The government’s decision to amalgamate three public sector banks (Bank of Baroda, Vijaya Bank and Dena Bank) is a band-aid exercise that seeks to keep one step ahead of the crisis and should not be seen as in any way seeking to improve the basic health of public sector banks.
The secretary of the financial services department which oversees the government-owned banks has claimed that this will “improve operational efficiency and customer service”. It is not at all clear how this will happen.
More revealing is his following assertion that “capital support to the new entity will be ensured”. This implies that the government would have found it difficult to restore the capital adequacy ratio of all 11 banks which have been placed under “prompt corrective action” (PCA) that has rendered them comatose, unable to undertake fresh lending.
If all the banks under PAC had to receive enough capital infusion from the government to restore their capital adequacy ratio, then finance minister Arun Jaitley would not be able to stand by his assertion to the prime minister that the fiscal deficit will be kept within declared bounds.
Importantly, what is not admitted is that if you merge a weak bank with a strong bank then you save the weak bank but also render weaker the other bank which would have remained stronger had it been left to fend for itself. This is, in fact, what is likely to happen to Bank of Baroda. Most recently it had staged an improvement over its earlier performance. Post the amalgamation, this recovery process is likely to get stalled.
The finance minister has reassured public sector bank employees by saying that the government wishes to save all the banks under PAC, adding that “nobody will have to worry.” More explicitly, “no employee will face adverse service conditions as a consequence of the amalgamation,” according to one news report.
But officials of the erstwhile associate banks of the State Bank of India are upset over the change in their career prospects as a result of the merger. They see themselves as second-class citizens vis-à-vis those of SBI proper and their promotion prospects hampered.
The critical issue before the Indian economy is that with its public sector banks, which account for over two-thirds of the banking sector, being severely impaired by their bad loans overload, the supply of fresh loans to enable high growth will be stanched. Jaitley had something specific to offer on this: “This amalgamated entity will increase banking operations.”
But one critical issue has to be addressed before bank lending to the corporate sector recovers its regular momentum. Senior bank managers are currently traumatised by the actions against some of them by the vigilance and investigative authorities pursuing cases of perceived fraud. A process of confidence building among the officials is needed and this is in its nature a time-consuming exercise.
The main reason why the merger is a stop-gap exercise is that it does not address the basic issues as to why bad loans came to be in such proportions. The project appraisal practices and capabilities in the public sector banks are inadequate so that large long-term loans to infrastructure projects get sanctioned with inadequate scrutiny, particularly when the herd mentality overtakes bankers during periods of irrational exuberance as happened in the run-up to the financial crisis of 2008.
If this is a psychological reality that cannot be avoided, banks’ insurance policy lies in detecting emerging ill health and erosion of promoter’ equity in projects as soon as it happens. There can be no compromise in this and for this, the quality of bank management has to improve substantially.
Additionally and crucially, a more professional set of managers has to be able to perform without interference from the political class and bureaucracy. In India, not only do powerful promoters pull political strings without hesitation, top managers sometimes owe their positions to lobbying on their behalf by powerful promoter groups. Such a manager can hardly move against promoters promptly when the need arises.
The solution to this systemic malady afflicting the public sector banks is obvious and globally regarded, academic and former Reserve Bank of India governor, Raghuram Rajan, has, in his note to the estimates committee of parliament spelt it out clearly: “improve governance of public sector banks and distance them from the government” and “delegate appointments entirely to an entity like the Banks Board Bureau.”
The NDA government understood this well and early in its life set up the bureau under the leadership of former comptroller and auditor general Vinod Rai. Rajan’s note does not say this but most unfortunately, having set the bureau in the first place, the government chose to ignore its detailed advice and Rai has now departed.
There is a deeper theoretical reason why merging smaller public sector banks to create a few big ones is not the answer. This is because, in the financial sector, big is no longer beautiful after the global financial crisis. One reason is that once an institution gets very big, systemically it becomes too big to be allowed to fail and so has to be rescued in case of need. Besides, size offers no intrinsic advantage.
The entity that will be created post the amalgamation of the three banks will not be in any better position to compete for large projects than Bank of Baroda would have been on its own. Large loans are often syndicated and all that a lead banker has to do is get its project appraisal right.
Additionally, in India, knowing the local business scene and having historical and organic roots in it is indispensable in lending to small and medium enterprises which are the real engine of growth. For example, if the former State Bank of Travancore knew its historical territory better than any other bank, then it should have been allowed to do its own thing and not get lost in a faceless large bureaucracy like the State Bank of India.
Public sector banks should be merged not mindlessly to create a few bigger banks and make life fiscally easier for the government but on intrinsic business merit as when a business considers it necessary to add a geography or an industry to its portmanteau.
Subir Roy is a senior journalist and the author of Made in India: A study of emerging competitiveness (Tata Mcgraw Hill, 2005) and Ujjivan: Transforming With Technology (OUP, 2018).