Bank merger posers

The finance minister's remarks at the annual general meeting of the Indian Banks' Association (IBA) the other day indicate that the government is in favour of consolidation in the Indian banking sector. Towards that end, the IBA has already formed a committee to look into the legal and regulatory issues involved in the merger of public sector banks.

The idea of encouraging mergers and acquisitions to create a few large and strong national banks, on the one hand, and several regional banks, on the other, was mooted more than a decade ago by the Narasimham committee.

Yet, despite the obvious benefits of consolidation, M&A activity in the banking sector has so far been confined to either the private sector or the merger of bankrupt banks with stronger ones. The difference this time is that the government seems to be actively promoting the idea.

There are several reasons why the government may be getting serious on consolidation. One is to make the system stronger and avoid having to bail out weak banks.

Another is to enable Indian banks to prepare for higher capital adequacy requirements under Basle-II. A third reason, and the one mentioned by the finance minister at the IBA meeting, is to enable Indian banks to achieve world-class status.

The oft-cited advantages of consolidation are the economies of scale involved""a bigger asset base, enabling a bank to take on larger exposures; geographical reach; the ability to take advantage of technology; the relatively small size of even the largest PSU banks compared to global banks; and the need to expand into related areas such as investment banking or bancassurance.

Many of these are weighty reasons. However, the real problem facing the financial sector today is not so much the condition of commercial banks, but the risks associated with cooperative banking.

The weakest links in the Indian financial system, and its soft underbelly, are badly mismanaged cooperative banks. This fact is borne out by the numerous runs on cooperative banks in recent weeks, and the restraining orders passed on some of them.

There are serious doubts about the quality of these banks' balance sheets after the implementation of the 90-day norm for recognising non-performing assets.

The FY2004 balance sheets of most of these banks are not yet in the public domain. The need of the hour is to fix the problems associated with the cooperative banking sector, but the structure does not allow for quick solutions, including the merger of weak banks with stronger ones.

Furthermore, the government's basic intention in promoting consolidation seems to be the creation of national champions in the banking sector. But consolidation will work only if the managements of the individual banks concerned feel that it will add value.

The government should not force the issue. M&As can bring benefits if banks can close down uneconomic branches, redeploy or retrench staff, make lateral recruitments, offer market-related salaries, reward performance, and penalise non-performance. Without managerial autonomy, bank consolidation may end up adding more fat than muscle""defeating the very purpose of the exercise.