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Mergers In India

Due to the relative smaller size of Indian banks, they are not able to compete globally in terms of fund mobilisation, growing credit demand and investment needs of the economy

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The Indian banking industry is at a cusp of change — with recent entrants driving innovation and impending consolidation on the anvil due to NPA crisis or potential synergies. The acquisition of ING Vysya bank by Kotak Mahindra and merging of SBI with its associate banks has brought the spotlight on consolidation. Similar is the case with the upcoming merger between IDFC and Capital First, acquisition of Bharat Financial by IndusInd Bank. However, consolidation of large Public Sector Banks have become the key discussion point as they struggle with ever increasing non-performing assets.

The banking sector, which has been a key driver for the growth of the economy is facing significant headwinds with non-performing assets expected to touch INR 9.5 trillion (10.5 per cent of advances) with total stressed assets at 11.5 trillion by March 2018— Public Sector Banks contributing around 80 per cent. Apart from NPAs, the PSBs are also struggling with productivity and efficiency in a dynamic and disruptive technological environment. All of these has impacted their capital adequacy and hence growth and profitability parameters hampering the credit offtake.

Another key concern with public sector banks is that most of them operate with a fairly undifferentiated and below optimal scale model, catering across segments with limited specialisation and no significant advantage in any sector. Eventually, the size and diversity of India demands more varied banks that sit across different layers of banking value chain.

While the government has taken steps to resolve this, it is also considering consolidation of public sector banks. While the idea of consolidation of PSBs is not new, it remains to be seen whether consolidation can obviate the ills of the current banking system.

Globally, consolidation in the financial services has been due to multiple reasons. In USA banks have reduced from 15k to 4.5k in the last thirty years due to globalisation and technological changes coupled with deregulation as an enabler. The Asian financial crisis led to restructuring in Malaysian banking sector and financial crisis in 2008 led to consolidation in Spain. However, the Latin American experience is entirely different — countries have followed market driven process of consolidation through deregulation, encouraging entry of foreign banks and privatisation of state-owned banks.

Studies have shown that there are multiple learnings that we can derive from consolidation of the financial services sector — revival in credit growth, better risk-based pricing , improved productivity and transfer of technology in product and processes. However, there are concerns around large banks becoming “too big to fail” with high level of market risk during volatile times.

The Indian banking sector is too fragmented compared to  other large economies. The top 5 banks in India contribute around 40 per cent of the banking credit compared to more than 90 per cent in economies like Germany, UK, Malaysia and 60 per cent in USA. Due to relative smaller size of Indian banks, they are not able to compete globally in terms of fund mobilisation, growing credit demand and investment needs of the economy. The banks also need a larger capital base to fund large infrastructure projects as well as manage NPAs effectively. Smaller public sector banks will find it more challenging to compete with a sub-scale undifferentiated model. Consolidation is taking place in the private sector as well, as new-age private banks strengthen their offerings in the retail banking space and also expand on a pan-India basis to achieve economies of scale.

Clearly, there is a case for consolidation, particularly the public sector banks in India. However, the question remains that what would be an effective combination that will make our banking system stronger and healthier? Empirically, what has worked is consolidation of banks that can complement each other in terms of geographical presence, focus areas (target segments, products) and human resources leading to effective re-distribution of resources through increased set of customers, optimisation of branch network, infrastructure and manpower. The synergy gains will lead to improved productivity, efficiency and better risk management leading to lower capital requirements.

The target model of consolidation will be the key — whether weak banks should be merged with strong ones, or whether geographical presence/culture of banks should be given importance. Our considered view is that merger whether two or multi-way (three or four) between stronger and weaker banks would require a careful assessment and planning of resource and capital optimisation — how much capital shock can be absorbed by the stronger banks vis-à-vis value generation (better leverage, optimum utilisation of resources etc.) within a given time frame. But, if mergers happen only to save weaker banks, it may fail as we have seen in Europe. We also believe in a government led restructuring of the banking space, private banks should also be invited in the consolidation process.

It is important to note that most of our PSBs are regionally focused, have a strong loyal customer base. Therefore, consolidation between banks with strong presence in different geographies can help in acquisition of new customers and lead to cost optimisation and value maximisation. However, multiple issues needs to be addressed — integration and management of cultural difference, disparate technology and HR systems to name a few — for a merger to be successful.

The goal of consolidation should be to create 2-3 large globally competitive universal banks (requiring multi-way mergers between several banks) which can play a larger role in the world banking stage, with rest as differentiated segment/region focused banks helping to facilitate small business demands. However, it is imperative that the banks should prepare for a long haul for actualising the gains from the consolidation. Our view is that the banks need to create an implementation roadmap — it will take 18-24 months for cultural and technology integration while it may take another 3 years to derive synergy gains, if everything goes fine. In conclusion, consolidation may be the need of the hour, but careful planning and execution will remain the cornerstone for success.

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.

Hemant Jhajhria

The author is partner, Financial Services, PwC (India)

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Sanjoy Majumder

The author is principal consultant, Financial Services & Markets, PwC

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