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Consolidation among Public Sector Banks (Shri R. Gandhi Deputy Governor - April 22 2016 - at the MINT South Banking Enclave Bangalore)

News and Press Release - Dated:- 26-4-2016 - At present banking system in India is evolving with a mixture of bank types serving different segments of the economy. In the last few years, the system has seen entry of new banks and emergence of new bank types targeted to serve niche segments of the society. However, banking system continues to be dominated by Public Sector Banks (PSBs) which still have more than 70 per cent market share of the banking system assets. At present there are 27 PSBs wi .....

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in reaping rich benefits of economies of scale and scope. 2. The suggestion of consolidation among PSBs has quite old history. Narasimham Committee Report in 1991 (NC-I), recommended a three tier banking structure in India through establishment of three large banks with international presence, eight to ten national banks and a large number of regional and local banks. Narasimham Committee Report in 1998 (NC-II) also reiterated the recommendations on NC-I. Recently, in the budget speech for 2016- .....

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f nominal GDP, there is no Indian bank in the list of 70 large banks in terms of asset size. We can easily see that large banks reap certain advantages in terms of efficiency, risk diversification and capacity to finance large projects. The efficiency gains resulting from lower cost of services and higher quality of services is too attractive to ignore. 5. It is also felt that a larger bank may be less risky than a smaller bank as the larger bank will have a more diversified portfolio resulting .....

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efit from economies of scale in terms of risk diversification, although this benefit disappears when banks become excessively large beyond a certain threshold size. This threshold size has been subject of much debate in the discipline of finance. However, there is no clear research which may point towards an optimum size for a bank in a particular country. Perhaps in future, research will throw light on the optimum size of banks. However, in the context of India, it is felt that there is ample r .....

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s evidence which shows that this index has been falling over the years in India. 7. There are 48 domestic banks (excluding RRBs and LABs) out of which there are 27 PSBs having a market share of around 70% in terms of asset size. A comparison of performance of larger PSBs with smaller PSBs does indicate that larger PSBs perform better. For example, among all PSBs, larger PSBs like SBI and Bank of Baroda are trading at higher Price to Book Value ratio in comparison to other smaller PSBs. SBI has b .....

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nks also have to grow in size to meet the higher demand of credit. The banking system will be required to enhance its capacity to lend to larger companies and to larger projects. With increase in credit penetration and as credit to GDP ratio increases from present levels of 50 percent, PSBs with a market share of over 70 per cent need to contribute significantly in the process. Without strong PSBs which are efficient, competitive and well-capitalised, meeting higher demands of bank credit would .....

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mmon equity capital than other banks. Further, Financial Stability Board has agreed on Total Loss-Absorbing Capacity (TLAC) standard for G-SIBs. G-SIBs will be required to meet the TLAC requirement alongside the minimum regulatory requirements set out in the Basel III framework. Specifically, they will be required to meet a Minimum TLAC of at least 16% of the resolution group s risk-weighted assets (TLAC RWA Minimum) from 1 January 2019 and at least 18% from 1 January 2022. These regulatory requ .....

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anking system in the past 12. There have been two types of bank consolidation in India. One and most obvious has been voluntary merger of banks driven by the need for synergy, growth and operational efficiency in operations. Recent merger of ING Vysya Bank with Kotak Mahindra Bank is an example of this kind of consolidation. ING Vysya Bank had a stronger presence in South India while Kotak had an extended franchise in the West and North India. The merger created a large financial institution wit .....

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tive of voluntary mergers of banks which have the prospect of creating value for those banks. However, such examples are not many in public sector banks sphere. Recent merger of State Bank of Saurashtra and State Bank of Indore into State Bank of India may be seen as basically merger among group companies. The only example of merger of two PSBs is merger of New Bank of India with Punjab National Bank in 1993. However, this was not a voluntary merger. 13. The other type of merger of banks has bee .....

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chanism. The merger of Global Trust Bank with Oriental Bank of Commerce in 2004 was an example of this kind of merger. Earlier way back in 1960s, post Palai Central Bank s failure, there were several such mergers guided by the Reserve Bank. 14. Since the onset of reforms, there have been about 32 mergers / amalgamations in the banking sector. Prior to 1999, most of the mergers were driven by resolution of weak banks under Section 45 of Banking Regulation Act 1949. However, after 1999, there has .....

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lways beneficial for the banking system and overall economy. The benefit of size is observed up to a threshold level of size. A size beyond this threshold size may have negative consequences for the economy. Existence of excessively large banks may also create significant moral hazard costs for the entire system. A failure of a very large bank may have systemic implications and therefore, there is a perception that large banks may be bailed out during stress periods. This expectation of governme .....

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nly. One of the important aspects of the post crisis regulatory reforms has been formulation of specific regulatory requirements targeted at larger banks. 17. PSBs as a group have not been performing well during the last few years. There has been a large increase in Non-Performing Assets (NPAs). As a part of managing large NPAs, some suggestions have been made that perhaps a consolidation of PSBs can render them more capable of managing such challenges relatively better. The basic argument is th .....

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ocess is not handled properly. The problems of capital shortages and higher NPAs may get transmitted to stronger bank due to unduly haste or a mechanical merger process. Consolidation should not be seen from the sole perspective of creating larger sized banks. While it is agreed that under present banking structure in India, creating a few large size banks is desirable, it has to be a well calibrated and cautious process. Suggested Consolidation Process 19. Ideally, the process has to be initiat .....

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of two PSBs coming together voluntarily and planning for merger have not been seen, although such examples have been quite numerous in private banking sector. So the question is how to ensure consolidation among PSBs when PSBs themselves are not coming forward voluntarily. One way forward may be a nudge from large shareholder of PSBs i.e. Government of India. As the Honourable Finance Minister, in his Budget speech of 2016-17 has mentioned, that a road map in this regard will be announced soon. .....

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s of banks on the tentative plans it might be having with respect to individual banks and try to understand their reactions. Further, interests of all stakeholders like depositors, borrowers, supervisor, employees, etc. also need to be balanced. Perhaps, the recently constituted Banks Board Bureau (BBB) can perform such an advisory role. 21. It also needs to be emphasised that PSBs are listed and their shares are held by diversified private institutions and individuals and interests of these min .....

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of 1800, the competition authorities are usually alarmed about competition issues. Hence, the aspects related to competition and consumer protection need to be evaluated diligently in the context of consolidation. 23. There may also be significant implementation challenges in the merger of two entities even if it is based on sound business logic and synergy. Integration of two different organisation cultures and technological platforms may not be a simple process. The treatment of legacy issues .....

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s. Under this type of consolidation, a bank consciously decides to be in particular types of businesses and sheds or quits certain types of businesses. Why a bank would decide so? One set of circumstances, as I have alluded earlier, relates to reaction and readjustment to the new regulatory structure. The TLAC requirements, the Dodd-Frank Act compliance, the Vickers Commission reforms, the Likanen Group reforms, etc. have forced banks in USA, UK and EU to rethink and rearrange their businesses. .....

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