See discussions, stats, and author profiles for this publication at: https://www.researchgate.

net/publication/331275161

THE CONSOLIDATION OF PUBLIC SECTOR BANKS: A RAY OF HOPE

TO THE NPA PROBLEM IN INDIA- IJLPR (NUJS)

Article · July 2018

CITATIONS READS

0 1,164

1 author:

Krati Rajoria
Amity University Madhya Pradesh
12 PUBLICATIONS   1 CITATION   

SEE PROFILE

All content following this page was uploaded by Krati Rajoria on 22 February 2019.

The user has requested enhancement of the downloaded file.

 Rajoria / The Consolidation Of Public Sector Banks: A Ray Of Hope To The NPA Problem In India

THE CONSOLIDATION OF PUBLIC SECTOR BANKS: A RAY OF

HOPE TO THE NPA PROBLEM IN INDIA

Krati Rajoria
Assistant Professor, Amity Law School, Amity University Madhya Pradesh
email: rajoria88@gmail.com

Abstract
Debate around merger of PSBs to consolidate them into 6 mega-banks has
geared-up, with the recent merger of SBI with 5 other associate banks, The
paper makes a case for consolidation of PSBs in order to reduce NPAs,
increase efficiency and improve risk diversification. The author looks at
whether bank consolidation improves bank healthiness and stabilizes the
banking system. The paper is divided into five parts. Part I is the
Introduction; Part II deals with the rising NPA problem in Public Sector
Banks and identifies the reasons for the same; Part III Traces the history of
the banking system consolidation; Part IV analyses the practicality of the
consolidation of banks; Part V provides for recommendations and
conclusion. The paper concludes with author making an effective case for
consolidation. While many issues such as inter alia human resource,
evaluating business and performance of the two banks, geographical limits
and ‘too big to fail’ policy of the government needs to be revisited,
consolidation of banks seems imminent and a way out at least to some extent
to manage the NPA menace.

Keywords: Consolidation, NPA, PSBs

1. Introduction

After Finance Minister Arun Jaitely proposed formulating a ‘roadmap’ for

consolidation of banks in his 2016-2017 budget speech1, kick-start of the
process of transformation of IDBI Bank and cabinet’s approval on June 15,
2016 to merge State Bank of India (‘SBI’) with its five other associate
banks2, the consolidation of Public Sector Banks (‘PSBs’) in India seems
imminent. However, with the policy focus of the present government
shifting towards consolidation of banks, the debate around its viability and
benefits of consolidation of PSBs with an aim to reduce Non-Performing
assets (‘NPA’) has also received limelight. The debate on consolidation in
the banking sector raises questions on whether mergers will enhance the
efficiency of surviving banks and contribute to their stabilization.

1
Arun Jaitely, Budget Speech 2016-2017 available at http://indiabudget.nic.in/ub2016-
17/bs/bs.pdf (p.18).
2
Cabinet approves merger of 5 associate banks with SBI, Economic Times, June 15, 2016.

ISSN (O): 2278-3156 Vol. 7 No. 2 July 2018 97

International Journal of Law and Policy Review (IJLPR)

PSBs continue to hold the highest level of stressed advances ratio at 14.5
per cent as opposed to Private Sector Banks (‘PVBs’) or Foreign Banks
(‘FBs’). 3 According to India Ratings and Research, impaired assets are
likely to rise to 12.5 per cent of loans in 2016-17, from 10.8 per cent in
FY15.4 The primary stressed advance ratios were observed within the basic
metal, metal products, construction and textiles sector. As of March 2016,
gross NPA of 40 listed banks were at INR 5.82 trillion. The aggregate gross
NPA of PSBs at the end of September quarter earnings was Rs.6.49 trillion
which is a 97% increase from Rs.3.29 trillion at the same time in 2015.5

With overall stressed assets in India amounting to around INR 7 trillion,

special situation investments are on the rise. Macro-economic aspects aside,
the enabling legal framework such as the liberalization of foreign
investments in Asset Reconstruction Companies, the recent amendment in
SARFAESI Act, Bankruptcy Code, Joint Lender Forum, Strategic Debt
Restructuring norms etc. have added a further impetus to the sector and has
helped create significant opportunity for both financial sponsors and
strategic buyers. However, the dynamic economic landscape and the rapid
legal development have also created significant challenges. While these
measures are aimed at reducing bad loans in the banking sector,
consolidation of Indian banking industry is another highly probable and
effective measure to resolve the bad loan problems.

But before we discuss the resolution of the financial distress of PSBs by

merging it with other PSBs, it is important to identify the reasons for rising
NPA in PSBs in order to correctly evaluate the possible implications of a
merger between two PSBs.

