Punjab National Bank
A Punjab National Bank branch in Mumbai | Bloomberg
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The government has announced merger of public sector banks to create fewer and larger public sector banks. If all goes well, and the merged entities are more efficient, then in the long run tax-payer money will be saved as these banks may not require repeated capital infusion. However, this is a big challenge. Perhaps the move is also an attempt to boost credit in the economy in the immediate context given the slowdown.

Consolidation of public sector banks has been an idea that has been around for many years. Yet, the difficulties in merging banks with different cultures, overlapping branches which would have to be shut in the event of a merger, fears of job losses, different HR practices and other such issues, prevented consolidation from going through. Mergers could reduce duplication, help in consolidating balance sheets, reduce operating costs and increase efficiencies. It would seem that the objective of the consolidation is intended as a structural reform, and not merely a measure to boost credit in the short-term. Hopefully, there are synergies in the businesses of the merging banks and the consolidation will not be as challenging as some may have worried.

The key question is not merely what is good for the banks, but what the implications of bank consolidation are for the larger Indian economy. Will these banks better satisfy the credit needs of the Indian economy? Will they become more profitable and require less tax-payer money as recapitalisation? Will it now be easier to privatise them, if the political will is there? Will this consolidation give India a more competitive banking sector?

One of the biggest issues with Indian banking today is how little the sector supports small firms. Barely 5 per cent of bank credit goes to small firms. Less than 2 per cent of the credit needs of small Indian businesses are satisfied by bank finance. At a time when employment is a huge challenge and the NBFCs or shadow banking system is imploding, the question is, will the credit needs of the millions of potential entrepreneurs in the country be satisfied better after this consolidation?

In the absence of a competitive banking sector, Indian banks, particularly those in the public sector, have often been ‘lazy’ bankers. They have been happy to lend to the government without putting in the effort to look for higher returns by lending to entrepreneurs. In addition, given the fears of vigilance agencies, bankers are risk-averse. Since banks consider small loans to be risky and expensive to give considering the average cost of loan evaluation, policy makers have sought to address the problem by mandating banks to give small loans. Schemes such as Mudra are likely to have to continue with the bigger, consolidated banks.

Also read: Modi govt is countering the slow economic tempo with counter-narrative of being responsive

Fewer pros, more cons

The objective of public sector banking in India is not to make profits but to help the political and economic agenda of the government. Banks have to lend to small borrowers, priority sectors like exports, farm sector, small scale industry or lend to the government. These are mandated through RBI regulations. In addition, banks are known to have lent to infrastructure projects, or to certain groups of companies. This is often at the cost of lending to smaller borrowers.

The lack of competition in Indian banking resulted in a large unbanked population. Banks would often turn away customers with their many forms and onerous KYC requirements. A poor customer walking into a bank branch was usually not welcome. Small accounts do not bring profits, it is costly to keep a zero-balance account alive. It takes effort and time. Again, this problem was sought to be addressed through schemes such as Jan Dhan where most bank accounts opened for the unbanked were with public sector banks. Will this change with the consolidation? There is no reason for it to.

In recent months, the issue most debated is of monetary policy transmission, that banks have not passed on cuts in interest rates to borrowers. The much hoped for increase in demand that could prevent a slowdown did not happen, despite many rate cuts. One reason for this was the lack of competition in Indian banking. Will bank consolidation help bring in more competition and address this issue? Very unlikely. If anything, greater concentration would make it easier for banks to cartelise and offer similar rates, rather than compete for customers. As a consequence, monetary policy transmission is going to remain a challenge.

Finally, consolidation further reduces the hope of the government privatising public sector banks. Larger banks will be harder to sell, their unions bigger and buyers fewer. One hopes that bank consolidation achieves the objective of making public sector banks more efficient, and that this is only a first step in the journey towards giving greater access to banking to both the small borrower and the small depositor.

Also read: Amend the law to settle conflict over RBI’s surplus once and for all

The author is an economist and a professor at the National Institute of Public Finance and Policy. Views are personal.

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  1. The large banks will not condescend to the need of small borrower and small depositor. With few number there will be no competition. As of now there is absolutely no spirit of competition among public sector banks. After consolidation the miniscule of competitive spirit existing now would completely vanish. I think this would give a boost to co-operative banking structure, particularly the credit societies in the countries. They should make use of this opportunity by expanding their activities and rendering their efficient service to their members.

