All may not be right and bright with the world, and Indian economy, but the UPA government is going full steam ahead. Stung by China, which in a decade or so has seen four of its banks in the list of top-10 biggest global banks, the Manmohan-Chidambaram team is now pushing for creation of an Indian banking behemoth to rub shoulders with the global banking giants.

The idea, say experts, is to enhance India’s role in the Western financial markets.

Not quite surprisingly, the need for restructuring of banks was felt soon after India liberalized its economy in 1991, under finance minister Manmohan Singh. And it is under P Chidambaram’s watch as the finance minister that India is feeling 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,” as he put it in May this year.

Ergo, the decision to make the State Bank of India (SBI), the country’s biggest bank by a long, long margin with over 14,000 branches, play a bigger role – globally.

So by the end of this month, SBI is expected to announce merger of one of its associate banks with the parent institution. In line are five associate SBI banks: State Bank of Bikaner and Jaipur (headquartered in Jaipur), State Bank of Hyderabad (Hyderabad), State Bank of Mysore (Bangalore), State Bank of Patiala (Patiala) and State Bank of Travancore (with Thiruvananthapuram as headquarters), expected to be part of the giant called SBI in the next 10 years.
“This was recommended by various committees since 1991 (and) one of the first candidates would be the SBI. It should merge conceptually and thereby bring a lot of efficiency in operations to serve as the global bank for Indian export and import firms. They (SBI) need to do a lot of thinking and reorganisation to make global operations more profitable,” says DK Mittal, former secretary, department of financial services, under whose tenure the government brought out a blueprint on the functional improvement in the operations of public sector banks (PSBs), including the option for merger. 

Having retired in February 2013, Mittal had written to the head of PSBs about improving their administration and performance.

That the game is on well and truly was borne out by the Reserve Bank of India’s (RBI) decision in August to issue a discussion paper on indicative reorientation of the banking structure. In the paper, the banking regulator suggests creation of three or four very large banks. “The desire to find a place in the global list for Indian banks probably emerges as we increasingly integrate with the global economy and progress to fuller capital account convertibility,” says the 88-page discussion paper, titled ‘Banking Structure in India: The Way Forward’.

“Globalisation of Indian banks,” the paper says, “would further integrate Indian economy with the vicissitudes of global finance, exposing it thereby to higher degrees of contagion and external sources of systemic risks.”

Formed in 1959 through parliament statue (SBI Subsidiary Banks Act, 1959), these associate banks are area specific banks with strong geographical importance in the state. Having headquarters in Bangalore, Thiruvananthapuram, Hyderabad, Jaipur and Patiala, these banks have overwhelming presence in the area.

So how will the ambitious idea work out? The government plans to merge one of these associate banks every two years, leading to a complete merger, and “consolidation” of banking business, over the next 10 years. “Consolidation in the banking sector may pave the way for stronger institutions with the capacity to meet corporate and infrastructure funding needs,” the RBI paper explains. According to the 12th five-year plan, India needs investments worth $1 trillion only to scale up its infrastructure.

The government’s logic of creating a banking behemoth in SBI has, however, not struck a chord with employees associations in the industry. The All-India Bank Employees’ Association (AIBEA), the country’s biggest such union, and the Bank Employees Federation of India (BEFI) have already called a day-long bank strike on September 25 to protest the move. That comes close on the heels of the ‘anti-merger’ day observed by these unions on September 5.
“We strongly protest against any such proposal of closing down the associate banks and (being taken) over by SBI,” AIBEA says in a letter to the finance minister. “There is no demand from employees, depositors, borrowers, the general public and even shareholders for merger of the associate banks with SBI. Then why (plan) such a merger?”

Jyoti Prakash Gadia, convener of the panel on banking and finance at industry lobby Confederation of Indian Industry (CII), also says the idea might sound good on paper but is not that great when implemented because there have been problems with the merger of banks globally, and there is constant apprehension of such big banks failing, and leaving the economy doddering.

Need to create banking giant

While the idea may not exactly be oven-fresh, the finance minister gave it momentum. “Mergers may reduce competition in certain segments or geographies substantially and may alter competition between banks and non-banks,” he said in the inaugural lecture on the annual day of the Competition Commission of India (CCI) in May.

