Dear Finance Minister, Consolidation No Remedy For The Banking Mess

The second edition of Gyan Sangam—a forum of bankers, regulators and policymakers created by the government to brainstorm critical issues that have been plaguing the banking sector—was a relatively tame affair. Bulging non-performing assets or NPAs of the state-owned banks, recovery of bad loans, reforms in terms of giving the bank employees ownership in the form of stock options and consolidation dominated the discussions.

At the end of it, on Saturday, finance minister Arun Jaitley reiterated the government’s commitment to bank consolidation. He wants fewer strong banks than many weak banks. A committee will be set up to examine the feasibility of bank consolidation.

Consolidation is something that the government as well as the Reserve Bank of India (RBI) have been talking about for years now. In fact, around the time former finance minister Pranab Mukherjee announced the opening up of the banking sector for private entities in his 2010 budget, then RBI governor D. Subbarao was pushing for the consolidation of banks.

The sector was opened up and applications were sought to set up new banks because India was hugely unbanked with only one-third of the adult population having access to formal banking services. Since then, two new universal banks have come up and conditional licences have been given to 10 small finance banks and 11 payments banks. Also, the Pradhan Mantri Jan Dhan Yojana (PMJDY)—a national mission on financial inclusion—has opened some 221.1 million new bank accounts.

The apparent success of PMJDY has probably once again shifted the focus on consolidation—we don’t need too many banks as a larger portion of India’s population has now come under the banking fold. The emphasis is on having stronger banks that can support the investment needs of corporations and economic growth. How does one go about it? Should the relatively stronger banks take over weak banks? Can some of the weak banks in different geographies be bundled up? There is no easy answer.

In the December quarter, the pack of 24 public sector banks collectively posted a loss of Rs.10,912 crore with half of them in the red. Rising NPAs forced them to set aside dollops of money and that led to the losses. In the three months ended 31 December, their gross NPAs rose by about Rs.1.3 trillion to Rs.3.93 trillion. After provisions, the state-run banks now account for more than 90% of Rs.2.5 trillion net NPAs of listed Indian banks.

If we take a close look at the balance sheets of the state-owned banks, we can classify them into three categories. In the first set, there will be State Bank of India, Bank of Baroda, Union Bank of India and a few other relatively small banks with not-so-bad numbers such as Indian Bank, Syndicate Bank, Vijaya Bank, etc. The second set of banks is in a far worse shape. Bank of India, Indian Overseas Bank, Central Bank, IDBI Bank Ltd, United Bank of India, Uco Bank and a few others belong to this category. Finally, there are a few banks, including Punjab National Bank, that are not in a healthy state at all, but they have an inherent strength to overcome the problems of bad assets and bounce back. To be sure, all are majority owned by the government and none will fail—hence depositors’ money is safe with each of them.

India has its history of bank failures, but that’s in the distant past. In 1930, there were 1,258 banks registered under the Indian Companies Act, including loan companies and the so-called nidhis, which were in the business of borrowing and lending money only among their members even as they issued pass books and cheque books. By 1947, the year of Independence, the number of scheduled banks reduced to 82. The partition of the country dealt a blow to the banking industry and West Bengal bore the brunt. Of the 38 banks that failed in 1947, 17 were in West Bengal. Till 1960s, many more banks went belly up because of greed, corruption and lack of regulation.

Since economic liberalization, barring a handful of cooperative banks, no bank has been allowed to fail. Each time cracks surfaced in a bank’s balance sheet, RBI threw a protective ring around it and ‘found’ a suitor for it with the sole objective of protecting the interest of depositors and avoiding any systemic crisis that could have been caused by a bank failure.

In 1993, New Bank of India was merged with Punjab National Bank—the last instance of a state-owned bank being merged with another. In the recent past, a couple of State of India associate banks got merged with the parent, but that’s more of a family affair as the State Bank group virtually operates as a single entity.

Of course, there have been many instances of private banks being merged with state-owned and other private banks. For instance, Oriental Bank of Commerce was persuaded to take over the troubled Global Trust Bank Ltd, and Bank of Rajasthan Ltd was merged with ICICI Bank Ltd. Officially, all of them are voluntary mergers, but in most cases, the banking regulator plays a role. And, not all such mergers have a happy ending.

Over-enthusiasm over consolidation may end up making the relatively stronger banks weak, defeating the very purpose of consolidation. A better option could be converting the weakest banks into the so-called narrow banks. The four parameters that can be taken into consideration to decide on this could be stressed assets, capital adequacy ratio, return on equity and return on assets.

They should stop lending and, instead, focus on recovery of bad loans and invest resources in government bonds. The treasury income and interest on performing loans will help them pay interest to the existing depositors and salary to employees even as they should not be allowed to take fresh deposits. During this period, they can sell loan assets and deposits to other banks. Once all deposits are redeemed and loans repaid/recovered/sold, they will turn into shell companies. At this stage, their branches and other physical assets could be auctioned to other public, private and foreign banks, making the last rites painless for the industry and profitable for the owners.

However, if consolidation means banishing Bharatiya Mahila Bank from the banking landscape in India, it should have been done yesterday. It’s not weak as such but probably irrelevant; it is small and hence won’t affect the balance sheet of a relatively stronger bank with which it can get merged.

Tamal Bandyopadhyay, consulting editor at Mint, is adviser to Bandhan Bank. He is also the author of Sahara: The Untold Story and A Bank for the Buck. His Twitter handle is @tamalbandyo.

Comments are welcome at [email protected]

This blog first appeared in www.livemint.com

Photo courtesy: Hindustan Times