  2. The objective is more to hide the weak balance sheets and high reported and unreported NPAs. Since no branch is to be closed or staff strength is to be reduced then, pray, what is the use of this massive and expensive exercise? maybe after 10 years or so they will start demergers to make them lean and thin, to make them accountable, dynamic, efficient etc etc.
    It would be enlightening to know how much Govt. has injected capital into PSU banks in the last 20 years. and also their performance vis-a-vis HDFC, ICICI bank etc.
    I recall Indian Airlines was first named Indian (why?) and after some time merged with Air India. All sins were buried or cremated or washed… take your pick. That is another scam and fraud on taxpayers no politician or civil servant would like to reflect upon.

  3. Ms Pattnaik seems to have not the least understanding of Indian banking.

    Under-competition is the least of the issues in Indian banks, excess competition and disguised employment is! With regards to efficiency, the public sector banks were the very lowest be it number of people, branches and automation as unlike private players they could not shut down branches, shed staff or spend on technology to improve efficiency or customer experience. This consolidation itself is half the work done as we shall live with most of the above issues till good economics (but bad politics) results into consolidation of branches.

    What she has got right is that credit is not flowing into the MSME sector. In the past due to the non-organised nature of this sector and very little visibility of cash flows as there was a huge cash element. Although it was not the intended objective of demonetisation, but coupled with GST, the 2 steps, have the potential to organise the MSME sector so that the business is recorded and cash flows can be visualised. Banks only lend to organisations where they have complete sight on the business transactions.
    I say this as an ex-banker and no political leanings whatsoever!

  4. Beyond and apart from the mergers announced, we need a lot of reforms in banking. First is for government to get out of banks ownership and control as soon as possible, with or without merger. Second, merge and convert cooperative banks into corporate structure and bring them under RBI. There is a lot of mess in that area which no one talks about. Third, have one product for depositors which gives them 100 per cent safety by investing their funds with government and government paying market rate on deposits. This should convert remaining part of liabilities into risky one beyond the floor of deposit insurance and this will convert bank deposits into credit mutual fund pattern just like market listed mutual funds. Fourth, have more bank licenses issued for competion. Fifth, government should give credit guarantees for specific sectors to increase the flow of credit beyond RBI guidelines. It is RBI or ideally a separate Banking Regular that completely regulate banking in future and disband Banking Division under Finance Ministry immediately. Modi alone can implement these changes in one shot and it is time he sets his heart on them, once he is done with his political agenda of Ram Temple and UCC, now that Art 370 is out of the way. These are all legacy issues and need strong political will. He should also implement all the recommendations of Justice Srikrishna Committee on Financial Sector reforms at one go. Modi hai to mumkin hai!! Hope we don’t end up saying finally….Modi tha tab mumkin tha!! Like we rue the mistakes of Nehru and Indira.

  5. If Ila Pathak kows the solutions of India’s problems, people would elect Illa rather than Modi. However, so far Khan Market and Lutyens had not offered any solutions when were roaming freely in the corridors of power center in Delhi.

    • You may like to read Shri S A Aiyer’s column in the ToI. He too questions the wisdom of these recent bank mergers, expressing a fear that the weak may pull down the strong. Both he and Dr Ila Patnaik, based on a lifetime of domain knowledge and experience, are flagging issues of concern. When the whole country is facing economic hardship, good advice should be welcomed.

    • If you had known to analyze public policy, you’d have been appointed to research institutes instead of being a pile-on who except for wiping his own ass and taking a bath, (if you really do that) depends on underpaid domestic labor.

    • Very true that Lutyens and Khan market gang gave no solutions, but the biggest puzzle is why the present government follows the same policies formulated by them. For 60 odd years Khan market gang followed the policy that government knows best and must run Banks, companies, hotels, temples etc. So why is present government following the same policy?

  6. This consolidation has brought out socialist nature of this government, a belief that only government knows how to do business and not any of us. This decision will most probably mark as a downfall of Indian banking sector which hopefully later turn into breaking up of these giant monopolistic banks into competitive banks catering to real small entrepreneurs of India. Had high hopes from this “minimum government maximum governance” govt. Guess they fooled me into thinking that this meant more liberalization and capitalism. Doesn’t seem this way.

  7. Two very interesting statistics in the column. Only 5% of bank credit flowing to small firms at first flush may be understandable, if large / leviathan firms are hoovering up vast quantities of bank credit. However, for only 2% of the credit needs of small firms to be provided by banks is deeply troubling. One, it means that the objective of financial inclusion, which was the rationale for nationalisation, has not been met. It also highlights the immense credit needs of small firms, almost in a position to absorb the entire quantum of bank loans. Large borrowers pay Prime rates, small borrowers could pay more, since that is still lower than what the informal sources cost. There seems to be a good business opportunity here, something like what Grameen Bank exploited inBangladesh.

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