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The acquisition of ING Vysya Bank by Kotak Mahindra Bank has not only brought these stocks into focus but also given other banking stocks a boost. Against a 0.86 per cent move on the Nifty, banking sector index, Bank Nifty has moved up by 2.55 per cent.
Mergers generally have a tendency of re-rating the entire sector as the acquisition valuations are used by the market to adjust valuations of the players in the sector.
But the Kotak–ING Vyasa merger has much larger ramifications for the sector other than just valuation adjustment. The merger now makes Kotak Mahindra Bank a strong national player, the fourth largest in the private sector, with pan India presence. Citi Research terms the merger as value enhancing and a right step.
With new banks likely to be cleared by RBI soon, consolidation is expected to pick up to gain market share. Private sector players, being nimble footed have a clear advantage over public sector banks in growing their business inorganically. Among the public sector banks, State Bank of India has been merging smaller banks into itself. But there is enough room for public sector players to consolidate themselves.
The merger once again raises the question of big banks versus small banks. Former Chairman of SBI, AK Purwar in an interview with CNBC said that he personally feels that there has to be not one SBI but at least four-five banks of the size of SBI where they can compliment globally and compete domestically. Former Finance Minister P Chidambaram was also in favour of mergers in the banking system so that India can have two-three global sized banks.
The Lehman crisis however revealed the problems of big banks, which have to be saved in a crisis as they are too big to fail and can rock the economy. Ireland is the best example of how an economy collapsed trying to prevent a big bank collapse. Ireland provided extensive financial support to its large banks but had to seek financial assistance from the EU and the IMF in 2010.
However, it is also true that smaller banks fail more often than larger ones. Because of their larger asset base, bigger banks are considered to be less risky as compared to the smaller ones. Further, failure of smaller banks does not present systemic risk as they are generally not interconnected as compared to larger banks.
It is also a fact that as the economy grows banks needs to get bigger to finance their growth. Between 1984 and 2011, number of banks in the USA reduced from 14,483 to 6,290 while the asset base increased from $167 million in 1984 to $893 million in 2011 ( Read here) largely on account of consolidation.
A discussion paper by RBI on ‘Banking Structure in India – The way forward’ advocates consolidation of banks. The report says ‘The issue of consolidation in the banking sector has assumed significance, considering the need for a few Indian banks to cater to global needs by becoming global players and the growing corporate and infrastructure funding needs.
On smaller banks, the report says that they play an important role in the supply of credit to small enterprises and agriculture and banking services in unbanked and under-banked regions in the country. While permitting large number of small banks, however, the issues relating to their size, numbers, capital requirements, exposure norms, regulatory prescriptions, corporate governance and resolution need to be suitably addressed.
The large size of projects India is talking of needs larger sized banks to finance it. Chidambaram rightly said "The need for two or three world sized banks in an economy that is poised to become one among the five largest in the world is rather obvious."
While both types of banks are needed for the economy, the urgent need is for creating bigger banks and the fastest way to do this is through consolidation. Private sector players have identified the opportunity and it is up to the government to recognize it and encourage consolidation of public sector players as well.