Raising concern about the position of Indian banks, RBI followed suit. “Since 1991, Indian economy has grown manifold and there has been progressive liberalisation and globalisation. During this period the number of new commercial banks licensed is only 12 and none of the Indian banks has acquired the size and reach on a global scale,” says the RBI paper.

“No Indian bank can compete with any global bank,” says Pradeep Shankar, former managing director of State Bank of Indore.

His contention is seconded by rankings accorded by Brand Directory, which is quoted by the RBI paper: only one Indian bank figures among the 50 biggest banks of the world – SBI, ranked at 38. While ICICI Bank is 99 and HDFC Bank 126, the second best among PSU banks is Punjab National Bank (PNB), ranked a poor 189, followed by Bank of Baroda (BoB) at 206.

In contrast are the Chinese banks, which are moving up the ladder at a stupendous pace. According to the latest report in Banker, a trade publication of the renowned British magazine, The Economist, the Industrial and Commercial Bank of China (ICBC) has topped the world’s banking list by market capitalization for 2013 – a first for a Chinese bank. According to data available, ICBC has 244 overseas branches in 34 countries and regions.

Besides, as many as three other Chinese banks – China Construction Bank, Bank of China and Agriculture Bank of China – are among the world’s top 10 biggest banks, the Banker says. Three decades ago, China created all four banks from its central bank, People’s Bank of China, and the ascension has been at an enviable clip since. In early 2000, the report says, ICBC was ranked an also-ran 32nd among the world’s top 1,000 banks – incidentally, nearly the same position the SBI enjoys today.

While the RBI paper on banking reforms gives the system a pat on the back – “financial soundness of the Indian commercial banking system compares favourably with most advanced and emerging countries,” it says – challenges nevertheless lie ahead. Like the Indian banking system withstood the 2008 global financial crisis, which tumbled the banking system of many western countries, experts also point out that the ongoing move to implement Basel-III norms in parts since April 2013 (see box for what Basel-III norms are) would necessitate certain changes. It is viewed that banks have to realign their businesses for optimisation of core capital to implement these norms, which are a set of international banking regulations and are to be fully put into action by March 31, 2018.

In that case, smaller banks will need a lot of capital infusion. According to D Subbarao, the RBI governor till recently, Indian banks will need to raise as much as Rs 4.95 trillion to meet Basel-III norms by 2018. This also includes Rs 3.25 trillion as non-equity capital and Rs 1.75 trillion in equity capital over the next five years.

The banks also need capitalisation to meet their enhanced lending, which is increasing every year. “So you need consolidation among banks. There is a need for merger because smaller banks with large NPAs can’t sustain,” senior business and finance journalist Alam Srinivas says. “Associate banks, or even smaller banks, can’t survive on their own in future.”

Nirupama Soundararajan, additional director of the industry chamber FICCI’s committee on banking and financial institutions, elaborates the same point: “If smaller banks are merged into the big banks, the cost will be absorbed by the parent bank.”

Asked about the observation that SBI, if and when it becomes a banking giant, would find it difficult to get a footing in overbanked western economies, Soundararajan shrugs off the suggestion. “Indian banks can tap two important sectors by going global. The first is the NRI community, which wants to put money into banks, especially Indian banks. (The second group is) Indian industries that are going abroad – Indian banks would be the natural choice of doing transactions (for these companies),” she adds.

Merger: concerns and apprehensions

In 115 years of India’s banking history, Punjab National Bank (PNB) has seen seven mergers – the most for any Indian bank. But the first time a public sector bank was merged with another came on September 4, 1993, when New Bank of India (NBI) merged with PNB. Bleeding with heavy losses, non-performing assets (NPAs) of NBI were 53 percent of the bank’s total assets at the time of the merger.

But it was far from a smooth transition. “The business figure of NBI was equivalent to five or six big branches of PNB and staff productivity was very low. The NBI did not even have advanced technology,” says CS Jog, former general manager (credit) at PNB who was involved in the merger operations. Looking at the forthcoming merger plans of SBI from his own experience at the PNB-NBI merger, Jog says adjusting human resources is the biggest problem in a merger, though there are also cultural and working predicaments as well.

For eight years, the NBI employees were not promoted – “they felt they had been victimised,” Jog recalls. In 1997, about four years since the merger, the number of NBI branches was reduced from 591 to 525 to avoid duplicating branches in the same area.

