A study has found that the government's consolidation of public sector banks (PSBs) cannot be explained on efficiency grounds and that the merger of these banks was actually weakening the banking system."Our empirical analysis shows that the merger decisions were not necessarily on efficiency grounds," the Economic & Political Weekly said in a May 14 article.
"The results show limited evidence that mergers improve cost efficiency. In most cases, merger is leading to worsening of performance of the good bank and hence weakening the banking system further," the article added.
The article (external link, behind paywall), titled 'Bank Merger, Credit Growth, and the Great Slowdown in India', is authored by Abhiman Das and Subal Kumbhakar. While Das teaches economics at the Indian Institute of Management-Ahmedabad, Kumbhakar does so at the State University of New York, US.
Using a method called stochastic frontier approach, or SFA, the duo found little economic basis for the PSB mergers that have taken in place in recent years.
On March 4, 2020, the Union cabinet approved the 'mega consolidation' of PSBs with effect from April 1, 2020. This involved the amalgamation of Oriental Bank of Commerce (OBC) and United Bank of India into Punjab National Bank, Syndicate Bank into Canara Bank, Andhra Bank and Corporation Bank into Union Bank of India, and Allahabad Bank into Indian Bank.
Earlier, in January 2019, the cabinet had approved the unification of Vijaya Bank, Dena Bank and Bank of Baroda. In February 2017, the cabinet approved State Bank of India (SBI) acquiring five of its subsidiary banks.
Among the reasons the government advanced for the mergers was that the larger entities would lend themselves to greater competitiveness in India and globally. "Greater scale and synergy through consolidation would lead to cost benefits which should enable the PSBs to enhance their competitiveness and positively impact the Indian banking system… The adoption of best practices across amalgamating entities would enable the banks to improve their cost efficiency and risk management, and also boost the goal of financial inclusion through wider reach," the government said in March 2020.
However, the study by Das and Kumbhakar found little support for these claims.
"The basis of the recent spate of mergers is not clear. On many occasions, poor performing banks were merged with a better performing one. For example, all the associates of SBI had registered losses before merging them with the SBI," the article said.
The authors looked at two merged banks, Dena Bank and OBC, as an example and checked their performance prior to the merger. The study found Dena Bank's efficiency had been declining since 2014 to nearly 60 percent by 2018.
Meanwhile, its cost inefficiency had increased by a little more than 30 percent over the same four-year period, suggesting Dena Bank should have been restructured much earlier.
As per the article, inefficiency can be caused by bad management, the ownership, government regulations, and policies regarding bad loans, among other factors.
In the case of OBC, the analysis found it to be doing well till 2011. However, its efficiency fell to 86 percent from close to 95 percent, before recovering somewhat to 92 percent in 2020.
"Therefore, OBC's merger with Punjab National Bank in 2020 makes very little economic sense, unless one argues that OBC will be able to pull the efficiency of PNB after the merger," the authors argued.
They added there were several examples showing that post-merger efficiency of Punjab National Bank had declined following the merger.
The article said details of the study would soon be published as a working paper.
"The merger exercise in India is a special one. Instead of denationalisation, it promotes further nationalisation. In particular, when the merger involves a PSB, it is always pro-nationalisation. A private bank (in most cases a failing bank) is merged with a public bank, but not vice versa," the article concluded.
