Consolidation, Yes! But PSU banks need transformation even more

Finance Minister Nirmala Sitharaman told CNBC-TV18 on Thursday, November 6, that the next phase of public sector bank (PSB) consolidation is already underway. One hopes this time the government attempts a seminal overhaul of the ownership, control, and working of PSU banks, rather than simply stop at consolidation.

There is a small turn in the finance minister’s words that emboldens one to hope.

Speaking at the SBI annual summit, the minister said India needs “a lot of big, world-class banks” to meet the growing needs of a fast-expanding economy. She added, “Work has commenced. We are discussing with the RBI and banks. This is not just about amalgamation. We need an environment where banks can operate and grow,” she noted.

The last sentence of the above quote is what gives one hope that the government will go beyond mere amalgamation, which is what it has restricted itself to in the previous rounds of consolidation.

Consolidating whom with whom

But the first question that arises is about the details of the consolidation itself:

The first possibility is the government will merely coalesce the remaining unamalgamated PSU banks, i.e., merge into Bank of India the smaller ones like UCO, Central, IOB, and BoM. In this list, Bank of India is the largest with a book size over Rs 6 trillion. The other four have a deposit base of between Rs 3.0 to 3.6 trillion.

This isn’t as easy as it sounds. The speed of integration depends much on the technology each bank uses. Technology integration with banks whose systems run on different platforms can be mind-boggling.

A second possibility is to merge each of these banks with one of the larger ones, since the goal is to create larger banks. Here the match-making can be on the basis of technology compatibility or regional compatibility. Thinking geographically, UCO and Central Banks can go to PNB, BOI to Union, and IOB to Indian Bank.

However, let us note the FM's statement: India needs a lot of world-class big banks. If bigness is the criterion, then the biggest one achieved from the above combinations is Union-plus-Bank of India, which can yield a bank with Rs 18–19 trillion in deposits, making it the third largest after SBI and HDFC Bank. This may well be the government's plan, since the Union-BOI merger plan is one of the oldest conceived by the Indian government — way back in 2007.

Fourthly, if the idea is to have an even larger bank, then a merger of BoB and Union Bank is a possible option, yielding a bank with deposits over Rs 25 trillion, which will still be slightly smaller than HDFC Bank.

Cultural integration- A big challenge

One mustn't talk glibly of big bank integration. While technological integration is difficult, cultural integration is even more challenging. Bank CEOs have to put all their might into handholding seniors of an incoming bank. A veteran banker, who spoke on condition of strict anonymity, pointed to the integration of Syndicate Bank into Canara Bank in 2019–20. Both being Karnataka-centered banks, the cultural integration was expected to be easy. Yet, bankers say the integration left scores of hiccups: there is always a Syndicate group and a Canara group within the bank, with Syndicate employees oftentimes feeling left out of the reckoning.

PSU banks- SBI's systems

Which brings one to the real demand: that PSU banks need transformation, not just consolidation. PSU bankers often envy the excellent systems-driven culture in State Bank. Also, SBI has had one big advantage: the SBI MDs and Chairman are promoted from the ranks. In PSU banks, CEOs are often pulled from any bank, and a new CEO often takes a couple of years to figure out the processes, the loan book, and the culture of the new bank before he can plan improvements, by which time he is close to the end of his tenure.

The finance ministry has been aware of this issue and has granted fixed three-year tenures in many cases, but that usually doesn't suffice. RBI has advised a preference for CEOs from within the PSU bank, but there is not often a big pool of talent. As PSU banks get bigger with consolidation, perhaps an SBI-like treatment can be applied, i.e., promoting the CEO from within the ranks as much as possible and, more importantly, encouraging PSU bank CEOs to think about adopting SBI's systems and SOPs.

Legislative and mindset transformation

But a more key requirement is a legislative change, which can come only if there is a mindset change. Twenty-five years ago, then RBI deputy governor Y. V. Reddy (later to become one of RBI's best governors) suggested that the Banking Companies (Acquisition and Transfer of Undertakings) Act, which governs PSU banks, be done away with, and PSU banks be brought under the Companies Act, like all private sector banks.

This will enable the government to reduce its stake in PSU banks to below 50%. At 49%, the government still is the dominant owner. But the banks will be outside the purview of the CAG and the CVC.

Also, their boards will have to have 51% independent directors. All these can drive a sea change in the way the banks are run. Younger CEOs can be chosen by the NRCs of the now-independent boards. CEOs can be given more extensions. And, more importantly, compensation packages for the highest levels can be redesigned with ESOPs to attract the best talent.

Consolidation is welcome, but one hopes the FM meant much more when she said: "This is not just about amalgamation. We need an environment where banks can operate and grow."

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