2. Rising NPA in PSB - Identifying the Reasons

The incidence of NPAs is higher in PSBs, which is a matter of severe

concern. Let us first try to understand the context behind such high
incidence before taking any corrective measures.

Till 1997 when bad loans were on a rise, Indian banks dramatically lowered
their NPA below global average of 7% by 2006. But after 2008, both PSBs

3
Reserve Bank of India, Financial Stability Report, June 2016, available at
https://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/0FSR2316BB76DB39BF964542B9
D1EBE2CBC273E7.PDF, (p.23). (Last visited on December 21, 2017)
4
Stressed assets ratio of banks to rise to 12.5% in FY16, The Hindu, Feb 2, 2016, available
at http://www.thehindu.com/news/cities/mumbai/business/stressed-assets-ratio-of-banks-to-
rise-to-125-in-fy16/article8181866.ece. (Last visited on December 21, 2017)
5
Ashwin Ramarathinam & Sahib Sharma, Bad loans continue to pile up at banks in Q2,
Livemint, November 15, 2016.

98 Vol.7 No. 2 July 2018 ISSN (O): 2278-3156

 Rajoria / The Consolidation Of Public Sector Banks: A Ray Of Hope To The NPA Problem In India

and PVBs took a different view on what to do with bad loans and how to
prepare balance sheets.6 This led to rising NPAs in PSBs which was more
than that of PVBs.

PSBs constitute over 75% of total advances made, a higher proportion of

which is in the stressed sectors such as infrastructure sector (32.8%), basic
metal and metal products (13.6%), and textiles sector (6.9%).7 PSBs share
of lending to the stressed assets sectors such as mining, iron and steel,
textiles, infrastructure and aviation is also high. For example, PSBs account
for 17.6% of total advances to infrastructure as compared to 8.4% by
PVBs.8 PSBs have 14.5% share of stressed loans of their total loan book
while that of private and foreign banks was 4.5%.9 Data as on December
2015 shows that textile industry had the highest number of standard
accounts slipping into NPA category at 8.8% followed by cement at 8%. In
terms of the loan outstanding amount, the slippage was highest in iron and
steel industry at 7.8% followed by textile at 6.4%.10

Fitch Ratings which downgraded Indian Banking Sector outlook to

‘negative’ said that Indian banks capital positions which was historically
weak has worsened due to delayed recognition of asset problems and high
loan loss provisions. It speculated the position to remain weak unless
government infused significant capital in the banks.11

Many sources of lending distress were highlighted by Raghuram Rajan12 in

his speech. First, the repayment of loans has become difficult because a
number of these loans were made in 2007-2008 when the economic growth

6
Sugata Ghosh, Concerted action and not blind mergers will help tackle NPAs at public
sector banks, The Economic Times Blogs, January 18, 2016.
7
Master Circular - Prudential Norms on Income Recognition, Asset Classification and
Provisioning pertaining to Advances, RBI/2015-16/101, July 1, 2015, (pp. 4.2.5), available
at https://rbidocs.rbi.org.in/rdocs/notification/PDFs/101MC16B68A0EDCA9434CBC239
741F5267329.PDF. (Last visited on December 24, 2017)
8
Charan Singh & Jagvinder Singh Bar, Stressed Assets and Banking in India, April 2016,
Working Paper No. 507, IIMB-WP N0. 507, available at
https://www.iimb.ernet.in/research/sites/default/files/WP%20No.%20507.PDF. (Last
visited on December 24, 2017)
9
NPAs, low loan demand block for lending despite huge deposit: Study, The Economic
Times, December 1, 2016.
10
Sangita Mehta, Infrastructure, metals and textile sector have contributed most to the
stressed loans, The Economic Times, June 28, 2016.
11
Fitch Ratings downgrades Indian Banking sector outlook ‘negative’, Business Standard,
July 5, 2016.
12
Raghuram Rajan, Resolving stress in banking sector, June 22, 2016, ASSOCHAM –
Interactive Meet with Industry & Trade, Bengaluru, available at https://rbidocs.rbi.org.in
/rdocs/Speeches/PDFs/RSBS220616AF29FC8F00A048B58685073669B575C5.PDF. (Last
visited on December 24, 2017)

ISSN (O): 2278-3156 Vol. 7 No. 2 July 2018 99

International Journal of Law and Policy Review (IJLPR)

was high, deposits in PSBs were rapid and many infrastructure projects
were financed. The banks extrapolated the past growth and over-estimated
the future growth, which was blemished by global financial crisis. Second,
lending by PSBs is tarnished by senseless enthusiasm and excessive
dependence on evaluations by others. Due to inefficient post-lending
monitoring and loan recovery system, many banks do not receive the
interest. In many cases the PVBs were more agile in securing their
collaterals from promoters or getting repaid even as PSBs supported
projects with fresh loans.

