Is consolidation in the banking sector a myth?

DEBATE

Leo Puri,
Director (financial services),
McKinsey

A myth is something which is not happening now - something that is not there in reality. Nevertheless myths inspire people's imagination. Consider, for instance, stories from Indian mythology. We don't know whether the events narrated in the stories actually happened, but they influence us a lot, have a strong hold on us, and impact our behaviour. The consolidation scenario in Indian banking looks similar. It is being talked about a lot by bankers, analysts and regulators, but it is not happening. It it also not clear why it is not happening.

Why do we need consolidation in the banking sector? The banking system as a whole needs to raise capital and only strong banks are likely to do so. Consolidation can make this possible. Skills need to be concentrated at one place for getting the best benefits.

We should be looking at a market capitalisation of $40-60 billion in five years from now and not just $5-10 billion as is the case now. There is a need to improve the architecture of the financial system. Hence consolidation is required, and will be healthy.

But what is preventing consolidation? Despite all the loud talk, very little activity is seen on this front. The only instances of some consolidation have been in the case of ICICI Bank-Bank of Madura, HDFC Bank-Times Bank and Centurion Bank-Bank of Punjab. And these cannot be called major events. We are yet to see any major move from big players like SBI, ICICI Bank and HDFC Bank.

Moreover, the government has also not clearly defined its position about consolidation in public sector banks (PSBs).

There are four things that are primarily holding back the consolidation process. Firstly, government is the owner of about 75 per cent of the total assets in the banking system. It has been unable to build the consensus required to bring consolidation.

The consensus has to be built at the employee and management levels. Issues like succession planning and leadership are also important in this context.

Secondly, competition levels have been increasing, but have not reached a point of unsustainability yet. Our banks are still able to sustain in the current form. Even less efficient banks are able to survive in this 'walled garden' where competition has not been allowed to freely come in. Though there are great opportunities in India, neither are private banks allowed to acquire PSBs nor are foreign banks granted a free entry.

A third reason is continuing legislative barriers. Some technical barriers need to be removed. The systems are unable to push forward reforms and amendments are required in laws like Banking Regulation Act. The ground is not yet ready. Lastly, the ability to extract value from consolidation in India is not yet proven. It is yet to be tested.

Moreover in any market, it is the leaders who enhance consolidation. But the leaders in Indian banking have no incentive to do this as they are doing relatively well in the 'walled garden'. They are not in a rush to play the role of the bridegroom. Thus, consolidation remains sub-optimal.

Again, not all consolidation is good. Cobbling together weak banks is not the ideal thing to happen. We need to have strong banks with good managements to be a part of the exercise. So the consolidation in Indian banking continues to be a myth. We are not sure how far it will actually happen.

What could happen in future? Globally, strong competition, both domestic and global, led to the consolidation in banking. The challenge for India going forward is not to weaken the sector, but to bring competition.

Thus, over the next four-five years, the sector will find a way as the systems integrate further. If not now, we may see consolidation happening by around 2010.

H N Sinor,
Chief Executive,
Indian Banks Association

For the past several years, we have been hearing a lot about consolidation in the banking industry. While there are stray cases of M&A activities in the sector, we have not so far seen any major movement in this direction.

As a result there is cynicism around consolidation in the segment. But I do not believe that it is a mere myth and that we will not be seeing major consolidation efforts in the banking sector.

In fact, consolidation in the banking system will be the way forward and there are two factors which will force the sector to consolidate. One, sheer market compulsions arising out of the growth potential in the Indian economy which is right now firing on all cylinders.

Two, the need for efficient capital management under Basel-II norms which are likely to come into effect within 18 months. Today, every sector of economy - agriculture, SME (small and medium enterprises), large manufacturing, services, retail or infrastructure - is poised for growth and it will put pressure on the banking system for funding this growth.

Size and scale will be of paramount importance, as it will give banks larger resources and greater resistance. Banks will need more capital not only to fund the growth but also to provide cushion against higher risks.

Besides, banks will need greater penetration to meet the aspirations of customers who are under-serviced. Consolidation provides an answer for bringing in size and scale, efficient management of scarce capital and greater financial stability, reducing systemic risk and improving shareholder value.

However, the process of consolidation cannot be without pains. Major challenges will be in terms of branch rationalisation, re-skilling of labour force, technological up-gradation and development of new products and processes.

Consolidation will also have to be seen from another angle. Regulators already prescribed the roadmap for entry of the foreign banks by 2009. They also came out with clear guidelines in terms of ownership and governance structure in private sector banks, making it mandatory to have a capital base of Rs 300 crore within a specified timeframe. Similarly, special prescriptions are made for urban co-operative banks and regional rural banks, signaling regulators' preference for consolidation.

Juxtaposing these guidelines from regulators and the environmental compulsions, one cannot but foresee mergers in the banking sector taking place at an accelerated pace over next two to four years. It is inevitable.