PSBs Merging Amidst The Pandemic: Will It Help?

The mergers are not reforms in the truest sense of the word but a compulsion considering our precarious economic situation.

Nibu Pullamvilavil | June 26, 2020

PSBs Merging amidst the Pandemic: Will it help?

  Business Standard

On 30th August 2019, the Finance Minister announced the merger of several Public-Sector Banks (PSB). The amalgamation of 10 public sector banks into four has been reported to be ‘working smoothly’ for the past two months even amidst the draconian lockdowns. While it is a relief to know that at least one sector is able to function without much disruption, it becomes imperative to evaluate the impact of this Mega-Merger of PSBs.

For doing so, we will need to answer some fundamental questions such as why do Mergers & Acquisitions (M&A) take place, will the proposed mergers address the problems that currently ail PSBs and most importantly whether the proposed mergers will reform the PSBs. So, why do Mergers & Acquisitions take place? Synergies. So, what are Synergies?

Synergy is the value addition that gets generated by amalgamating the firms involved in either a Merger or an Acquisition. The additional value has to be the value after the merger compared with the sum of the values if the same firms had not merged. It is critical that parties involved in a M&A deal answer this counterfactual question prior to moving forward.

Synergies broadly fall into 2 categories: Cost and Revenue Synergies. Cost synergies are easier to achieve and typically involve layoffs and elimination of redundant resources. However, the Finance Minister has stated that there will not be a single layoff due to the merger. Another cost synergy is the lower cost of bankruptcy due to greater access to resources attributable to the size of the merged entity. But size is a double edged sword and there are costs associated with size as well, chief among them being that larger firms are typically more difficult to manage. A report by Credit Suisse states that the merger is unlikely to have meaningful cost synergies. It adds that “the limited flexibility on restructuring and rationalisation indicates that meaningful cost synergies from PSB mergers are unlikely.”

Revenue synergies are realized through increased sales for the merged entity compared to the sum of the revenues of the standalone firms. Revenue synergies are created through the development of new products, combining capabilities in different parts of the value chain & cross selling. It is not possible to achieve these synergies without a seamless cultural integration of the employees. This is easier said than done. During the Air India – Indian Airlines Merger, the key challenge was to integrate the labour forces of both airlines. There was serious discord in organizational cultures given that employees at Air India were at a higher level of seniority with respect to their Indian Airlines counterparts.

In order to be able to estimate the cost and revenue synergies, strategic thinking and due diligence is of utmost importance. On the Big Picture on Rajya Sabha TV on August 31st , Pankaj Jain, Additional Finance Secretary stated in his opening remarks that the core principle consideration made while evaluating which banks to merge was the backend IT system and its commonality among banks. This was done to minimize customer disruption. He then went on to state that following this consideration, synergies were evaluated for the merged PSBs. This is concerning since the primary objective of a merger or an acquisition should be maximizing synergies and not minimizing disruption in the short term.

It is important to note that most M&A deals (including those in the private sector) disappoint with 70%–90% of mergers and acquisitions being abysmal failures. In a survey conducted by McKinsey in 2002, it was noted that one quarter of firms overestimated cost synergies by 25%. The case was far more severe when it came to estimating revenue synergies with over 70% of the mergers failing to achieve their expected revenue synergies.

So, will a merger address the problems that currently ails PSBs? This first requires us to understand what currently ails the PSB’s. The PJ Nayak Committee Report in 2014 stated that PSB’s have lower profitability ratios, lower productivity ratios and weaker asset quality than their private sector competitors. The report clearly identifies Governance Reforms as the key to reforming Public Sector Banks.

As a part of the merger, the Government will also be injecting Rs 55,250 crore into the PSB’s. The report states in its first recommendation that the recapitalisation of these banks will impose significant fiscal costs if the governance at these PSBs continues as present. The recommendation goes on to state that the Government has two options: Privatise PSBs and allow their future solvency to be subject to market competition or design a new governance structure for these banks which would better ensure their ability to compete successfully. In view of these recommendations, the government should embark on fiscal consolidation of these PSBs following governance improvement.

Presently there are external constraints imposed upon public sector banks which are inapplicable to their private sector competitors. These constraints encompass dual regulation (Finance Ministry and RBI), the manner of appointment of directors to boards, the short average tenures of Chairmen and Executive Directors, compensation constraints, external vigilance enforcement and applicability of the Right to Information Act. Each of these constraints disadvantage these banks in their ability to compete with their private sector competitors. The Nayak Committee report states emphatically that only after these external constraints have been addressed should PSBs address internal weaknesses that affect their competitiveness.

The announcement on August 30th has tried to address a few of the challenges mentioned above with longer terms for the directors on management committee of board, hiring a Chief Risk Officer from the market and a pipeline of future chiefs to be created under the Banks Board Bureau’s Leadership Development programme. However none of the proposals alleviate the external constraints that the PSBs operate under.

And now to answer the final question of whether a Merger will address the problems that currently ails PSBs. The simple answer is no. Since the steps taken are piecemeal, it is unlikely that there will be an improvement in the governance of these banks. The mergers are not reforms in the truest sense of the word but a compulsion considering our precarious economic situation. Unfortunately, the government falls to prey to the adage that the road to hell is paved with good intentions.

It is critical that the Finance Ministry embarks upon true reform of the PSBs by implementing the recommendations made in the PJ Nayak Committee Report. The present government has the political mandate and will along with expertise required to carry out such reform.

Nibu Pullamvilavil is an alumnus of the Indian School of Business and LAMP Fellow, 2015-16.