The next government-owned bank was merged only after 15 years, when State Bank of Saurashtra was merged with SBI in 2008. While the Left parties raised objection to the merger, the Lok Sabha put its seal on the decision: the bills to repeal the State Bank of Saurashtra Act and amend the SBI (Subsidiary Banks) Act were passed by voice vote in parliament in 2009.

In 2010, State Bank of Indore was merged with SBI with the cabinet’s approval. After that, staff benefit cost delayed the merger of associate banks with SBI. There are three terminal benefits – gratuity, pension and provident fund – for SBI employees compared to two (gratuity and pension) for the staff in associate banks.

Experts also point out the fact that a merger is likely to be helpful and less challenging if both banks in question use the same technology, which holds true for SBI and its associate banks. “So there will be no problem if these banks are merged,” says P Sudhakar, former general-secretary of Associate Bank Officers’ Association (ABOA) who retired recently from State Bank of Hyderabad. “The only problem SBI will face in merging with its associates is from SBT, because the bank has lots of litigations.”

SBT, as also State Bank of Bikaner and Jaipur and State Bank of Mysore, would take additional time in merging with the SBI because all three banks are listed entities, with non-promoter holding ranging between 7.7 percent and 25 percent.

The State Bank of Hyderabad and State Bank of Patiala are fully owned by SBI.

Merger: contrarian view

While the SBI’s merger process with its associate banks is said to cost the government about Rs 10,000 crore, Sudhakar, says that shouldn’t be a huge problem. “First, the government is not going ahead with the merger of banks in one go, and second, there are ‘secret reserves’ (contingency fund) with the bank which can take care of merger.”

But experts say the time is not ripe for the SBI to go international. “Before Lehman Brothers (US banking giant that declared bankruptcy in 2008 and precipitated the crisis in that market), mergers were the hot debate (in banking circles). There was the suggestion that there should be top banks in India. But there is always a chance of big banks failing and harming the economy,” says Gadia of CII.

Experts also say the government will have to be careful with the merger process. “Every bank has got its business stronghold (in different regions of the country). If a bank is strong in western India and merges with two or three small banks of the same region, will the mergers be called successful? Will it really serve the purpose of merger?” Jog asks.

“When you merge banks it will only increase the size of the balance sheet,” he says. “When you go international what about your social commitments?”
Soundararajan counters: “The global operational profit can be utilised in meeting financial inclusion schemes and taking banking to unbanked areas. Our economy can only benefit from that.” But amid the big debate between yeas and nays, the merger will take time in India.

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The 5-minute capsule

Where Indian banks stand in global league

• State Bank of India: 38
• ICICI Bank: 99
• HDFC Bank: 126
• Axis Bank: 175
• Punjab National Bank: 189
• Bank of Baroda: 206
•  

RBI paper on consolidation of banks

Pros 

• Consolidation may facilitate geographical diversification and access to new markets
• Big banks are usually expected to create standardised mass-market financial products
• Transaction costs and risks associated with financing of small businesses may be high for small banks. Large and consolidated banks can mitigate costs better and lend to these sectors

Cons

• Consolidated banks may rather cater to big-ticket businesses, and in the process adversely affect financial inclusion
• On globalisation, an opposing view is that instead of looking outwards, Indian banks should look inwards by scaling financial deepening.

Banking on behemoth? What experts say

DK Mittal (former secretary, department of financial services): Merger will become inevitable if the economy remains so (in crisis). NPAs will then touch about 10-15% (from the present 4-5%). In that case, either the good banks or the government would have to bail out the bad banks. This situation, rather than politics or pressure from trade unions, will force PSBs to merge among themselves.

Nirupama Soundararajan (additional director, FICCI committee on banking and financial institutions): There can be quid pro quo – if other countries do not let Indian banks to work, then there can be agreement with that country: you open a bank here, and Indian banks will do the same.

Pradeep Shankar (former MD, State Bank of Indore): Consolidation in banking sector may pave way for stronger financial institutions with capacity to meet corporate infrastructure funding needs. Like in the case of Tata buying Corus, Indian banks can chip with the funding.

Jyoti Prakash Gadia (convener, CII panel on banking and finance): If big banks fail, it will hurt the economy. Failure of small banks will not hurt much. Recent trend says big banks are failing often.

CS Jog (former general manager-credit, PNB): There are restrictions in operating in other countries. Getting a banking foothold in the West is not easy, as new licences are not easily given. Most western countries have got strict regulators.