The Public Sector Bank Amalgamation

It was on the 1st April, 2020 that government owned public sector banks were merged with the aim of creating stronger banks which can survive competition at the global level. Like and homogeneous banks were merged in order to create synergies that could be beneficial and help us achieve the 5 trillion dollar economy goal. The target was to create banks which could stand the test of global competition and make their place in the global markets. The Oriental Bank of Commerce (OBC) and United Bank of India were merged with Punjab National Bank (PNB), leading the merger to be the second largest public sector bank in India. Similarly, Andhra Bank and Corporation Bank have now lost their individuality and become a part of Union Bank of India. Allahabad Bank has been amalgamated with the Indian Bank. Syndicate Bank is now a part of Canara Bank

These mergers have both good and bad aspects to consider. Let’s look at the good first, the merged bank can definitely reap larger benefits of economies of scale and scope, increasing their operational efficiency, accountability and the ability to provide a much diverse range of products and services to its clients (few of which weren’t possible at all banks earlier). Yet another positive outcome is continual credit flow in the market even during times of crises. Many small banks suffer from NPA due to which lending is restricted to few borrowers with credit rating. But a merger of such small banks, leads the merged bank to better manage resources due to operational efficiency (economies of scale) and significantly reducing the amount of NPAs and making sure that loans are easily available for various projects. The merged institution can significantly reduce the amount operation costs smaller banks had to incur previously. Not only that, the customer base has undoubtedly expanded due to such mergers. Stronger banks are likely to attract more capital in form of both deposits and equity owing to the fact that they can stand strong in times of stress. The synergies of the merger can definitely help banks reduce NPAs as monitoring and screening costs would reduce considerably and hence reduce both adverse selection and moral hazard.

But there is an added downside risk as well, merging these banks make them larger entities and in case there is a catastrophic bank panic, these banks will become “TOO BIG TO FAIL” and bailing them out can prove to be very costly requiring huge sums of taxpayer’s money. Fewer banks in the industry naturally reduce competition, and this can cause them to be incompetent and instead of making them more efficient they could become inefficient. The banking risk is now highly concentrated in a few banks. Post consolidation, the number of Public sector banks have dropped from 27 to 12.

The merger has affected quite a few individuals for instance investors/ equity holders of these banks and the customers of the amalgamating banks. The shareholders of OBC were offered 1150 shares of PNB for 1000 shares of OBC, and 121 PNB shares were swapped for 1000 shares of United Bank of India. Union Bank of India declared a swap ratio of 325 shares in exchange for 1000 Andhra Bank shares and 330 shares for 1000 equity shares of Corporation Bank. 115 Indian Bank shares were issued for every 1000 shares of Allahabad Bank, while Canara Bank announced a swap ratio of 158 shares for 1000 Syndicate Bank equity shares. One of the main reasons for a merger was to increase loan availability, make stronger banks and reduce NPAs for which a budget of Rs. 17,666 crores was allocated to PNB, followed by 11,968 crores for Union Bank of India. A total of nearly 5000 crores was dedicated to Indian Bank. Canara Bank was given Rs 6,571 crore.

Have these mergers really been able to create any synergies?

  • The Net NPA ratio signifies the strength of the bank, lower the ratio better it is as this implies that the bank has higher graded superior assets and very little Bad debts and NPAs. Indian Bank’s asset quality has been affected due to poor screening and monitoring by Allahabad Bank, resulting in low quality loans. In spite of that post mergers Indian Bank has reported to have the lowest Net NPA ratio of 4.39% whereas the bank with the highest net NPA ratio is the combined entity of PNB + OBC +United Bank of India at 6.61%, this is due to the large amount of NPAs that PNB has acquired through United Bank of India for which the same ratio stood at a whopping high of 8.67%. Union Bank of India has also seen a fall in the same parameter due to the amalgamation reducing the net NPA ratio from 6.85% to 6.30% making it a stronger bank by having improved its asset quality.
  • The CASA ratio is the ratio of Current and Savings account deposits to Total deposits. A higher CASA ratio is undoubtedly preferred as this signifies that the Banks are able to borrow cheaper via lower interest rates offered on Current and Savings account deposits thereby improving efficiency. These figures do not reveal good things about the merger. The only bank which has seen a rise in CASA ratio post-merger is Indian Bank taking a jump from 34.71% to 46.65%. The amalgamated entity of Canara Bank has seen a meagre rise of 1.03% in this ratio. The other 2 mergers namely PNB and Union Bank of India have led to this ratio decline by approximately 3% in either case.
  •  Loan Book size tells us the total amount of funds advanced. This figure has almost doubled and grown one fold for both Indian Bank and Union Bank post mergers. Following that PNB has seen the most benefit in this aspect due to the merger as this figure has grown by nearly 50% reaching a whopping high level of 6,84,500 crores.
  • PCR ratio stands for Provision coverage ratio which again is an indicator of how sound a bank is. It is the cushion of funds set aside to absorb losses that can potentially arise due to NPAs and Bad debts. A higher PCR indicates good quality assets and lower risks of Bad debts, defaults and losses from the same. The PCR of Indian Bank (49.13% to 66.21%) has surged due to the previously maintained high PCR of the merging Allahabad Bank. Canara Bank and Union Bank of India have seen little improvement of 3/4% rise. The figures are particularly exciting for PNB as the same has dropped due to poor PCR  maintained previously by United Bank of India which was only 51% way lower than the ideal 70%.

Overall there are some pros and cons of these Mergers as they come with short term costs, a risk of creating fewer banks that could potentially become “Too Big to Fail” during periods of Financial and Banking stress. But in the long run, the synergies will definitely overweigh all the short term costs and add to economic growth.

Author: Kushboo Luniya
B.Sc. Economics & Finance, University Of London

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