In the working paper by Charan & Jagvinder Singh13, the case study on
tractors appropriately highlight the contrast in approach between loans
advanced by PSBs and PVBs. The verification process of the loan,
application, repayment capability and recovery plan in PSBs is not robust.
There is no follow up by PSBs after the loan is dispensed and no strict
recovery regime. PSBs are reluctant to repossess (say) the tractor, many
times because of political reasons unlike PVBs.

Corporate governance norms in Boards of PSBs is also faulty. As was

highlighted in Report of Committee headed by P.J. Nayak14 the composition
of Boards of PSBs has many critical problems. Except for the shareholder
directors, the Board is ‘non-independent’. Even the independent directors
are largely nominees of government. The non-government shareholding is
largely held by institutions that are indirectly controlled by the government.
It is these institutions which largely select the independent directors as well.
Thus, the PSBs do not have independence and semblance to good corporate
governance.15

Former RBI Governor Raghuram Rajan blamed the overall economic

downturn in increasing stressed assets in India. Wilful default, corruption
and loan frauds are some other reasons cited by him in response to K.V.
Thomas led Public Accounts Committee questions.16 Slow policy decision-
making, tight liquidity and a sluggish economy have also contributed to the

13
Supra note 8.
14
Report of The Committee to Review Governance of Boards of Banks in India, May 12,
2014, available at https://rbi.org.in/Scripts/PublicationReportDetails.aspx?ID=784#CH4.
(Last visited on December 24, 2017)
15
M.S. Sriram, Governance reforms in Banks: Nayak Committee Report, Business Today,
May 20, 2014, available at http://www.businesstoday.in/opinion/columns/m.-.s-sriram-on-
governance-reforms-in-banks/story/206375.html. (Last visited on December 30, 2017)
16
Six reasons why bad loans are a menace in India, according to Raghuram Rajan, May 1,
2016, DNA, available at http://www.dnaindia.com/money/report-six-reasons-why-bad-
loans-are-a-menace-in-india-according-to-raghuram-rajan-2207976. Last visited on
December 30, 2017)

100 Vol.7 No. 2 July 2018 ISSN (O): 2278-3156

 Rajoria / The Consolidation Of Public Sector Banks: A Ray Of Hope To The NPA Problem In India

disparate performance of PSB.17 However, one needs to understand that the

causative factors might be unable to reflect actual proportion of non-
performance of banks owning to genuine business risks.

3. Tracing the History of Banking System Consolidation

The need for consolidation of PSBs cannot be overstated. With no bank in

the country featuring in the top 10 banks of the world in terms of asset size,
consolidation of banks seems obvious and forthcoming to finance the
infrastructure needs of the country.18 There are 27 PSBs in the country and
various Reports19, which have advocated the merger of small PSBs to reap
the benefits of economies of scale and scope. Consolidation will help in
utilization of capital more efficiently and the merged entity will have greater
capacity to raise capital. It will also increase the ability of banks to recover
bad loans with the combined entity having far more focused approach.20
Let us first look at the global experience from banking consolidation and
trace the history of consolidation of Indian banking system and evaluate its
successes and failures.

3.1 Consolidation of Banks: Cross-Country Experiences

International experience towards consolidation of banking system has been

favorable. When banking crises weakened the financial systems in many
countries, in order to improve the efficiency and structure of the banking
industry they went for consolidation and mergers. While consolidation in
Central Europe was market driven it was done due to serious banking crises
in Korea and South-East Asian countries.21

In Japan many banks were consolidated between 1990-2004 when many

suffered losses from huge amount of non-performing loans.22 These banks

17
Outlook for stressed assets markets in India, 2014, Alvarez & Marsal, available at
https://www.alvarezandmarsal.com/sites/archive/files/sidebar-callouts/india-stressed-
assets.pdf. Last visited on December 30, 2017)
18
Indian banks should aim to be in world’s top 10: PM Modi, NDTV Profit, January 3,
2015.
19
See: Fitch: India Bank Consolidation positive in long-term, March 9, 2016,
https://www.fitchratings.com/site/pr/1000697. Last visited on December 30, 2017)
20
Manojit Saha, Public sector bank consolidation: A painful journey ahead, The Hindu,
March 27, 2016.
21
M Jayadev & Rudra Sensarma, Mergers in Indian Banks: An analysis,
https://core.ac.uk/download/pdf/1639429.pdf (p.8-9). (Last visited on December 30, 2017)
22
Kaoru Hosono, Koji Sakai & Kotaro Tsuru, Consolidation of banks in Japan: Causes
and Consequences, RIETI Discussion Paper Series 07-E -059,
http://www.rieti.go.jp/jp/publications/dp/07e059.pdf (p.32). (Last visited on December 30,
2017)

ISSN (O): 2278-3156 Vol. 7 No. 2 July 2018 101

International Journal of Law and Policy Review (IJLPR)

gained a lot of momentum and profited as a result of large-scale mergers

and acquisitions between 1990-2004.23

The authorities in Italy to deal with non-performing loans fostered

consolidation of their highly fragmented banking sector along with
improving the Italian insolvency system. International Monetary Fund in its
Report of July 2016 24 also approved consolidation of baking system for
cleaning the balance sheets and improving profitability.

