Merger of half-a-dozen banks in offing? Here are challenges that may come up

The BJP-led NDA government is expected to speed up the banking consolidation, especially, in the public sector banks (PSBs). The plan is to create a few large banks by merging 2-3 banks together. The recent merger of Bank of Baroda (BoB), Dena Bank and Vijaya Bank, which is effective from April this year, was the first off the block. The merger is currently undergoing the integration process, where there are challenges such as technology, people, culture etc. But such a big merger also throws up many challenges, which are likely to extend the balance sheet clean up for a couple of years. What are the areas to watch out for if the government decides to merge half a dozen banks?

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Creating Clones

PSBs are basically corporate banks. They mirror each other. The biggest chunk in their portfolio is of infrastructure (power, telecom, roads etc), iron and steel and textiles. Take for example Dena Bank, which has a very high -- 16.18 per cent --exposure to infrastructure especially in power and telecom. Bank of Baroda, which is a large bank, has 8.44 per cent exposure to infrastructure. Similarly, PSBs have high exposure (top 5) to iron and steel, textile and chemicals. This would certainly create more trouble for the combined entity as many of these are stressed sectors.

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Retail Banking Challenge

The common challenge for PSBs is retail banking; where all the banks are struggling with the exception of State Bank of India. The branch network has duplication, the look and the feel mirror each other and the staffers are also in the same age group. These banks have to scale up the digitisation drive and also tap the newer areas like affordable housing, consumer durable financing and business banking. These areas are tapped by NBFCs, fintech and many new private sector banks. In fact, there is a large portfolio of MSMEs and agriculture that will come to the combined entity after the merger.

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High-Cost Model

The merged entity would not get any benefit of efficiencies. The PSBs have a very high-cost structure. Take for example, in the BoB-Dena and Vijaya Bank, the Dena Bank has a very high cost to income ratio, which is an indicator of cost efficiency, of 67.52 per cent as against BoB's 45.56 per cent. The biggest challenge in PSB merger is to cut costs, bring efficiencies, improve profit per branch and profit per employee.

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The High Cost of Funds

The cost of funds plays a very important role in the competitive banking landscape. The weak entities that are merging tend to have a higher cost of funds. Take for example the BoB, which has a cost of deposit at 5.33 per cent as against Vijaya Bank's 5.81 per cent. While the private banks are using the digitisation and also digital modes to raise deposits and target new customers, the PSBs have this challenge of reducing the cost of the deposit. At the same time, they have to deploy their resources to high yielding assets to earn high interest. Most of the PSBs have a net interest margin of less than 3 per cent. This is one area where PSBs will face challenges. Take for example, HDFC Bank, which has a net interest margin of 3.87 per cent.