Consolidation in the banking industry

S Subramanian Director, Enam Financial Consultants

As Indians we are today served by 288 scheduled commercial banks (including 196 Regional Rural Banks) through over 32,000 branches across the length and breadth of the country.

This does not count the number of co-operative banks and non banking financial companies that also provide a significant banking service. Most of the banking products follow a commodity pricing strategy and the differentiation is essentially based on new product introduction and customer service. Therefore, at one level we could claim we are over-banked.

At the same time India is probably amongst the least penetrated credit markets in the world. To illustrate a couple of examples: Our retail credit is at 2 per cent of GDP (against 8 per cent for Thailand and 41 per cent for Korea), credit cards in issuance is just 1 per cent of the population against a whopping 82 per cent in Korea.

We look at the consolidation debate against this backdrop.

Size matters: Size is a great competitive strength in banks. Size enables banks to lend large sums to blue-chip corporates, thereby ensuring a better quality asset book.

Thus, a virtuous cycle of quality assets leading to better credit rating which in turn will lead to a lower cost of funds will get established.

In addition, size enables banks to offer a wider variety of products that could generate highly profitable fee based income.

A wide variety of retail products require significant overhead infrastructure to be established. Such a large overhead infrastructure can only be effectively be utilised by large sized banks.

Continuous capital infusion is an essential ingredient for growth in the banking industry. Larger banks have the ability to add capital at better valuations than smaller banks.

Consolidation normally happens in a mature industry. The Indian banking industry is one of the oldest industries, with the State Bank of India tracing its history back to the 1800s through the three provincial banks (Bank of Madras, Bank of Bombay and Bank of Bengal).

In such mature industries existing and large players have significant competitive advantages over both the smaller players and newer entrants.

Smaller banks tend become weaker over time. We believe market factors over a period of time will push the sector to consolidate. The government is just hastening that process.

Is there a room for new entrants? Even in mature industries, newer entrances that manage to bring in significant amount of new technology, processes, establish higher service standards and other innovations do gain a foothold. The new private sector banks in India(established since 1994 onwards) have clearly established the veracity of this argument.

But it is the credit of the existing banking sector that they have and are continuing to learn and incorporate these new ideas processes etc. into their organizations. The newer banks have taught the older established elephants how to dance.

Merger criteria: Given that we favour consolidation in the banking industry we would advise strongly that a merger among strong banks will throw greater value to all the stake holders including depositors, borrowers, employees and shareholders (government included).

We believe the government should utilise the valuation gains of such a merger of strong banks to capitalise and strengthen the weak banks.

Growth sans M&As possible

A K Jana President, All India Bank Officers Confederation

In 1991 the Narasimham Committee for financial sector reforms suggested consolidation of public sector banks to create three or four big banks with international presence, six to seven national banks and rest to be local banks.

The Indian Banks' Association has reportedly formed a committee to consider mergers and acquisitions of banks in the run up to consolidation.

The finance minister too has expressed his views in favour of consolidation of banks to attend global standards. But he suggested that such merger would not be imposed by the government and that the process should be voluntary.

The media has started making noises on such move of consolidation and many bank chairmen expressed their desire to take over one bank or the other.

The trade unions will not support the move. It may be recalled that due to unions' stiff resistance, the banks privatisation Bill could not be passed in the Parliament.

Let us take a close look on why mergers and acquisitions in the banking industry is not the order of the day.

The public sector banks are doing very well and efficiency has improved triggered by competition. The merger will lead to monopolisation and efficiency may suffer a set back. Why are the bankers in a hurry to play the merger game when the finance minister has left it to the market force to decide?

Each bank in India has got a strong root to its origin, developed a culture of its own and employees and customers have a strong brand loyalty towards the bank. Mergers will destroy this unique character of Indian banking and affect both the merged and the merging entities.

If the merger move is initiated to reduce the transaction cost by downsizing the bank and the workforce, it may not hold water. There are many areas where the cost reduction is possible without resorting to merger and acquisition.

Already most of the banks have invested huge amount in technology which will be redundant and further investment of huge amount could be necessary to synergise the operations after merger.

M&As are a misplaced priority. Banking industry is in turmoil due to delay in wage revision. The IBA should first sort out the issue to avoid further deterioration of industrial relations.

Besides, M&A will facilitate foreign take over of banks through the FDI route. The simultaneous move to remove the cap of 10 per cent voting right has to be considered in this context.

Finally, if we have some banks of global standard, few of the big banks including the private one should be encouraged to open their branches in other countries.

They have necessary experience and skill to attain a global size and the government must help them out in reaching out to overseas markets.

All responsible trade unions are alive to the ground reality and they know that they will have to adjust with the changes with the market forces.

But the fact remains that the industry can grow and become efficient without a hasty move towards mergers & acquisitions (M&As). They are required in a crisis situation.

When we look for M&As for growth, it must be done after much deliberations and without sacrificing the interest of the workforce, the common people and the country as a whole.