'Bank'ing on Consolidation..

State Bank of India (SBI) has set the ball rolling for consolidation in banking sector with stating its intentions to merge the associate banks with itself, a long awaited move. A brief look at the rationale and the challenges…

For an industry to prosper, it is essential to have a competitive structure which is neither too fragmented nor too monopolistic. While a monopolistic structure leads to super normal profits, a fragmented structure causes stress in the industry leading to higher susceptibility of industry players to shocks and therefore, higher rate of corporate failures. (PSBs have not seen too many failures because they have the central government to bail them out). In terms of numbers, there are a total of 27 PSBs with an average market share of 2.6%. In comparison, most mega industry has players with market share of at least 10-15%.

The fragmented nature of the industry is also proven mathematically by the index called Herfindahl-Hirschman index (HHI), an established indicator for measuring the level of fragmentation which is calculated by putting each company’s share in a mathematical formula. For Indian Banking industry, HHI stands at 5.2% as per an RBI paper, a very low value. An ideal HHI is considered to be 18%, above which the competition commission starts evaluating the industry.

Other than the structure itself, another important need for consolidation is that this will allow the bank to lend to high value, critical mega projects seamlessly as the risk exposure relative to the capital base will come down. Currently, with a low capital base, banks take partial exposure by forming a consortium to manage their risks causing duplication of effort and delay in project sanction. Further downside is that if such a loan goes bad, there are serious issues in coordination/ managing difference of opinion causing delay in resolution and further erosion in value of asset securing the loan.

An additional benefit of the consolidation which has not been fully appreciated is that it would help large banks to look outside India more aggressively with a stronger balance sheet and ability to take risks. And of course, the consolidation would also bring down cost of transaction through better economies of scale, reduction in duplication of support infrastructure and so on.

So, what are the major concerns with regard to the merger… One rather reasonable concern relates to the high level of NPA which has, sort of, distorted the market value of the banks. A bank, which is otherwise reasonably strong, may have taken larger exposure in infrastructure/ heavy industry projects which are not performing well currently eroding the bank’s market value. However, the bigger challenge remains in managing the fear of the employees with regard to closure of branch and hence relocation or job loss. However, having seen some merger in the past in the sector and growing realization among everyone of the need to be competitive, the resistance should be manageable.

So, time to look forward to a global Indian Bank..??!

 (Image courtesy – SBI facebook page)

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