The International Monetary Fund Financial Stability Report, 2016 25

suggested to the European banks that consolidation of banks must be
undertaken to reduce non-performing loans and structural drags on
profitability along with strengthening of insolvency regime. To keep the
importance of Germany’s banking sector and to prevent it from further
shrinking, experts have suggested a speedy consolidation of the banking
sector and realignment of business models.26

Many other countries such as inter alia, United Kingdom and United States
of America also went for massive banking sector consolidation to get rid of
non-performing loans, which proved useful in the long run. For example,
The Riegle-Neal Interstate Banking and Branching Efficiency Act, 199427 in
the USA allowed banks to consolidate their operations under one band. It
also encouraged the banks to expand, diversify their holdings and realize
economies of scale.28 These processes made banking simpler for customer,
increased financial stability and improved bank efficiency.29 The same has

23
Id.
24
IMF working paper, José Garrido, Emanuel Kopp & Anke Weber, Cleaning-up Bank
Balance sheets: Economic, Legal and Supervisory Measures for Italy, 2016,
https://www.imf.org/external/pubs/ft/wp/2016/wp16135.pdf (p. 4). (Last visited on
December 30, 2017)
25
International Monetary Fund, GLOBAL FINANCIAL STABILIT Y REPORT:
FOSTERING STABILIT Y IN A LOW-GROWTH, LOW-RATE ERA, October 2016,
http://www.imf.org/external/pubs/ft/gfsr/2016/02/pdf/text.pdf (p.10); David Lawder, IMF
says European banks need urgent asset clean-up, consolidation, Reuters, October 5, 2016.
26
German banks falling behind, Reuters, http://www.dw.com/en/german-banks-falling-
behind/a-36663330. (Last visited on December 30, 2017)
27
Pub. L. No. 103-328, 108 Stat. 2338 (1994) (codified in 12 U.S.C.).
28
Indick, Murray A. & Satish M. Kini, The Interstate Banking and Branching Efficiency
Act: New Options, New Problems, 112 Banking L.J. 100, 1995.
29
Hubert P. Janicki and Edward Simpson Prescott, Changes in the Size Distribution of U.S.
Banks: 1960–2005, Federal Reserve Bank of Richmond Economic Quarterly, Vol. 92/4, p.
296, Fall 2006; James Barty and Tommy Ricketts, Promoting competition in the UK
Banking industry, June 2014, https://www.bba.org.uk/wp-content/uploads/2014/06/BBA
_Competition_Report_23.06_WEB_2.0.pdf (p. 51). (Last visited on December 30,
2017)

102 Vol.7 No. 2 July 2018 ISSN (O): 2278-3156

 Rajoria / The Consolidation Of Public Sector Banks: A Ray Of Hope To The NPA Problem In India

also been corroborated by various Reports of International Monetary Fund

as mentioned above.

3.2 Consolidation of Banks: Indian Banking System

Historically, India has been slow in bank consolidation that has left the
sector highly fragmented. Despite many recommendations of merging PSBs
and creating a conducive environment for mergers and amalgamations in
reports such as Narasimham Committee Report I (1991)30 and II (1998) and
Rakesh Mohan- led Committee on Financial Sector Assessment, 31 the
consolidation of Indian banking sector has been debated and discussed for
many years.

Many Experts have believed from a very long time that India has too many
PSBs which compete in the same geography and have roughly similar
business models.32

There are primarily two kinds of bank consolidation. The first is a voluntary
merger and the other is merger of banks done from the perspective of
resolution of weak banks.

