Will a Big Bank Merger Help India’s Crisis of Liquidity and Confidence? 

The mega merger announcement can't achieve desired results without accompanying reform on a number of fronts.

The new government has barely settled down and it suddenly appears that every day brings with it a new package of ‘reforms’ or policy announcements to address the economic slowdown that India is grappling with. 

After the finance minister announced a set of new measures last week to address some existing supply-side bottlenecks and credit concerns affecting core sector growth, there were new changes made to the foreign direct investment (FDI) cap limits across various sectors (to crowd in foreign investment). And now, we have another mega announcement – the merging of ten public sector banks into four big banks. 

In some ways, the pace at which such announcements are coming is both an acknowledgement and a statement on the severity of India’s current economic situation. It is also a telling remark on how the economy has been handled over the last few years; even if some of the current concerns, especially those relating to lower productivity and export demand, are connected with the general global economic atmosphere. 

Business and investment cycles are functions of confidence-cycles. Confidence, or the lack of it, has a multiplier effect in an economy, which is connected with the further generation of more opportunities for private investors and firms.  

Ever since the collapse of infra-finance operator, the IL&FS group, last September, the Indian economy has been battling with a serious crisis of confidence and a severe liquidity crunch – a squeeze of the type where even public sector banks are simply unwilling to dole out credit without reclaiming or dealing with existing bad debts (or NPAs). The situation is worse for NBFCs (Non-Bank Financial Corporations) that provide more credit to small and medium scale enterprises than banks.

The big bank merger announcement needs to be viewed in this light. 

Also read | Centre Announces Sweeping Plan to Merge 10 Public Sector Banks Into 4 Entities

The announcement calls for four new mergers now. The first will see Punjab National Bank, Oriental Bank of Commerce and United Bank of India combining to form the second-largest bank now after the State Bank of India (SBI). The second will see Canara and Syndicate Bank amalgamate into one. The third will have Union Bank of India merge with Andhra Bank and Corporation Bank. And finally, Allahabad Bank will merge with Indian Bank. After this, the total number of state-run lenders in India will come down to 12, from the earlier 27 that existed back in 2017.

A welcome announcement here is in relation to how six existing PSU banks (Bank of Maharashtra, Punjab and Sind Bank, UCO Bank, Indian Overseas Bank, Bank of India and Central Bank of India) will be independent or operate as separate entities. 

What this should ideally do is enable these banks, that otherwise worsen their lending patterns or accrue bad debts, to be allowed to turn insolvent or bankrupt. Having said that, most of these banks are those with a strong regional focus and would require a fundamental restructuring (in their lending approach) to improve their balance sheets. The introduction of IBC has definitely improved the corporate borrowing scenario and will yield positive steps – if the implementation of the Code continues to be swift.

But what does this particular big-bank merger announcement signify?

For its signaling effect, the merger, as the finance minister mentioned, may allow an enhanced risk appetite for these institutions, and may make it slightly easier for the government to coordinate and push for re-capitalisation of these banks, as it targets to assign funds out of the surplus funds (Rs 1.76 lacs crores) received from the Reserve Bank of India (RBI) a few days ago. 

At the same time, it also makes merged banks to fall under the ‘too big to fail’ category – something that is also seen with other large credit-fueled economies, including the state-owned financial banks of China and private banks of the US. 

The ‘too big to fail’ concept centres around an idea that certain institutions remain so vital to the economy that they cannot be allowed to fail under any circumstances, owing to the damage they would cause to citizens and the national economy. The government usually bails these institutions during times of crises and this has been observed more frequently in cases of sovereign bank defaults seen in countries like the US (last seen during the 2007-08 crisis). 

Also read | In Boost to Modi Govt, RBI Agrees to Make Record Rs 1.76 Lakh Crore Transfer

In the Indian context, not only would the NPA ratios of merging banks add up to a larger number for the anchor bank institution now, but it would now also require the government and the RBI to be more vigilant in times ahead to monitor ‘risk of default’ for these big banks. This must be done to avoid a situation where the government is called to bail out any of the big banks from its already restricted fiscal space. Increased space and ease for credit mustn’t lead to an exacerbation of financial debt, as seen in China. 

One also doesn’t know how marginal cost of funds-based lending rates (MCLR) would be synchronised post the merger, especially at a time when transmission process in rate cuts (between RBI and PSBs) has remained a constant problem in ensuring policy benefits to actual customers. Last week, the finance minister emphasised the need to have a more improved coordination transmission rate mechanism to ensure a direct harmonisation between monetary policy cuts announced by the RBI and its linking to actual borrowing rate cuts of public sector banks. 

As of now, eight state-run lenders have already announced repo-rate linked loans. If handled well, a bigger bank network (with fewer anchors) can ensure a better transmission process. 

More importantly, politically-speaking, the move seems to also be positioned in tandem with the prime minister’s vision statement of a $5 trillion economy.

But would a merger help in addressing the larger crisis of confidence? 

Also read | Latest GDP Growth Figures Raise Questions About State of Indian Economy

The answer to this lies in how well the government treats the public sector banks going forward, including the big merged banks. So far, the history of Indian governments dealing with public sector banks and their lending mechanisms has been dreadful. The current state of most debt-ridden PSU banks – especially those with a regional or state focus, can be largely owed to the interventionist approach undertaken by the governments through greater bureaucratic influence and from the persistent election cycle of announced loan waiver grants.

Going forward, the Modi government, despite its over-centralised approach to the economy’s management, may perhaps learn from its own errs and those of its predecessors by gradually turning existing PSU banks and the big merged banks into different forms of independently managed special purpose vehicles. This, for one, can help the respective bank-management boards to exercise greater operational and functional autonomy and also make them target specific directional areas for credit transfers. Especially in areas of agri-business, housing, infrastructure, textiles, renewables and so on where there is dearth of cheap and swift credit.

Deepanshu Mohan is an associate professor and director, Centre for New Economics Studies at O.P. Jindal University. He is a visiting professor to the Department of Economics, Carleton University, Canada.