Wednesday, September 4, 2019

Big Bang Bank Mergers


Bank Mergers Again at Most Inopportune Time

Strong economy and weak banking can hardly coexist. We have been stuck with weak banking for the last eight years in a row despite most wanted reforms like the introduction of IBC, drive for financial inclusion like Jan Dhan and introduction of MUDRA. There were 40 mergers and takeovers during the post nationalisation period including the SBI merger.  One wonders whether we have drawn lessons from these experiences.

Looking at the immediate past, SBI merger with Associates is yet to deliver the intended results. 5000 branches were wound up effectively guillotining the reach to the rural clientele. Decision-making is at its lowest speed. Highly informed sources say that the merged associate bank staff at all levels are looked down upon by the pre-merger SBI. Achievement motivation is at its low levels.

Even as such settling was in the process, second bout of merger took place with Bank of Baroda, Vijaya Bank and Dena Bank. While the SBI balance sheet took two years to come back to profit, BoB jumped to profit at the end of first year itself. Obviously emboldened by the apparent frictionless mergers in the immediate past, MoF announced merging ten banks into four.

Can this be at any worse time than now, when headwinds of recession are blowing hard and global uncertainties are on the rise with trade wars between US and China and our own economy’s GDP growth tanking to 5% this quarter, the lowest in the last eight years?

25 years passed since Narasimham Committee recommended for six large banks but warned that it should not be with a combination of weak banks. Watch out: just eight months back, all the targeted banks were under Prompt Corrective Action Plan (PCA). Nine out of the ten have net NPAs above the danger level of 5%. Further all these banks are to be recapitalised meaning that they are weak upfront on capital. Further, lately, their balance sheets are saddled with Derivatives and Guarantees that may move up and add to the losses. Therefore, those targeted for merger are weak banks and not strong ones.

Y.V. Reddy, D. Subba Rao and Raghuram Rajan on one occasion or the other have cautioned the government over consolidation of Indian Banks as a panacea for the ills of the banking system.

While past accomplishments are no guarantee to future success, past failures can serve as good foundation for enduring success. Financial analysts like Anil Gupta of ICRA feel that the merging banks require harmonisation of asset quality and higher provisioning levels among the merging banks. 

Every merger or acquisition is expected to create value from synergy of some kind, and yet all the statistics show that successes are in the minority and failure can be quite expensive. Excepting that all the targeted banks have technologies in sync, no other synergies are seen on the horizon. Each suffers from heavy baggage of NPAs with several of them in the uncertain NCLT window.

Banking is all about financial intermediation. People are at the epicentre of banking both before and behind the counters. Culture of institutions is intertwined with the diverse cultures spread across the country. Success of mergers across periods and nations is elusive regarding the human resource and cultural issues.

Canara and Syndicate Banks are of the same soil and they have better prospect than the rest to derive advantage of merger. All the other merging banks would struggle to synergise on cadre management, incentive system, risk practices etc. Let us not forget that there is a 74% spurt in Bank frauds in PSBs more than others and several of them emanated from system weaknesses.

It is therefore important that the big banks start becoming humble and learn lessons instead of becoming conglomerates of unwieldy nature. Banking basics and customer service can hardly be bargained.

Government after hindsight decided to start the Development Banks to fund infrastructure projects and relieve the PSBs from this window as experience amply demonstrated that they are not cut for that job well due to their funding long-term projects with short term resources.
McKinsey has recently warned in an article: “Today’s environment is characterized by rising levels of risk emanating from the shift to digital channels and tools, greater reliance on third parties and the cloud, proliferating cyberattacks, and multiplying reputational risks posed by social media. Faulty moves to make risk management more efficient can cost an institution significantly more than they save.” Will the new CROs, when appointed, be capable of taking care of this concern?

In another study on M&A, Becky Kaetzler et al. argue for a healthy Organisational Health Index post-merger where they say that unhealthy acquirers destroy value, while healthy acquirers create value and tilt the odds toward success. Leaders considering mergers should first assess their organization’s own health to better gauge whether or not to take the merger plunge. In the instant case, all the organisations in the target are not at the expected health in the financial sector.

Leadership for transformation and good governance are critical for financial mergers to be successful. These emerging big Four out of ten should prove on these two counts that they hold these necessary virtues.

The announcement on governance improvements simultaneously released by the FM need a lot more assurance on the selection processes for the Independent Directors, non-executive Chairmen and their role. It would in fact be prudent to introduce a Declaration in 250 words annually as to his contribution to the Organisation so that the Board and the Directors can measure up the achievements against such statement. The bigger reform required from the owner is a pledge not to interfere in loan sanctions and move a resolution in the Parliament that no party would indulge in loan write off either for the farm or other sectors unless the areas are affected by severe natural calamities.