Merger of Kotak Mahindra Bank with ING Vysya Bank is an illustration of

voluntary merger which was driven by geographical synergies and
economic logic which is common in the private sector.33 Other illustrations
of such voluntary mergers are acquisition of Bank of Madura in 2001 and
Sangli Bank in 2007 by ICICI Bank and acquisition of Centurion Bank of
Punjab by HDFC Bank in 2008.34 State Bank of Saurashtra and State Bank
of Indore merging with SBI was a merger of group companies. The Reserve
Bank of India (‘RBI’) has powers under section 44A of Banking Regulation
Act, 1949 to approve such voluntary mergers and till now have been quite
supportive of them.35

30
Chapter VII, Organisation, Methods and Procedures in Banks, NARSIMHAN
COMMITTEE REPORT ON THE FINANCIAL SYSTEMS, (November 16, 1991).
31
India’s Financial Sector An Assessment available at https://www.rbi.org.in
/scripts/PublicationReportDetails.aspx?ID=544 (Last visited on December 30, 2017)
32
Polling synergies, Beyond Markets, Volume 8 Issue 07 | 01st - 15th Jul ’16,
http://www.nirmalbang.com/BeyondMarketNew/Beyond%20Market%20-
%20Issue%20123.pdf (p.7). (Last visited on December 30, 2017)
33
RBI approved ING Vysya - Kotak Mahindra merger, Business Standard, April 2, 2015.
34
M Jayadev & Rudra Sensarma, Mergers in Indian Banks: An analysis,
https://core.ac.uk/download/pdf/1639429.pdf. (Last visited on December 30, 2017)
35
Sec. 44 A of the Banking Regulation Act, 1949 provides for a detailed Procedure for
amalgamation of banking companies subject to the sanctioning of the amalgamation
scheme by Reserve Bank of India

ISSN (O): 2278-3156 Vol. 7 No. 2 July 2018 103

International Journal of Law and Policy Review (IJLPR)

The other kind of merger is done from the perspective of resolution of a

weak bank and is governed by section 45 of Banking Regulation Act,
1949 which empowers RBI to make a scheme of amalgamation of a bank
with another bank if it is in the depositor’s interest or in the interest of
overall banking system.36 The operations of weak bank may be kept under
moratorium for a certain period of time to ensure smooth implementation of
the scheme. Many private sector banks have been merged with each-other
under this scheme such as merger of Global Trust Bank with Oriental Bank
of Commerce in 2004. Earlier way back in 1960s, post Palai Central Bank’s
failure, there were several such mergers guided by the Reserve Bank.37

Before 1999, most mergers were of the second kind, however post that
period there has been an increasing trend of voluntary mergers but mostly
among PVBs. The PSBs seem to have bypassed the trend despite
opportunities existing.

Consolidation of PSBs was in agenda of previous UPA government I & II

(2004-2014) 38 but the then finance minister P. Chidambaram wanted the
proposal to come from the bank’s Boards as was proposed in Narasimham
Committee Report I, 1991, which never happened. The BJP-led Narendra
Modi government floated the idea of consolidation in first Gyan Sangam
organized by Finance Ministry in 2015 where bankers unanimously opposed
the idea and said that time has not come for consolidation.39 It was also
largely agreed that government of India will have to take the initiative for
consolidation of banks and it cannot happen through individual initiatives of
the banks.40

As a result, the second edition of Gyan Sangam, which took place in March
2016, the discussion was on how to consolidate the banks than whether to
consolidate the banks.41 The Finance Ministry proposed to formulate a bank
consolidation committee and tweak laws such as the SARFESI Act and laws
with respect to Debt Recovery Tribunals.42

36
Sec. 45 of the Banking Regulation Act, 1949 provides for Power of Reserve Bank to
apply to Central Government for suspension of business by a banking company and to
prepare scheme of reconstitution of amalgamation.
37
Supra note 29.
38
Report to the People, UPA Government (2004-2008) available at
http://archivepmo.nic.in/drmanmohansingh/upa_en_2004-08.pdf (Last visited on January
13, 2018)
39
PSU Bank officers stage protest at Gyan Sangam, NDTV Profit, March 4, 2016.
40
Supra note 21 at 5.
41
Supra note 33 at 6.
42
Gyan Sangam 2016 ends; Focus on bank consolidation, NPAs, Money Control, March 7,
2016, http://www.moneycontrol.com/news/business/gyan-sangam-2016-ends-focusbank-
consolidation-npas_5776541.html. (Last visited on January 13, 2018)

104 Vol.7 No. 2 July 2018 ISSN (O): 2278-3156

 Rajoria / The Consolidation Of Public Sector Banks: A Ray Of Hope To The NPA Problem In India

4. Consolidation of Banks- How Practical is it?

4.1 Arguments in Favor of Consolidation

As per Fitch Ratings Agency report of March 2016, a consolidated Indian

banking structure would be a positive development for the Indian banking
system. The Report says that more stable banking systems tend to be
structured around a number of ‘large’ banking groups. Such large banks
enjoy less volatility in earnings, stronger overall profitability and ratings and
better risk diversification. Examples can be observed in Asia-Pacific
including Australia, Singapore, as well as some less developed banking
systems in Thailand and Malaysia.43

