Reserve Bank of India (RBI) governor, Raghuram Rajan, has publicly made a strong case against merging a weak public sector bank, neck-deep in bad loans, with a strong bank as a panacea to salvage the former from an eventual disaster.
Rajan has made three important observations:
First, merging two unhealthy banks in the financial system will create an unhealthy entity that would lead to creation of a bigger problem in the economy.
Second, even in the case of the merger of an unhealthy bank with a large healthy bank, the merger would bring problems to the acquiring bank.
Third, in the event of a merger of a weak bank with a strong bank, the acquirer will have to deal with the cultural problems that arise out of the merger, besides dealing with the primary challenge-the bad loan pile in the weak bank-creating difficulties for the strong bank.
For these reasons, Rajan advices Jaitley and his team to exercise abundant caution before even thinking about a merger of a weak bank with a well-run, strong bank.
The caution comes at a time when the government is planning the merger of a few perceived weak/smaller state-run banks such as Kolkata-based United Bank of India and Dena Bank with relatively larger, stronger banks such as Union Bank of India and IDBI Bank.
The finance ministry is particularly interested in merging United Bank on account of high bad loan issue in that bank.
Bad loans of United Bank surged to double digits early this year (Gross bad loans rose to 11percent of total loan book and capital adequacy fell to bare minimum of 9.01pecent), raising questions about the risk management systems in the bank and the stability of the organization. The whole issue came to a temporary halt with the resignation of bank's former chairperson, Archana Bahrgava in February this year.
The ministry has already had informal discussions with these banks regarding the possibilities of the merger. Besides United and Dena, the government is also contemplating the mergers of a few other smaller state-run banks in due course, even though there are no formal proposals for any of these at this stage.
Rajan's subtle message to the finance ministry is this: Do not hurry on the merger of United Bank-like cases with a well-run, currently strong bank. You could be inviting a bigger problem to deal with by doing so.
By any yardsticks, it will be ideal for the government to pay attention to the former international monetary fund economist-turned-central banker and do not hurry with the merger of United Bank or any other weaker state-run bank for a few reasons:
First, the bad loan problem in a particular bank is created over years, not overnight. Hence the solution cannot come overnight. Apart fromthe general economic slowdown common to all banks, the reasons forsticky assets in a bank can vary from careless lending to weak risk management tools to interested-party lending at the behest of powerful industrialists or politicians.
In other words, there is a past attached to the stressed assets in the books of every bank and most, if not all, reasons for the bad loan rise in different banks can be unique to that bank.
In the event of a merger, dealing with this bad loan pile may not be easier for a currently healthy bank that is forced to acquire the weak bank. Besides causing a sudden rise in its bad loans and resultant provision levels, the new chunk of bad assets can become a drag on the books of the host bank for next several years, causing an imbalance in the book of acquiring bank. This can possibly have a contagious effect on its overall book.
Second, no bank merger happens smoothly. Any merger comes with its own set of issues at the time of integration. These issues range from the culture of the merging banks, their business systems in place and own core areas of expertise and geographies. This is especially true in the case of public sector banks, which are heavily unionized, where the integration process can be a lot tougher, unlike in the case of State Bank of India and its subsidiaries, where work culture and systems in place are the same.
Third, through the merger of two banks, the government will be only transferring the problem from one entity to another. The steps the government can take to cure the bad loan problem in a particular bank, such as installing better risk management tools, bringing in expert agencies or putting in place better management, can be done even without a merger. In fact, that can yield faster results since the problem is isolated and easy to identify.
In the event of a forced, bad loan-driven merger, should the acquiring bank focus on the integration challenges or containing the bad loan issue? The answer tothis question is difficult for any expert banker, since both issues demand immediate attention. Repairing bad loans is a difficult affair and requires day-to-day monitoring. The handling turns even difficult if bad loans are imported from another bank.
It is better to treat stress associated with each banks separately. Consolidation can happen in the cases of stronger banks, where, as Rajan said, there will not be any problems to fix other than the merger itself.
by rajkumar mahendra
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