Further, higher capital allocation with or without Basel III cannot prevent bank failures triggered by systems, people and processes. Capital infusion should be done after specific commitments from the capital-deficit banks on the credit flow to the prioritised sectors, revival and restructuring of viable enterprises in accordance with the RBI mandates and recovery of NPAs.

There can be no energy without friction. The envisaged mergers are bound to have friction and it is the future that decides whether this will bring positive or negative energy. It’s to be hoped that even renewable energy through the cross-culture merger would bring the intended results. Let us not forget the dictum – too big to fail’ would eventually require the government to bail them out of any failure that ordinary citizens would not like to see or wish.





Monday, August 5, 2019

Is rate cut desirable?


Is Rate Cut Desirable?

Monetary and Fiscal Policies are the two engines of growth. While the fiscal policy is annual and out with the Union Budget, Monetary policy is more dynamic and adaptive to the economic environment and conditioned by the inflation target. It matters little either for the FM or the RBI Governor whether tomatoes are sold at Rs.80/kg or potatoes Rs.12/kg. Inflation target of 4% still appears to leave headroom for the RBI to go in for further rate cut – a policy of continuity.

US Federal Bank opted for rate reduction signaling the need for buttressing the US economy in the wake of another impending recession, much to the chagrin and disappointment of Europe and UK. Will India have to follow suit or should it go on its own? What is desirable?

Exports are on the decline. Complacence in forex reserves at the present level at around  $450bn would appear misplaced viewed against the China’s reserves even against their declining growth rate and current trade war with the US. With the UK on Brexit mode for certain going by the promise of present Prime Minister by October 2019 would further alter the trade balances globally. The present trade balance looks only a temporary comfort.

Our careful management of exports and continuous search for new markets for Indian goods call for an aggressive manufacturing policy and prevention of asset deterioration in the corporate and MSME sectors. Export of culture related products and traditional artisan products would hold good prospect and this can happen in dynamic credit markets at affordable rates of interest and not so much the subsidies.

View this in the backdrop of major central banks’ similar exercises this season: whether US or Canada and Basel warnings. Financial columnists like Ian Mcguan warn the Federal Bank against further rate cut. Eric Lascelles, Chief Economist at RBC Global Asset Management says: “the longer that people go in an environment of lower rates, the more accustomed they get to them – and the more difficult it is to raise borrowing costs.” This should explain the reason for the Indian banks going slow on rate cut transmission to the borrowers.

Further, their net interest incomes of banks have been looking south for the last five years. On top, their off-balance sheet exposures are more than the balance sheet trending to a danger that the world economy saw in 2007 and 2008.

Stock markets largely influenced by global trends and the announcements in the Union Budget over the FPI are tottering. Bond yields are also not so attractive unless they are of longer duration than 10years. Increase in minimum public shareholding could trigger a sale of shares – but not when the market is poised for decline. Company valuations are causing a serious concern at the moment.
Major Banks including SBI transmitted Central Bank rate cut on deposits. Domestic Savings already on decline could slide down further. Depositors and investors looking for safe returns year after year are a disappointed lot, for they are at their near-zero return of the money held.

Consumer index and business confidence index for June 2019 are on the disappointing numbers. Indian economy is not on a borrowing spree during the last five years. Instances like Amrapali, Hiranandini, DHL, have enough caution on hold for lending aggressively for real estate. Real Estate and housing finance, if pushed beyond limits, would put the lending institutions in a more beleaguered position than now. Priority sector lending is any way on low yields.

IMF downgrade of global growth rate to 3.2% in 2019-20 is a pointer to bolstering growth through debt route with interest rate cuts by the central banks. It should however be kept in mind that Central Banks and Governments have actively encouraged debt-driven consumption and investment in order to prop up growth. Such policies alter the dynamics of credit markets.

Climate risks are accentuating credit risks. Indian banks are yet to poise themselves to cushion against such risks. When global banks take the climate risks seriously and Indian banks delay, the impact on Indian credit markets is going to be high risk driven.

Budget lines amply indicate the necessity of more private investments to flow to key infrastructure sectors like roads, railways, airways, ports and such investments need to come from more debt than savings and investments in the emerging low rate scenario. With the uniform corporate tax rate at 25% government expects that there will be more corporate participation. But the emerging context does not elude much confidence among several well meaning economists.

If growth is a concern and if it should look only to credit markets then, infrastructure for lending needs to improve and this calls for re-positioning and reforming banks and setting up Development Banks where long term funds will be spent for long term purposes. Structural reforms should follow any impending rate cuts.

August first week is with expectation of a further rate cut to bolster the staring decline in growth. Is growth contingent upon debt or investment? This is a question that should deserve serious consideration in the context of risk-starved banks yet to recover from the self-built shocks of the NPA-overhang.

Published in Telangana Today, 5th August 2019