Consolidation of 27 PSBs into at least 6 PSBs 44 (also as proposed by

Narasimham Committee Report I, 1991) 45 with better efficiency and
international presence will help finance large and diversified requirements
of the country. India which is a growing economy needs mega-banks to
finance large scale infrastructure projects. Large banks will help reap the
benefits of risk diversification, efficiency in terms of low cost and high
quality services and finance massive projects.46 A country as big in size as
India has only one bank whose letters of credit and guarantees are
universally accepted (SBI) which should not be the case. The system should
have 5-6 such banks which have the balance sheet strength, trust of the
international organizations and can issue letters which are universally
accepted.47

Looking at the Indian banking scenario which seems too fragmented (the
Herfindahl-Hirschmann Index ‘HHI’ for Indian banking sector using square
of on-balance sheet market share of all banks in the system is 518.53 which
is very low proving there is room for consolidation) 48 it is advisable to
consolidate banks which have relatively strong capital ratios and are in a
better position to withstand shocks to asset quality.

43
Fitch: India Bank consolidation positive in long-term, March 9, 2016,
https://www.fitchratings.com/site/pr/1000697. (Last visited on January 13, 2018)
44
Govt. considers merging 26 banks into six big lenders, Business Standard, June 22, 2016.
45
Supra note 30 at 6.
46
Sharan poovanna and Nidheesh M.K., Indian banking system highly fragmented, needs
consolidation: R. Gandhi, Livemint, April 23, 2016.
47
M Damodaran, Is merging PSU banks good idea? Experts debate pros and cons, Money
Control, August 3, 2014.
48
R. Gandhi, Consolidation among Public Sector Banks, April 26, 2016,
https://www.rbi.org.in/Scripts/BS_SpeechesView.aspx?Id=999. (Last visited on January
13, 2018)

ISSN (O): 2278-3156 Vol. 7 No. 2 July 2018 105

International Journal of Law and Policy Review (IJLPR)

Further, with growing India companies, the demand for large scale credit
will become rampant which can only be met by large and strong PSBs.
Hence, the banks will also have to grow in size to meet the demand of huge
credit in an efficient, competitive and well-capitalized manner. 49
Consolidation of banks will also lead to lesser number of bank branches in
urban areas where there are too many branches of different banks in the
same area. Consolidated banks will apply stricter standards to recognize
NPAs than before thereby resulting in increase in disclosed NPA.50

Opponents of merger often talk about ‘privatization’ as an alternative. The

government may consider privatizing a few inefficient PSBs and revisit the
old policy of social control. While privatization will ensure discipline in the
loss making PSBs and force them to rectify their ways and change their
strategy of operations it will have massive deterrent effect on the staff and
management of the banks.51

5. Arguments against Consolidation

While there are many benefits of consolidation of Indian banking system,

the possible challenges and issues in its implementation cannot be ruled out
and/or ignored.

Moody’s Investors Service52 has also suggested that consolidation of Indian

banking system amidst rising stressed assets since 2012 will offset potential
long-term benefits. The Report highlights that no PSB currently has the
financial strength to assume a consolidator’s role without risking its own
credit rating post-merger.

The only support could be from the government, which can infuse equity
capital to shore up capital buffers. 53 The capital adequacy ratio of most
PSBs with the exception of Bank of Baroda and Bank of India is not close to
the minimum capital adequacy levels required under Basel III norms.54 As
per Basel III norms banks must have an adequacy ratio of 10.25% by March
2017 11.5% by March 2019.55

49
Supra note 40 at 7
50
Supra note 22 at 5.
51
Charan Singh, Don’t merge loss-making banks, privatize them, The Hindu, July 1, 2016.
52
Moody’s Investors Service, Moody's: Consolidation of Indian banking system presents
greater risks than benefits, June 28, 2016, https://www.moodys.com/research/Moodys-
Consolidation- of- Indian- banking- system- presents- greater- risks-than--PR_351286.
(Last visited on January 13, 2018)
53
Id.
54
https://www.bis.org/bcbs/basel3/compilation.htm (Last visited on January 13, 2018)
55
Vishwanath Nair, Public sector Banks mergers face many hurdles, Livemint, October 12,
2016.

