was long overdue. After appointing a private sector professional as head of two PSBs, banking reforms had taken a back seat as nothing substantial was done by the bank board bureau, which was supposed to transform the working of PSU banks. It was largely the RBI, which has been tightening the provision norms for banks, trying to clean up the system.

The question is whether the money brought in by the government will have the desired impact on the banking sector, improve chances of a credit off take or will it meet the same fate as previous recapitalisation attempts? In the past, credit growth was pushed in the short-term, which impacted the economy, but there was no change in the macro working structure of PSBs. The probability of an improvement this time is slightly higher as compared to the past because of two reasons. First, the hard RBI stand has led to the establishment of a process for NPA recognition, which has brought some creditability to the balance sheet numbers of PSU banks, making the cost of raising funds lower for them. Second, with a bankruptcy code in place means that the element of corruption would come down in the lending process, as promoters cannot be sure that even if they are able to manage the bank they would be in control of the company in case of a default.

But before the government goes ahead and puts money into the banks, it would be worthwhile for it to conduct an additional exercise, which may be resisted by the banks.  It is very important that before the injection of money, a plan of merger and consolidation must be put in place. Banks that try and resist the mergers should not be given additional capital. For such a move to work, the government needs to shed the façade that PSBs are independent and their boards are entitled to do what they want without governmental interference. In reality, the government is the largest shareholder of PSU banks and can ask them to look at merger and acquisition amongst themselves and not merely rely on the board to take such steps voluntarily, as they are unlikely to do so. No bank chairman would like to see return ratios coming down during his or her tenure, which obviously will happen in the short term when merger takes place.

The list of banks that will be acquiring and the ones, which are going to be acquired, is very clear. It does not need rocket science to figure out that the top three to four banks would be taking over small and inefficient banks. So why can’t the top four banks be asked to submit their plans regarding takeovers and mergers, which would have details about the banks they plan to acquire and the capital needed by the merged entity to be an effective and efficient lender. The reason for merger to precede capital infusion is appropriate because the dirt hidden in the books of smaller banks would come out when due diligence is done. There is little point in recapitalising a weak bank and then merging it with another bank, because in the process more capital would get adjusted for provisions first by small banks and then by the large bank.