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India does not need too many govt banks; consolidation the right move

Dhiraj Relli |  Jun 26, 2017 02:04 PM IST
Dhiraj Relli, MD & CEO, HDFC Securities
After the merger of SBI and its subsidiaries (which seems to be moving smoothly as of now), the Finance Ministry is actively considering more consolidation in the banking space. Apparently, NITI Aayog is working on a road map for further consolidation of public sector banks (PSBs), by studying their synergies, issues such as financial health, NPAs, geographical outreach, regional balance, HR transition, systems’ compatibilities and other aspects.
India does not need so many PSBs. Though this move to consolidate state-run banks will reduce their numbers, it will also make them healthier. This, in turn, will help them stand up to competition from global banks, which will eventually have to be allowed to enter India, either as part of a WTO deal on services, or as part of a bilateral or regional free trade pact. In such cases, the merger proposals will also need clearance from the Competition Commission of India (CCI).
The Government has to be vigilant during the consolidation process, so as to not merge a weak bank with a larger one in a manner which would adversely impact the profitability of the latter. The Narasimham panel was in favour of the closure of weak banks. Most PSBs are listed, and minority shareholders cannot be burdened with decisions that are not justifiable from the commercial angle, or made out of some compulsion.
The merger may be in the form of regional consolidation, wherein a bank in north India  takes over a smaller bank in the south, and so on. A contrary view is that the merger should be between PSBs located in the same geographical location, reflecting the importance of the identity of a bank in a particular region. A combination of the two views could also be used. The potential threat to the deposit base from the upcoming differentiated banks (payment banks, small finance banks etc) to the PSBs is a factor that needs to be kept in mind.
Bank consolidation could also entail the monetisation of real estate assets, offering VRS to manage the headcount, and sale of subsidiaries involved in the so-called non-core businesses, such as insurance and capital markets. The consolidation of PSBs could also involve the leveraging of technology.
The supremacy of PSBs faces constant competition from private sector banks, with their enhanced reach and digitisation. The consolidation of PSBs may be able to avert the inevitable loss of market share to private sector banks/NBFCs to some extent. This process will enable PSBs to raise private capital from the market, and not rely on government largesse. However, we have to be aware of the fact that if the merged entity faces a financial predicament, it can pose a serious systemic risk, making the entire economy vulnerable. Further, we need to ensure that the creation of bigger players should not adversely impact service delivery, especially to MSMEs and micro customers.
NPAs in the banking system
Looking at the NPA situation, we see that while the overall bad loan ratio has stabilised (stressed assets growth is steadying), the next two quarters will reveal if this trend is sustainable. Post the sharp increase in NPAs in FY17 owing to AQR initiated by the RBI, the rise in NPAs can be believed to have peaked for many banks. However, there are yet more skeletons waiting to come out of the closet in certain cases.
All eyes are now on how the recent NPA ordinance works for the resolution of bad loans. The Government has given more power to the RBI, allowing it to be directly involved in case-to-case NPA resolution, and enforce the Insolvency Act if a firm fails to repay money borrowed from banks within a certain time frame.
The RBI has identified 12 accounts for insolvency proceedings, each having outstanding loans of over Rs 5,000 crore, accounting for 25% of the total NPAs of banks. The banking sector is saddled with NPAs of over Rs 8 lakh crore, of which Rs 6 lakh crore is with PSBs. The resolution of non-performing loans is likely to call for significant haircuts, if re-priced loans are to attract the attention of private investors and asset reconstruction companies.
The provisioning cost for corporate lenders could fall from 270 bps in FY17 to ~170 bps in FY19, owing to the requirement of meeting shortfalls in provisioning against past NPAs, high levels of watchlist assets resulting in pressure on RoE etc, justifying the discount in valuations to retail lenders. 
Stressed asset resolution may result in higher provisioning for corporate lenders. The provision coverage ratio for the system will have to rise from 37 to 43% of stressed loans to 55 to 60%, post the reference to the IBC, unless the RBI comes out with fresh provisioning norms for such cases.  
While the steel sector’s prospects have improved in the last few quarters, the situation in power and infrastructure is still grim, owing to overcapacity and regulatory uncertainties.
  Apart from methods to deal with the stock of NPAs, there is also need for a long-term plan to avoid future generation of problematic loan defaults.
Dhiraj Relli is MD & CEO of HDFC Securities

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