Merger of banks has been done to address the issue of economic slowdown. The Finance Minister announced the merger of ten public sector banks into four, reducing the number of public sector banks from 27 to 12, with the goal of boosting the economy by increasing liquidity, diversifying risk, and combating the issue of non-performing assets. Following the merger, India's Finance Minister also announced a recapitalization of INR 55,000 crore.

What is Merger and Amalgamation?

• A merger occurs when two or more companies/entities combine to form either a new company or an existing company that absorbs the other target companies.
  • For example, the consolidation of two entities, Tata Steel and the UK-based Corus Group, with the resulting entity being Tata Steel.
• Amalgamation is a type of merger in which two or more businesses combine to form a completely new entity/company.
  • For example, combination of two entities Mittal Steel and Arcelor have formed a new entity. ArcelorMittal
• Any two public sector banking entities may initiate merger talks, but the merger scheme must be finalised by the government in consultation with the central bank and voted on in Parliament.
• The scheme may be modified or rejected by Parliament. Parliamentary approval is also required in the case of a merger between a public sector bank and a private bank.
• Most bank mergers have resulted from the central bank's efforts to safeguard the financial system and depositors' funds.
• Some are also motivated by the need for consolidation and growth.
• Mergers anticipate that weak banks will sell assets, cut costs, and close loss-making branches.

Historical Perspective

• The Banking Regulation Act of 1949 specifies the procedures for bank consolidation.
• The idea of bank mergers has been floating around since 1998, when the M. Narasimham Committee recommended to the government that banks be merged into a three-tiered structure —
  • Three large banks with an international presence at top
  • Eight to ten national banks
  • Large number of regional and local banks.
• In 2014, the PJ Nayak Committee recommended that the government privatise or merge some PSBs.
• The government approved the "merger" of SBI's five associate banks and Bharatiya Mahila Bank (BMB) with SBI in 2017.
• In 2017, the government formed an Alternative Mechanism Panel, led by the Minister of Finance and Corporate Affairs, to investigate merger proposals of public sector banks.

Reasons for Merger of Banks

• The Indian government believes that a larger bank will be more resilient in the face of adversity.
• A larger bank also has a larger corpus to distribute, which improves the bank's ability to lend to large projects, particularly those in the infrastructure and power sectors.
• The government believes that larger banks will be able to compete more effectively on a global scale, as well as increase their economic efficiency by eliminating similar jobs and lowering lending costs.
• To protect vulnerable PSBs from loss, thereby protecting customers and the financial system.
• Larger banks would also be able to comply with BASEL III standards.
• The formation of larger banks can help to address the problem of credit lending, which is based on the twin balance sheet crisis.

Current Status of Merger of Banks in India

• The Finance Minister announced the largest consolidation plan for public sector banks (PSBs), merging ten of them into four.
• The Indian government has decided to merge the following banks:
  • Indian Bank and Allahabad Bank (Anchor Bank - Indian Bank).
  • Punjab National Bank, Oriental Bank of Commerce, and United Bank will be merged (Anchor Bank - PNB).
  • The Union Bank of India will be merged with Andhra Bank and Corporation Bank (Anchor Bank - Union Bank of India).
  • Canara Bank and Syndicate Bank (Anchor Bank - Canara Bank).
• After consolidation, the total number of PSBs has decreased from 27 in 2017 to 12.
• Previously, Vijaya Bank and Dena Bank merged with Bank of Baroda (BoB) – effective April 1, 2019.
• Following the completion of all merger exercises, India's next-generation PSBs can now be ranked according to their business size, as follows:

Merger of Banks – Benefits

• The consolidation of PSBs aids in the strengthening of its presence on a global, national, and regional scale.
• Due tothe presence of shared overlapping networks, it has the potential to reduce operational costs. And the banks' lending costs will be reduced as their operational efficiency improves.
• All merged banks in a specific bucket share a common Core Banking Solutions (CBS) platform, which allows them to synergize technologically.
• Larger banks are better able to raise resources from the market rather than rely on the state exchequer.
• For the benefit of customers, the loan tracking mechanism in PSU banks is being improved.
• As the number of PSBs decreases as a result of the merger process, capital allocation, performance milestones, and monitoring will become easier for the government.
• Large banks will have large balance sheets as a result of the consolidation of PSBs, allowing them to meet the credit needs of the expanding Indian economy.
• It will also strengthen PSBs' ability to raise funds without relying on the state budget.
• Banking entities formed by the merger of PSU banks will be better able to absorb financial shocks.
• Economies of Scale - Bank mergers will result in improved scale efficiency due to increased customer base and market reach.
  • A broader range of products and services for customers would result in lower lending capital risk.
• Enhanced Operational Efficiency - A synergistic partnership would make the best use of each other's network, customer base, and access to low-cost deposits.
  • Organizational restructuring would improve managerial efficiency while also providing opportunities to learn best practises from each constituent entity.
• Global Bank - Stakeholders would have more options if banks were stronger and more globally competitive.

Merger of Banks – Challenges

• The banks that are merging are expected to see a slowdown in decision making at the top level, as senior executives of such banks will put all decisions on hold, resulting in a drop in credit delivery in the system.
• The geographical synergy between the merged banks is somewhat lacking during the merger process. In three of the four mergers, the merged banks only serve one region of the country.
• The move is sound, but the timing is not ideal. The economy is already slowing, and private consumption and investment are on the decline.
  • As a result, there is a need to boost the economy and increase credit flow in the short term, and this decision will impede that credit flow in the short term.
• A complex merger with a weaker and undercapitalized PSB would hinder the bank's recovery efforts because the weaknesses of one bank could be transferred to the merged entity, causing the merged entity to become weak.
• There would be a number of human resource issues, such as difficulty adapting to a new emerging culture, dissatisfaction due to long-distance transfers, and so on.
• Customer retention would be difficult because customers might be hesitant to bank with a larger parent bank.
• With increased market power, larger banks may engage in monopolistic behaviour, ignoring local needs.