106 Vol.7 No. 2 July 2018 ISSN (O): 2278-3156

 Rajoria / The Consolidation Of Public Sector Banks: A Ray Of Hope To The NPA Problem In India

The other massive challenge in consolidation of PSBs is the reluctance of

two PSBs to merge when the trend is quite common in the private sector.
The only way PSBs can be pushed towards consolidation is by interference
from the government. Though this will not be the correct manner of
implementing consolidation since it must be voluntary and not forced upon
a sector when it least wants to entertain it. The present Finance Minister Mr.
Arun Jaitely has already highlighted in his budget speech of 2016-2017 of a
‘roadmap’ in this regard to be announced soon. 56 A committee may be
formed by the government, which can thoroughly examine the business of
each PSB and find opportunities for consolidation based on strategy and
synergy in operations such as business, culture, treasury, IT and locational
advantage. The Boards of the concerned banks must be taken into
confidence and interest of all stakeholders must be taken into account.
However, the objectives for merger of banks like ICICI and SBI seem to
have been improvement in share prices, return on asset, return on equity,
earnings per share and net profits as opposed to synergy, efficiency and
economies of scale.57

Those proposing merger of banks suggest merger of banks from different

geographies to improve the number of branches of the consolidated entity in
both the areas. For example, merger of Kotak Mahindra Bank and ING
Vysya Bank was based on geographical synergies that increased the 15%
branches of Kotak Mahindra in south India to 38% post merger.58 However,
consolidation based on geographical synergies will bring various issues with
it. For example, a merged entity after merging a small south Indian bank
into a big north Indian bank will face difficulty in getting retail deposits.
There is a further fear of losing regional and local sensibilities. This is
especially true in the context of five associate banks of SBI merging with
the latter. SBI associate banks which use to cater to specific regions such as
inter alia, Travancore and Bikaner and Jaipur will now lose customers in
what was previously was their ‘operation areas’.59 Though SBI has a tacit
agreement to not compete with its associate banks, such considerations are
likely to get sidelined in light of higher bargaining power of SBI.

The integration of human resource and culture of two different geographies

will also be a difficult task as was the case in merger of New Bank of India

56
Speech of Arun Jaitley, Budget 2016-2017 February 29, 2016 available at (pg.18)
https://www.indiabudget.gov.in/ub2016-17/bs/bs.pdf
57
B Yerram Raju, Why consolidation of Indian banks is no cure to ills, Money Life, March
10, 2016, http://www.aibea.in/upload/flashnews/20160321.pdf (p.5). (Last visited on
January 13, 2018)
58
Supra note 21 at 5.
59
C.R.L. Narsimhan, State Bank of India consolidation has many benefits, but it is not
without pitfalls, THE WIRE, June 27, 2016.

ISSN (O): 2278-3156 Vol. 7 No. 2 July 2018 107

International Journal of Law and Policy Review (IJLPR)

with Punjab National Bank. The two banks might also be using two
different technology platforms, which could be a challenging task to
integrate. For example, merger of Global Trust Bank with Oriental Bank of
Commerce wherein former used a more sophisticated technology platform
as compared to latter took about a decade to assimilate.60

The other challenge in consolidation of PSBs is the employees/workers

union of the banks who have been opposed to consolidation of banks ever
since. The opposition is since 2004 when Finance Minister P. Chidambaram
talked about merger of Bank of India and Union of India.61 Their idea is that
the country needs ‘good banks’ and not ‘big banks’. The Unions have
insisted on first cleaning the balance sheet of the banks and strengthening
individual banks rather than weakening the stronger ones by merging
weaker banks with huge NPAs with bigger ones with cleaner balance
sheets. 62 Many of them further feel that now is not the right time to
consolidate banks when the health of the banks is continuously deteriorating
and banks such as Bank of Baroda, IDBI Bank and Bank of India have
reported record losses.63 The cost of consolidation may also go up in face of
opposition from employee unions and difference in employee schemes of
the two banks. For example, SBI merger with its associate banks will cost
SBI Rs.3500 crores to harmonize employee pension plans.64

Besides, there will inadvertently be problems of fitting general managers

and executive directors of two ranks and deciding on their seniority.65 SBI
has already received 2,500 requests for transfer on the intra-bank portal
which was started to provide comfort to 70,000 employees of five associate
banks which are apprehensive of their future ahead the merger.66

While merger of PSBs have been proposed to overcome the problem of

rising NPAs it is important to remember that merger between two banks
should not be seen as fixing short-term problems as faced by a few PSBs.

60
Supra note 48.
61
BoI, Union Bank set to merge in April, Business Standard, February 6, 2013,
http://www.business-standard.com/article/finance/boi-union-bank-set-to-merge-in-april-
104100601026_1.html
62
Surabhi, Bank consolidation: No major decision likely till FY17, Business Line, March
18, 2016, http://www.aibea.in/upload/flashnews/20160321.pdf (p.2). (Last visited on
January 13, 2018)
63
Supra note 21 at 5.
64
SBI, associate banks merger may be a costly affair: Credit Suisse, The Economic Times,
October 29, 2016; Supra 45 at 11.
65
M Damodaran, Is merging PSU banks good idea? Experts debate pros and cons, Money
control, August 3, 2014.
66
SBI-associate banks merger re-defines union-management relationship, Business
Standard, October 3, 2016.

