The central government has proposed amalgamation of three public sector banks (PSBs), the first stage of which has been completed. This strategic move is touted to be the beginning of transformation of PSBs into smart and agile entities to compete with their private peers. In this post, K. Srinivasa Rao discusses reasons for amalgamation, strengths and challenges of the new amalgamated entity, and ingredients for success of amalgamations in the PSB space.

The first phase of the proposed amalgamation of Vijaya Bank (VB) and Dena Bank (DB) with Bank of Baroda (BOB) mooted by the central government, has been completed and approved by individual boards of the three banks. In some of them internal committees have also been formed to prepare a blueprint to operationalise the process. It will be a historic initiative to revamp public sector banks (PSBs) which was pending since the banking sector reforms were initiated in 1991. This strategic move should be the beginning of transformation of PSBs into smart and agile entities to compete with private peers. Understandably, the consolidation is not confined to resolving lingering bad loan crisis alone. It has a bigger purpose of making the banking sector more robust and capable to (i) increase lending appetite, (ii) conserve capital, (iii) improve risk management capabilities, and (iv) attain economies of scale in augmenting business growth.   

A large number of stronger and bigger PSBs like the State Bank of India (SBI) can support the growing economy. Yet, amalgamation in the offing is a contentious and debatable policy. It can inflict intense short-term pains with prospects of long-term gains provided the amalgamation process is seamlessly executed, with firm but fine balancing of stakeholder interests. The interest of bank employees unions of various affiliations has to be protected and their competencies brought together for the growth of the new entity.  

The common mindset is to not disturb the apple cart even if synergy in consolidation is clearly visible. Procrastination in taking such strategic actions by successive leadership led to a prolonged delay in consolidation of PSBs despite wide consensus of experts on the idea. In the midst of deteriorating asset quality, many weak PSBs are gasping for breath. At this critical juncture, strategic solutions like consolidation in PSB space cannot be further postponed. It is time for leadership to initiate such a tectonic shift in policies despite diverse public opinions and widespread resentment – in the long-term interest. 

Reasons for amalgamation

PSBs have been operating in buyer’s market¹ in the post-reform era in the last over two and a half decades in intense competition. The entry of new generation of private banks, differentiated banks, and increased collaboration with fintech companies, non-banks, and insurance companies has led to massive diversification with inherent risks. The technological innovations and greater connect with non-bank financial services has brought new challenges which needs stronger risk appetite and larger asset size. Compared to international banks, the asset size of Indian banks is low. Even after merger, SBI ranks among the top 50 global banks in terms of asset size, somewhere around 45. 

Moreover, the changed operating environment demands new strategies to cope with challenges of maintaining quality and tackling capital adequacy issues – more importantly, to improve operational efficiency to compete with new peers. Perhaps the right time has arrived to think differently. Doing new age banking with archaic mindset may not be viable in the long run. 

The idea of consolidation of PSBs originates from the recommendations of the first Narasimham Committee on the Financial System (CFS), 1991. It was also reiterated in the second committee on Banking Sector reforms (BSR), 1998. The first committee (1991) proposed substantial reduction in number of PSBs. The redefined structure should have 3-4 large banks with international reach, 8-10 national banks, followed by a set of local banks and rural banks. Merger of PSBs was also recommended in the report of the working group on restructuring of weak banks led by Shri M.S. Verma, former Chairman of SBI in 1999. 

With SBI standing tall as a behemoth with total assets of Rs. 36.16 trillion (Q4 result, March 2018), followed by HDFC bank with asset size of Rs. 10.64 trillion (Q4 result, March 2018), the new amalgamated entity (NAE) formed with the assets of three PSBs (BOB, VB and DB) will be the third in terms of asset size with Rs. 10.19 trillion (Q4, March 2018). These mega banks can be followed by more PSBs coming together with impressive size and wider geographical reach to connect with not only domestic but also global banking system. In view of expert opinions and logical benefits of consolidation (stemming from SBI group consolidation), identification of the three PSBs for amalgamation is undertaken perhaps as the first leg in a conscious strategy to test success. 

Strength of the new amalgamated entity

Since NAE is formed with the assets of three PSBs it will be strong and resilient. It will have better business muscle with deposits and advances at Rs.14.82 trillion. A combined network of 9,489 branches can provide wider representation and better customer connect. Net non-performing assets (NPAs) would be down to 5.7% which is much better than aggregate net NPAs of PSB sector at 8.6% as per RBI’s (Reserve Bank of India) Financial Stability Report of June 2018. Provision coverage ratio (PCR) will improve to 67.5% much better than 63.7% of PSB sector average. The total number of employees will be 85,675, a strong force capable to offer improved services to satisfy the expanded customer base. But managing their frictions will be critical to optimise synergy. Well articulated and transparent human resource policy without any bias will be able to infuse confidence in the NAE. 

Other strengths will relate to consolidation of capital base. The total Tier I combined capital shall be 9.32% inching up its capital adequacy ratio (CAR) to 12.26%. Effectively some of the accumulated high net NPAs of DB at 11.04% can be absorbed due to comparatively low net NPAs in other two banks pegged at 4.1% for VB and 5.4% for BOB). The transition could be seamless as the technology platform – Finacle of Infosys – is uniform. The weakest link in the value chain is DB working under restricted conditions of prompt corrective action (PCA) of the RBI. But the other two banks are capable to handhold it to form a strong NAE. 

Human resource challenge 

In any strategic shift of such magnitude, the challenges ought to be daunting. The biggest challenge in implementing the proposed amalgamation will be to reorient human resource of the three banks to integrate them into a cohesive team to take the NAE forward. That would involve overcoming the emotional impact of losing its parental corporate brand image with which the employees have been associated and recognised by for decades. People with diverse age profiles and mindsets used to follow different risk appetites in parent banks. They now have to collaborate together to deliver better value in the NAE, creating innovative opportunities to meet their career aspirations. 

