A new public sector merger bodes well for Indian banking reform

by Manoj Ladwa

The big news from the Indian banking sector this month has been the bold announcement that three public sector banks – Bank of Baroda, Vijaya Bank and Dena Bank – will merge to create India’s third-largest lender.

Last year, India’s largest bank, the State Bank of India (SBI), merged with State Bank of Bikaner and Jaipur (SBBJ), State Bank of Mysore (SBM), State Bank of Travancore (SBT), State Bank of Hyderabad (SBH) and State Bank of Patiala (SBP) to create India’s only global-scale lender. Prior to this merger, SBI had been ranked as the 52nd largest bank in the world.

The Narendra Modi government seems to have kicked off an ambitious programme to reform India’s notoriously laidback banking sector. This is yet another much needed politically sensitive issue in India given the still powerful presence of strong trade unions in all these banks.

The ‘phone banking’ crisis

It would be fair to say that the Indian banking sector, particularly banks owned by the government of India, is in a mess – a legacy of what is being called “phone banking”, wherein senior (mostly Congress) politicians would routinely call up top bankers and order them to clear irregular and sometimes downright illegal advances to favoured businessmen.

This apart, the sector was packed with one medium-sized bank (by global standards), the State Bank of India (SBI), the largest in India, and dozens of smaller ones.

One only has to visit a typical public sector bank branch in India to realise that they are bloated, inefficient and, in many cases, very corrupt.

When the NPA bomb burst

Little wonder then that when the Narendra Modi government, which came to power in 2014, and the Reserve Bank of India (RBI) decided to crack down on dubious loans and crony capitalism that the ticking time-bomb, in the form of loans that have not been paid, exploded, setting back the growth trajectory of the Indian economy by years.

The RBI estimates the size of the non-performing assets (NPA) problem at about $61 billion or about 12 per cent of all advances. This has restricted the ability of banks to lend afresh and contributed significantly to India’s tepid investment cycle.

Merger part of a larger story

Each of these steps, the two sets of bank mergers and various steps to tackle the NPA issue have been announced separately – possibly to keep the politically-induced clamour to maintain the status quo in check. But the Modi government has discretely kicked off far-reaching reforms that promise to clean up the Indian banking sector and usher in governance and loan recovery protocols that are among the best in the world.

Here are some of the major banking reforms undertaken by the Modi government:

Insolvency and Bankruptcy Code (IBC): This new law mandates full resolution of the loan recovery process within a period of 180 days (extendable to 270 days if 75 per cent creditors agree), failing which defaulting companies are liquidated. This has ensured that politically connected businessmen can no longer get away by defaulting on large loans.

Credit Risk Management: Banks now have to regularly apply various analytical tools to existing loan accounts on an ongoing basis to track the health of each debtor and raise red flags in case of suspicion.

Giving RBI more powers: Banking laws have been amended to allow the RBI to more effectively monitor large accounts and also set up oversight committees to oversee these suspicious accounts.

Stricter provisioning norms: Public sector banks are being forced to recognise problem accounts early and provide larger reserves to deal with loan defaults. These are hurting their quarterly numbers but this is the bitter medicine that can cure their disease.

Corporate Governance: Norms on senior-level appointments have been tightened to ensure that only the best people rise to positions of authority.

It is going to be a long battle of attrition as powerful vested interested and the political backers are getting badly bruised. Already, some of India’s top industrialists, including several Forbes billionaires, have lost control of their flagship companies and may more are likely to follow suit.

It is highly likely that more mergers of public sector banks will follow. Larger banks will have better capital adequacy ratios, need less fund infusions from the government and help Indian industry compete better with the world.

2020-03-24T11:39:21+00:00October 4th, 2018|2017/2018, UK Edition – September 2018|

About the Author: Manoj Ladwa