Merger of Banks – Way Forward

• Dual regulation of PSBs by the Ministry of Finance and the RBI frequently results in decision paralysis – making consolidation of banks a redundant measure if they are not given the power to act quickly, as PJ Nayak pointed out.
• Before making any significant changes to any emerging architecture, public bank governance must be improved.
• Larger banks provide greater resilience to the banking sector, but ignoring larger red flags such as strong credit appraisal and risk control systems will do little to help create robust banks.
• As a result, it is critical to focus on ensuring a solid foundation for PSBs.

Conclusion

• While a larger bank has more capital, personnel, and expertise to deal with a severe fiscal challenge, historical evidence shows that larger banks are more likely to act in direct conflict with established principles of conventional human, social, and legal responsibilities.
• Larger banks have more lobbying power and a greater say in national law-making, allowing them to pass laws that benefit them. However, there is no guarantee that such legislation will benefit the general public.
• Some banks that grow too large and serve a large portion of the population become too big to fail, and it becomes a concern for governments around the world to ensure that such banks do not fail because their failure would have a catastrophic impact on global markets.

FAQs

MCQs

1. What is one of the primary reasons for merging banks in India?

A. To decrease competition
B. To reduce the number of branches
C. To strengthen the financial position
D. To limit consumer choices

2. Which of the following was a major bank merger in India in recent years?

A. Merger of SBI and ICICI
B. Merger of 10 PSBs into 4 banks
C. Merger of HDFC and Bank of Baroda
D. Merger of Axis Bank and Kotak Mahindra Bank

3. What is one potential disadvantage of bank mergers?

A. Increased customer service
B. Cultural integration issues
C. Greater product diversity
D. Expanded branch networks

4. How do bank mergers affect the banking landscape in India?

A. By increasing the number of banks
B. By reducing competition
C. By creating larger banking entities
D. By limiting access to banking services

5. Which body primarily regulates bank mergers in India?

A. Ministry of Finance
B. Reserve Bank of India (RBI)
C. Securities and Exchange Board of India (SEBI)
D. Insurance Regulatory and Development Authority (IRDA)

GS Mains Questions and Model Answers

1. Examine the impact of bank mergers on the Indian economy.

Answer: Bank mergers can have a profound impact on the Indian economy by promoting stability in the financial sector. By consolidating weaker banks with stronger entities, the overall health of the banking system is improved, which can enhance lending capacity and support economic growth. Mergers can lead to reduced operational costs, improved risk management, and greater resource allocation to priority sectors such as infrastructure and small businesses. However, there can also be negative consequences, such as reduced competition, potential job losses, and customer dissatisfaction during the transition period. A careful assessment of these impacts is necessary to maximize the benefits of bank mergers while mitigating adverse effects.

2. Discuss the reasons behind the recent trend of bank mergers in India and its implications for the banking sector.

Answer: The recent trend of bank mergers in India has been driven by several factors, including the need to strengthen the banking sector following the rise in non-performing assets (NPAs) and the increasing competition from private banks and financial institutions. Mergers are seen as a solution to create larger, more resilient banks capable of withstanding economic shocks and effectively serving a diverse clientele. The implications for the banking sector include enhanced operational efficiencies, improved credit ratings, and a more robust ability to lend. However, the challenges of integrating different corporate cultures and ensuring customer satisfaction must be addressed to achieve long-term success.

3. Analyze the regulatory framework governing bank mergers in India and its effectiveness.

Answer: The regulatory framework governing bank mergers in India is primarily overseen by the Reserve Bank of India (RBI), which sets guidelines for the merger process, evaluates proposals, and ensures compliance with prudential norms. The Companies Act and the Banking Regulation Act also provide legal provisions related to mergers and acquisitions. While the framework is designed to promote stability and protect stakeholders, there are concerns regarding its effectiveness, particularly in terms of transparency and speed of approvals. Streamlining the regulatory process and enhancing public engagement can improve the effectiveness of the current framework, ensuring that mergers benefit the banking sector and the economy at large.

Previous Year Questions on Merger of Banks

1. UPSC CSE Prelims 2019

Question: What is one of the key advantages of bank mergers?
A. Increased number of banks
B. Economies of scale
C. Reduced customer base
D. Complicated loan processes

Answer: B

Explanation: A key advantage of bank mergers is the realization of economies of scale, allowing banks to operate more efficiently and reduce costs.

2. UPSC CSE Mains 2021 (GS Paper 3)

Question: Critically analyze the impact of recent bank mergers on the Indian banking sector and the economy.

Answer: Recent bank mergers have had a significant impact on the Indian banking sector by creating larger and more financially stable institutions capable of meeting the evolving needs of the economy. These mergers have led to a reduction in the number of banks, which can enhance operational efficiencies and lead to improved credit availability. However, they also pose challenges such as potential job losses, customer dissatisfaction, and the need for effective integration of systems and cultures. Addressing these challenges while maximizing the benefits is crucial for ensuring a robust banking environment that can effectively support India’s economic growth.