- Introduction
Intending to boost the falling economy of the nation, the government made a lucrative effort where 10 public sector banks (PSB’s) were completely merged into 4 to create a converged as well as financially stronger global-sized lenders in the field of banking.
Four sets of mergers were proposed by the Central Government where Punjab National Bank, Oriental Bank of Commerce and United Bank of India will combine to form the nation’s second-largest lender; Canara Bank and Syndicate Bank will merge; Union Bank of India will amalgamate with Andhra Bank and Corporation Bank; and Indian Bank will merge with Allahabad Bank.
- Objective
For years, the worst-performing banks were put under Prompt Corrective Action (PCA) where they were allowed to accept deposits but were barred from indulging in commercial lending. With a promise to give banks 70,000 crores, as additional working capital, the action may buttress the bank merger, yet an additional working capital cannot be regarded as the sole criteria to determine the effectiveness of the said policy.
- History
In 1991, when almost every nation was facing an economy set-back, the government appointed the Narsimham Committee[i][1] to prepare a report and thereby suggest recommendations to boost the economy of India. Out of many, one of the recommendations was that there should be a 3-tier banking structure in the country, whereby 3 banks should be present internationally (the top in the country), 8-10 banks should be at tier 2 and there should be a large number of regional and local banks at the bottom. There was a simple objective behind doing so- to strengthen the risk-taking ability and to save banks from getting buried under the pile of bad assets.
- Law in force
Section 44A[ii] provides that in case of voluntary mergers, the same shall be initiated after a draft of the scheme has been proposed to the shareholders and has been approved by the 2/3rds of the majority. In case some of the shareholders are against the said merger, he should be given the value of shares as held by him in the said banking company, evaluated by shareholders. Once the scheme has been passed by the majority, it shall be submitted before RBI for the sanction and after the sanction, it becomes binding on the banking companies concerned.
The other way is the power of the central government to provide for the amalgamation of two or more banking companies under Section 396[iii] which highlight as follows-
Section 396(1) states that if the central government is satisfied that two or more companies should amalgamate, then after consulting the RBI, it shall do so by an order notified in the official gazette.
Section 396(3) provides that the interest or rights against the company should remain almost the same for the employees, if in case it is not so, they should have the right for compensation.
In the present case, although the merging is within the ambit of the government powers, yet deciding the rights and compensation has been completely left upon the government which ultimately gives arbitrary power to the union leading to violation of vested rights.
- Positive aspects
The most comprehensive cornerstones of whole financial sector reform process-the ideas of Narsimham Committee when applied to the policy of bank merger, will essentially be beneficial in a lot of aspects. The major aspects are:
It would bring about “operational flexibility” and “functional autonomy” which will further enhance efficiency, productivity and profitability. This is a criterion which would be present by the golden handshake scheme whether voluntary or forced. The big banks that are created as a result of this will have an enhanced capacity to give credit and they will also be able to compete globally and increase their operational efficiency
India’s bad loan[iv] and stressed debt has grown to an exception $190billion with a surge from 2.4 % to 11.6% from 2007 to 2018. It bypassed Italy during the last quarter who was able to secure its NPA’s by enforcing better financial policies. This will make the process easier by helping in dealing with the NPAs of PSUs. While the intention behind this move may have been to secure robust financial health and ensure better scale efficiency, this process of fast-track consolidation allows for an exemption for 10 years, from the approval of the Competition Commission of India (CCI) in case of mergers involving such PSBs.
It will lead to the enhanced competition that is required between the public sector banks and private sector ones, this enhanced competition, if taken in good faith, can bring about reforms by introducing new schemes that would ultimately benefit the depositors.
This will further promote banking regulation and supervision by corporate governance, transparency, and internal rating practices. An improvement in the above will lead to the initiation of International Policy reforms in the banking sector in the form of a result of increased efficiency and competitiveness.
The banks that have been merged have been chosen on the criterion that they must run on the same platform. This would not create any disruption in the banking facilities that is available to the people.
It might be possible that over the period it will help in boosting the underwriting standards of state-controlled lenders. Moreover, it will also help in improving the credit flows to smaller firms which generally supply goods and services to the larger companies.
- Drawbacks
Every major financial move was taken without giving the economy and people to adapt (e.g. process of bank nationalization) often carries with it certain drawbacks. Some of them may be as follows
When a weak bank is merged with a strong bank, the weak bank gets to develop at a higher rate and both get to share their resources. Yet in the present case, many geographical non-compatible banks have been merged are geographically non-compatible. E.g. United Bank headquartered in Kolkata is being merged with Delhi-based Punjab National Bank.
These merger proposals were introduced when the announcement came that the economy has reached its lowest level in previous 25 quarters clipping at a rate of 5% which clearly shows that the decision has been made in haste and to avoid opposition from people. The need of the hour was to stabilize the economy whereas the government is itself contributing to the destabilization.
The government’s Jan Dhan Yojana, which aimed at financial literacy as well as the promotion of banks, had major dependency on the number of branches that are available to people. Yet in the process of merger, hundreds of branches have been closed down.
While the benefits may loom large when it comes to the merger of the banks, in terms of scale and operations efficiency, higher productivity and filling business products or technology gaps; it may nevertheless prove to be detrimental.
There are various regulatory barriers as defined in the Competition Act, 2002. The presence of switching costs and asymmetric information regarding credit risks may further discourage this idea.
Owing to the present condition of the Indian economy, on a short-term basis, these mergers may contribute to almost nothing. This is because relying upon the conditions that are prevailing presently, the most pressing task of the management should be managing the NPAs and looking for the opportunities of lending but they would be busy in managing administrative and logistic challenges.
The shut-down of the number of branches will ultimately lead to the cutting-down of jobs and government’s plan to compensate has always been disputed since the famous Bank Nationalization[v] case.
- Conclusion
The new step by the government to do away with the mounting debts and increase the cost of capital might seem encouraging, it might prove to be detrimental for the general customers as well as the new entrants in the market. Moreover, there might be a possibility of abuse of a dominant position as regards to the competition act. Although it is true that by section 2(A)[vi], the provisions of CCI which acted as a watchdog on the mergers and acquisitions of the bank were discarded for the banking companies (in the interest of the depositors), yet this step might bring forth competition and general public concerns.
- The foremost step that the state could take is to strengthen its relationship with the private sector. The desperate times of economic crisis will surely bring about a need for such an action and that need would ultimately lead to a whole new set of opportunities.
- At this point of time when the global growth has been weakened to an almost crisis-level and Indian GDP is slowest in the past 24 quarters, this could prove to be a bold move as well as a high-risk oriented one. Although it opens up new areas of opportunities and follows the principle ‘too big to fail’, the effectiveness would solely be dependent upon the execution and future market response to a different business.
Although, indeed, Narsimham committee proposed about bank mergers at the
top level to facilitate the nation and to increase the size of the banks, what
one should not forget is that the committee also recommended that at the
primary level there must be numerous banks that could facilitate
[i] [i] Narsimham Committee (2), 1998 (Report).
[ii] Section 44A, Banking Regulation Act, 1949.
[iii] Companies Act, 1956 (1 of 1956).
[iv] IMF’s Financial Soundness Indicators; see also http://data.imf.org/?sk=388DFA60-1D26-4ADE-B505-A05A558D9A42
[v] RC Cooper v. Union of India (1970) 2 SCC 298.
[vi] Banking Laws (Amendment) Act, 2011.
This article is written by Lakshay Garg of GNLU, Gandhinagar.
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