Cultural integration and coherence among key policies, technology alignment, streamlining of organisational structure, redefining of lines of business, work flows, systems, and processes, and reorganising of systemic controls will have to be planned meticulously. The human resource at all levels will have to be geared up to execute the amalgamation process with alacrity and professional stance. An acceptable brand image is to be developed for the NAE. In order to ensure execution of the amalgamation process, combined team efforts will be needed. How the leadership is able to accomplish it will decide the future shape of NAE. 

An acceptable identity for the new entity

A more critical aspect than managing human resources will be to provide an impressive identity (name) to NAE. Quite often the terms ‘merger’ and ‘amalgamation’ are used interchangeably. But in the current context ‘amalgamation’ is proposed and not ‘merger’. Experts point out that merger refers to a corporate restructuring activity of two or more companies into a single company whereby the identities of some of the companies get dissolved. But amalgamation is a wider concept. Under accounting standards, in case of amalgamation, there is not only pooling of assets and liabilities but also swapping of shares based on market valuation. PSBs are governed under ‘Banking companies (acquisition and transfer of undertakings) Act, 1970’. 

Therefore, the roll-out of amalgamation process required approval by Board of Directors of the three banks separately which is now done. Based on their resolutions, it has to move to cabinet ministers and both houses of the Parliament. Only when the amalgamation scheme receives approvals from all concerned, it will be ready for execution. In the meantime, the banks can collaborate together to shape up the operationalisation of NAE. 

In the whole rigour of such approvals, the moot point of keen interest to all will be the brand identity of NAE. While every PSB in fray is unique with its reputation and brand image built over a century, it will be to use the brand image of at least one of the banks to maintain continuity. Destruction of brand value of all the three mighty PSBs will tantamount to raging them to the ground. It will take another hundred years to build it. It is not possible to jumble up the names just to maintain identity and while getting a new name could be easy, reinventing brand value will be difficult and costly. Further, based on the past experience of 22 bank mergers since 1990 (post-reform era), the name of the combined entity was never changed. 

In the given circumstances, if debated independently of the track record, continuation of NAE with the brand identity of BOB emerges as a consensual and logical name in the larger interest. The reach and depth of the image of BOB is such that is has a wide international reputation, which should not be withered away. 

Further, if BOB’s is not retained as the name of NAE, the whole purpose of transforming it into robust large size PSB will turn out to be nobody’s business. Like SBI, BOB should be allowed to take care of the two other PSBs so that the bigger PSB owns the responsibility to take amalgamation process to its logical end. 

A different name just to temporarily appease a section of people will have neither recognition nor ownership from any of the three PSBs except a psychological feeling of winning a war, which is already lost. In order to have stiff accountability for execution on the larger PSB, it will be necessary and non-negotiable imperative to retain the identity of the premier bank. If required, a well-calibrated voluntary retirement scheme can also be mooted to reduce the staff strength. It can weed out dissatisfied manpower and eventually reduce intermediation cost. 

Operationalisation of amalgamation

According to the plan announced by the government, once it approves of the amalgamation, the NAE can be formed and made functional from 1 April 2019 in terms of predetermined timelines and led by a team of the three banks. Background work would call for redrafting of many of the policies, drawing up standard operating procedures, and deciding stages of workflows to integrate back office operations for more efficient customer service. It will call for mapping skillsets and talent of all employees to enable better deployment of manpower, and assign responsibilities to lead profit centres of NAE. Managing human aspects of amalgamation will be very critical to improve the outcome. Closing down operational units must be decided purely on business considerations and mutual reciprocation. Setting up different management teams to work on diverse integration projects will have to be backed with faster decision support system.

The NAE can have better risk appetite that serves the very purpose for which amalgamation is initiated. The end goal is to ensure that better profitability numbers in future should be able to erase past accumulated losses. It will need a well-calibrated identity-neutral approach to trim down redundant organisational structure of banks under amalgamation. 

Way forward

If the real benefit of amalgamation in PSB space is to be derived, certain much awaited reinforcing bank reforms will have to be quickly implemented, rather simultaneously. (i) It has to begin with adding rigour in regulating the top echelons of banks’ leadership akin to their private peers. (ii) Strengthening board governance by introducing new criteria for selection, training and rigorous performance review of independent directors (IDs) which is glaringly missing. (iii) Empowering RBI to approve or change the board members including full-time directors depending upon the supervisory outcome. (iv) Developing sensitivity towards long-term quality consciousness and enforcing improved compliance standards is possible only if regulators are fully empowered in case of PSBs. That precisely is the reason why RBI is seeking powers to oversee the board structure of PSBs which is currently not in its purview. This limits its ability to oversee compliance in totality. (v) Induction of quality IDs with domain expertise can well be assigned to Banks Board Bureau (BBB) set up for the purpose.

It is important to consider removing dual regulation of PSBs by hastening setting up of Bank Investment Company (BIC) in line with the recommendations of Dr. P.J. Nayak Committee meant to review governance of boards of banks in India. The process of phasing out government ownership from 51% to 33% can also be thought through.

Hence, the success of amalgamation in PSB space will depend much on the ability to manage its aftermath with supporting changes. Using amalgamation as a standalone initiative without enough reinforcements will weaken the purpose of amalgamation resulting in inefficiency. The synergy of the bold bank reforms will have to be fully derived to infuse renewed optimism among PSBs. It will need inclusive ownership of all stakeholders in pursuing amalgamation so that large and strong PSBs can become strategic players in global banking space. 

Notes:

1. Buyer’s market is where supply is in abundance and demand is low, therefore prices remain low.