“ The whole idea that the consolidation of banks will solve the problem of public sector banking is not correct. If the problem is structural, if the problem is governance, it does not matter whether banks are large or small”- Dr. Y V Reddy, former RBI Governor, while delivering the Professor D T Lakdawala Memorial Lecture on “Future of Public Sector Banking”, 2017

On August 30, 2019, Government of India announced a major reform in the banking sector by merging large PSU banks. The plan is to merge 10 state-owned banks into four larger ones Banking mergers have been happening frequently in the last few years, but this time, the consolidation will leave only 12 PSU banks instead of 27 (as in 2017).

Mergers of banks, globally, have always led to delays in credit transmission into the economy. India is no different. At a critical time, when consumer spending has virtually come to a grinding halt, the need of the hour should have been to ease the flow of liquidity into the system. Instead, the announcement of this merger will dampen the transmission of credit into the system in the near future due to integration issues like “fit”, redeployment of staff, and fewer career opportunities. The merger of banks is a correct step, but severely ill – timed, given the current slowdown in the economy

For years, expert committees viz., Narasimham Committee (1991) and Narasimham Committee – II (1998) have recommended that India should have fewer but larger banks which are better managed to ensure optimal use of capital, efficiency of operations, wider reach and higher profitability. The basis is that rather than having several banks competing for the same market (in terms of deposits or loans) in the same geographies, leading to each one incurring overlapping costs, it would make ample logic to have large sized banks some of whom are concentrated majorly in one geography, or have complimentary presence in few. It has also been argued that such entities will then be able to respond better to emerging market trends or shifts and compete more with private banks. The Finance Minister has said that the proposed big banks would be able to compete globally and improve their operational efficiency once they lower their cost of lending and improve operational processes.

The Governments hopes that these mergers may solve the problems of PSBs, create more efficiencies in the banking system by reducing NPA and increasing credit activities. Large banks will be more confident to lend which in turn may revive investments in the economy. The government also hopes that by merging banks, large behemoths will be created which may be able to deal with financial situations more resiliently.

It may all be good in the long term and if the fundamentals of our economy are strong. Not now!

A bigger challenge now for the government will be in ensuring that there is no disruption in activity, especially lending, because of the proposed mergers at a time when banks are reluctant to lend to industry and customers. Our concern is that this announcement and the long gestation period for executing the mergers will lead to a further slowdown in credit flow for a while.

Krishan Goyal is Director, and Rajarshi Datta is Lead – Asset Management, Acquisory Consulting LLP. Their views are personal.