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Why merging public sector banks is not reform

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Merging of two weak banks into another weak bank is a tolerably decent  idea, under normal economic and financial conditions. But to pass it off as a major reform on a day when the economy hit a six-year-low in growth rings hollow, except that it has tragic implications.

Why merging public sector banks is not reform
Merging of two weak banks into another weak bank is a tolerably decent  idea, under normal economic and financial conditions. But to pass it off as a major reform on a day when the economy hit a six-year-low in growth rings hollow.
Actually the government is itself admitting that a key flaw in the public sector design is that talent from the ranks is not good enough and that is why, as part of the reforms, it has allowed public sector banks (PSBs) to hire a risk officer from the market, paying market-based compensation. Why only a risk officer? Don’t PSBs need best in class CEOs, CFOs, CTOs?  And indeed best in class marketing officers who can design loan and savings products?  The PSBs have since 1995, been competing with private sector banks which have access to such talent.
The year 1995 is important. Until the late eighties, the best candidates from IITs and the best universities wrote IAS exams, State Bank entrance exams and the National Recruitment exams of the PSBs. But after the liberalisation of the Indian economy in 1991, private sector companies grew aggressively and  attracted away the cream of the talent. Along with it  came the infotech revolution  (Infosys listed in 1991) and then private sector banks (1995) and  then more foreign banks, insurance companies and NBFCs. In the face of this competition, since the 90s, the PSBs with their moribund processes and stagnant salaries have attracted mediocre talent. Any bright spark, despite these service conditions was usually poached by private banks and NBFCs.
The need of the hour is for the government to let go off PSBs. The Banking Companies Act itself needs to go. The full name of this Act is Banking Companies (Acquisition and Transfer of Undertakings) Act and it was intended to nationalise private companies so that they serve government directed goals and not pursue profit. Twenty years after nationalisation, in 1992,  the government realised it doesn’t have the money to capitalise them and started listing them so that they may raise funds from the capital market. But the design of the Act is still intended to serve government goals and not compete on commercial lines.
The Act allows the government to appoint the CEO, the top management and the board members. And even if the government were to pretend that it has outsourced this to a respected bank board bureau, the Act still makes these banks run on government diktat and not on commercial logic. Witness, for instance, the diktat to the PSU banks to link their loan rates to the repo rate, without any worries about the cost of their deposits. This is like the government telling a hypothetical government-owned Hindustan Unilever to link its product prices to the CPI, never mind the cost of its raw material. The tragedy is that these PSBs have to compete with private sector banks who face no such diktat. Now if the RBI imposed external benchmarks on all banks,  that would be different. But this selective arm twisting of PSBs to suit the government’s aims is possible because of the Banking Companies Act and the government’s   dominant ownership.
True reform will require what financial sector giants like YV Reddy and PJ Nayak have long recommended: Abolish the Banking Companies Act, bring PSBs under the Companies Act, so that clauses like section 49 (ensuring truly independent directors) apply to PSBs as well. This will fix governance somewhat . Then as soon as the capital markets permit,  government stake in these PSBs needs to be brought below 50 percent. This will enable them to recruit competitively and indeed run on market-based principles.  That’s what you call reform.
For now the PSBs are going to be completely immersed in their integration issues. The SBI and Bank of Baroda (BoB) experience showed deep gashes in the combined banks for quite a few quarters after merger. The merging banks have barely recognised the bad loans created before 2013, when a new wave of bad loans created after 2014 are emerging: IL&FS, housing finance companies,  entities with promoters leveraged up to their neck against their own shares.  Instead of tackling  this continued onslaught, every senior banker in the merging PSB will be more worried about what will be his or her place in the new hierarchy. They will worry about nitty gritties of getting all their core banking systems merged. (It doesn’t help if they are all on Finnacle, BoB found that each of its merging partners had different versions of Finnacle). Each branch manager will worry about which of their units may be merged into another branch of a partner bank or how to tackle customers of the erstwhile competing bank. They will worry about  repainting their billboards and printing new stationary. BoB officials  say they had to even give customers new account numbers in place of the old and since many customers would continue to use old numbers, the bank’s software had to be designed to recognise two sets of numbers for the same account for a considerable period.
And all this chaos  with no change at all in governance standards, or in ability to recruit competitively or price products like the competition. And at a time when the best PSBs have a net NPA of 6 percent and capital that just makes it to Basel grade. And at a time when the economy is giving you that sinking feeling.

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Dr Reddys Labs4,843.35 -567.90 -10.49
Cipla913.10 -37.45 -3.94
Axis Bank731.70 -24.60 -3.25
Adani Ports663.20 -19.60 -2.87
Divis Labs4,791.40 -129.75 -2.64
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Dr Reddys Labs4,844.35 -564.80 -10.44
Axis Bank731.75 -24.40 -3.23
Kotak Mahindra1,697.95 -42.45 -2.44
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