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How Will Mergers Affect Public Sector Banks? Research Team | Posted On Tuesday, January 21,2020, 05:48 PM

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How Will Mergers Affect Public Sector Banks?



With the Finance minister announcing her plans for the creation of $5 Trillion economies, she has also announced the plan outlined by the government for the creation of an efficient banking structure. The government has thus announced the merging of 10 public sector banks with the aim to strengthen to boost economic growth. In this article, we will discuss the impact of mergers in the economy. 

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What is a Merger and Why are so Many State-Owned Banks Being Consolidated?

A merger is simply an agreement that combines two existing companies to form a new company. This is different from an acquisition where one company takes complete control of another business by paying for ownership in cash, stock or other means.

In the case of state-owned banks, the government is the holder of the majority of their stocks, thus they will experience no change in ownership. However, these banks will be restructured for various reasons like reducing the cost of operations, improving professional standards or increasing the efficiency ratio of business operations.

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The government has cited various reasons for these mergers like increasing the lending capacity of the banks that will help revive the pace of the economy. With India set to become a $5 trilling economy these measures are crucial to increase the credit growth to achieve its target. The government believes mergers will lead to an increase in the profitability of the banks thus enabling them to lower the lending rates.

Mergers help the existing smaller banks to enhance their identity as a larger bank. It also allows banks to establish a brand new customer base, empower its business and increase its hold in the market share. Previously the state-owned banks have suffered under a bad loan crisis. According to reports, the size of the gross non-performing assets of the state-owned banks stands at 7.9 lakh crores of 31st March 2019.

Although the mergers are not presented as a way to tackle the various problems faced by the state-owned banks, it may prove beneficial for the economy as it may help weaker banks to retain and emerge as a stronger one with large scale operations.

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Will the move help make banks stronger?

Merging of banks has initiated from the 1960s primarily to bail out the weaker banks and safeguard the interest of the customers. With the mega-merger in august 2019, 10 public sector banks were merged to create four large banks. Thus with this merger, India is currently operating with 12 public sector banks. The government is ensuring that these banks should be capable to meet higher funding demands and help in acquiring global trade.

The banks have been merged by the government keeping in mind the various benefits it offers. Larger banks are more capable of meeting domestic and foreign business funding requirements at a considerably lower operational cost. Mergers have always worked out from the business point of view and will result in better NPA and risk management.

However, this may also adversely affect the overall health of the banks and their overall prices of shares. For example, the shares of Indian bank and other strong banks have experienced a sharp decline on the first day of trading after the announcement of a merger.

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Thus whether a merger benefits the economy or further deteriorates it is still not predictable. So far mergers have worked well in India. But it remains to be seen whether the recent merger uplifts the operational benefits of the banks and compensates for deterioration of the financial of the stronger banks.

Will it address the bad loans crisis and help kick-start economic growth?

A merger will not directly reduce the size of bad loans and thus mergers do not directly address these problems. The Bad loan can only be reduced if there is a speedy recovery process or if the loans are written off in the bank’s balance sheet.

Mergers also do not address the issue of political interference in the decisions of the state-owned banks which is one of the main causes of bad loans.  Previously banks were nationalised to help all sections of the society receive easy credit. Nationalization also helped the government to fund various developmental projects and thus many state-owned banks were forced to provide loans over the years under political pressure. Thus these banks sometimes missed the opportunity of making profits due to inefficient business decisions.

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The government has announced some changes to help banks strengthen and gain an upper hand while making lending decisions. But experts believe this will not end the fundamental problem of political interference in the lending decisions of the banks. Thus many believe mergers will not help in curbing or reducing bad loans as it cannot directly address the root cause of problems faced by the state-owned banks.

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