Constrains in PSBs consolidation

What is the issue?

• Recently union government announced Alternative Mechanism to facilitate consolidation among the public sector banks (PSBs).
• Before implementing the recommendations government need to address few constrains in consolidation.

What is the actual status of Indian banking?

• At present, almost all PSBs are beset with stressed assets problem, with varying degrees of stress.
• It is argued that the Indian banking system are fragmented and uncompetitive.
• They do not capture scale benefits in risk diversification, IT and back-office processing.
• They lack skills in risk management, IT and product innovation.
• PSBs are mid-sized or “stuck-in-the-middle,” operating with similar business models.

What is Alternative Mechanism?

• Alternative Mechanism (AM) will create strong and competitive banks to meet the credit needs of a growing economy, absorb shocks.
• The salient features of the approval framework for consolidation of PSBs under AM are:

i) The decision regarding creating strong and competitive banks would be solely based on commercial considerations.

ii) The proposal must start from the Boards of PSBs.

iii) The proposals received from PSBs for in-principle approval for amalgamation would be placed before AM.

iv) After in-principle approval, PSBs would take steps in accordance with law and SEBI requirements.

v) The final scheme would be notified by the central government in consultation with the Reserve Bank of India (RBI).

What are committee reports favouring consolidation?

• Narasimham Committee I (1991) - Consolidation would make economic and commercial sense where the whole would be greater than the sum of its parts, and have a “force-multiplier effect.”
• It also recommended local banks whose operations would be confined to specific regions, and rural banks.
• Narasimham Committee II (1998) -It emphasised that consolidation process in PSBs needed to be based on synergies, and locational and business-specific complementarities.
• Raghuram Rajan Committee (2008) - This also favoured some consolidation among banks that aim to play on a larger stage and takeover of PSBs by other PSBs should not be discouraged.

What constrains need to be considered before consolidation?

• Some of the smaller banks that specialise in certain areas of business or regions may have a comparative advantage over larger banks by virtue of their core competence.
• “Too big to fail” banks create externalities for the economy, and when they fail, public authorities have no alternative but to bail them out.
• Even after merger of a few PSBs, no Indian bank, including SBI, will be able to become an international bank in true sense of the term.
• It cannot be said that skill-sets and managerial efficiency would improve.
• Similarly, it cannot be said that fewer banks would be more competitive at least theoretically, they would bring down competition.
• That would be unhelpful to the minority shareholders of the relatively stronger banks, if consolidation is done at lesser value.
• Even after consolidation, if strong and valuable PSBs do not emerge, their capacity to raise resources from the market without unduly depending on the state exchequer would be constrained.
• There are also major issues in merger, like resistance from trade unions, integration of human resources, culture, technological systems, business and accounting practices, etc.

Source: Financial Express