108 Vol.7 No. 2 July 2018 ISSN (O): 2278-3156

 Rajoria / The Consolidation Of Public Sector Banks: A Ray Of Hope To The NPA Problem In India

There must be a strategic vision which creates value of both merging banks
else a weak bank combined into a strong bank may result in a weak
combined entity if done in hurriedness or not handled properly. 67 For
example, according to a report by Credit Suisse (2016), the gross NPAs at
SBI’s associate banks more than doubled to 13.2% at the end of September
2016 as opposed to 6% last year.

This will transpire into 23% rise in SBI’s consolidated NPAs just from the
associates. 68 Hence, the merging of associate banks would outweigh the
benefits in the short-term as bad loans are expected to mount at the units.
Experts have further argued that consolidation should take place in an
optimistic and confident environment while being driven by inherent
strength of the banking system and not to escape from the problem of rising
NPAs.69

PSBs can also consider consolidating their business by strengthening the

business which they have an expertise in and quit the other areas. They can
leverage their core strength in a focused manner. For example, PSBs, which
have major strength, presence and expertise in agricultural sector, must
chose to focus on agriculture. It can help conserve capital and not waste
energy in highly complex specialized complex and project financing
business. The choice to be made is in between universal banking and
differentiated banking.

Mega size banks may also pose a systemic risk to the economy and may not
always be beneficial to the economy. The 2008 financial crisis also
highlighted the problems created by large banks, which are seen as ‘too big
to fail’. In fact most mega-mergers in banking industry took place to take
advantage of government’s ‘too big to fail’ policy.70

With government’s decision of scrapping old Rs.500 and 1000 notes on

November 8, 2016 there might be an increase in banks deposits. However,
PSBs will get a little higher amount of deposits due to semi-urban and rural
presence but it must be seen that how much of it is retained.71

67
Supra note 21 at 5.
68
SBI, associate banks merger may be a costly affair: Credit Suisse, The Economic Times,
October 29, 2016.
69
Consolidation in Indian Banking sector: Pros and Cons, May 19, 2016,
http://www.jagranjosh.com/current-affairs/consolidation-in-indian-banking-sector-pros-
cons-1463665135-1. (Last visited on January 13, 2018)
70
Youssef Cassis, Crises and opportunities: The Shaping of Modern Finance, Oxford
University Press, (p. 64).
71
Supra note 5 at 2.

ISSN (O): 2278-3156 Vol. 7 No. 2 July 2018 109

 International Journal of Law and Policy Review (IJLPR)

6. Recommendations & Concluding Remarks

It definitely cannot be denied that there is a huge scope for consolidation

among PSBs which can prove very successful in dealing with the problem
of rising NPA provided it is well-measured and based on sound economic
logic. It must also be remembered that consolidation not only means merger
of banks but also focusing on chosen business only.

It is imperative for the success of banking consolidation that it takes place

voluntarily or at least by taking into confidence the Boards of the banks and
various other stakeholders involved. This should especially be done for
government-enforced mergers.

The PSBs need to have a look at inter alia, their structure, functioning
methods, financial and risk management. They must actively participate in
the financial markets especially in the derivate instruments for hedging their
risks, retail banking in PSBs must be completely over-hauled in terms of
instruments, products and methods for deployment and PSBs must chart out
a clear capital raising plan for over the next 5 years.72 Bringing in credible
outsiders to state-owned banks and arranging a fund-line in a way that does
not bloat the equity of the banks can help reduce NPA in banks.73 With bad
loans in PSBs growing by 80,000crores in last three months (July-
September) it will help banks to be vigilant if government declares
exposures of banks in sectors and highlight the sectors that have stressed
assets on a quarterly basis. 74 The banks must also not be influenced by
politicians and lend in a specific sector, for example, steel.75

The long-term benefits of banking consolidation far outweigh the short-term

challenges that are associated with consolidation in the banking sector.
However, the immediate objective must be to address issues such as capital
shortfalls and PSB’s asset quality issues before any step further towards
banking consolidation takes place.

72
R. Gandhi, Public Sector Banks: At crossroads, January 12, 2015,
https://www.rbi.org.in/Scripts/BS_SpeechesView.aspx?Id=932. (Last visited on January
13, 2018)
73
Supra 6 at 3.
74
Bad loans in Public Sector Banks grow by 80,000 cores in 3 months, The Indian Express,
November 30, 2016.
75
Id.

110 Vol.7 No. 2 July 2018 ISSN (O): 2278-3156

View publication stats