Is Consolidation The Next Step In The Banking Clean-Up? 

Weak public sector banks may need to consolidate unless more capital is infused into them.

A cyclist rides past the Reserve Bank of India (RBI) headquarters in Mumbai. (Photographer: Dhiraj Singh/Bloomberg)
A cyclist rides past the Reserve Bank of India (RBI) headquarters in Mumbai. (Photographer: Dhiraj Singh/Bloomberg)

A plan to fast-track resolution of large bad loans could eventually push the Indian banking sector towards consolidation, as weaker banks face the possibility of further losses on account of high provisioning needs.

An amendment to the Banking Regulation Act, cleared last week, has given the regulator powers to direct banks to resolve a stressed account in a certain way, should lenders not be able to settle on a resolution plan by themselves. The idea is to try and resolve 40-50 large accounts over the next six to nine months, which form a bulk of nearly Rs 10 lakh crore in stressed assets.

The resolution plan comes at a time when capital is in short supply. The government has earmarked only Rs 10,000 crore for state-owned banks in the current year, and even that capital is coming attached with strict performance conditions.

If smaller banks see further losses on account of the fast-tracked resolution and capital remains scarce, then consolidation may be the best way out, said experts.

Abizer Diwanji, partner and head-financial services, EY, told BloombergQuint that if banks were to set aside 40 percent as provisions (which is the minimum provision before fully writing off an asset) against all the stressed loans in the system, the banking system would still need over Rs 70,000 crore in capital.

If you were to write-down about 60 percent of the debt in all the problem accounts, which is most likely going to be the case, the total capital requirement (for the banking system) could go over Rs 2 lakh crore. When faced with such a high requirement, it is obvious that some may not get the necessary capital.
Abizer Diwanji, Partner And Head-Financial Services, EY

The Weak Links

Those that do not get capital from the government and cannot raise it themselves from the market, may have no option but to keep shrinking. Under a new prompt corrective action framework, when banks breach certain benchmark, automatic restrictions on their ability to grow their business kick in.

This, put together with the attempt to resolve stressed assets quickly, could mean that some smaller banks would be best merged with stronger lenders.

Abhishek Bhattacharya, director and co-head of financial institutions at India Ratings & Reseach told BloombergQuint that a fast-tracked resolution strategy might make it easier for the government to decide which banks do not need to continue as independent franchises.

For example, 10 banks might be left with an impaired capital position. The government would then be in a position to decide which banks would be candidates for takeovers or mergers.
Abhishek Bhattacharya, Director and Co-Head - Financial Institutions, India Ratings & Research
Is Consolidation The Next Step In The Banking Clean-Up? 

Public sector banks have already been losing market share to private banks due to the lack of capital. Data compiled by BloombergQuint shows that over the past two financial years, the share of private sector banks has risen by almost 5 percentage points to about 29 percent of outstanding non-food credit.

Ashvin Parekh, managing partner, Ashvin Parekh Advisory Services LLP thinks that the next one year or so will give a clearer picture of banks that manage to survive the bad loan clean-up.

“In about a year, you will have some clarity on the survivors and non-survivors (among banks) of this whole resolution strategy. It would be good for the system to see weaker entities being taken over by the stronger ones,” Parekh told BloombergQuint.

SBI: A Test Case?

The government has already tested the waters by merging five associate banks of State Bank of India with the parent bank. The merger was effective April 1 and has not seen much public opposition from employee unions that have in the past opposed moves like consolidation and privatisation in the banking sector.

Since then officials have suggested that they may not be opposed to further consolidation.

At recent speeches, both Reserve Bank of India Governor Urjit Patel and Deputy Governor Viral Acharya have supported the idea.

"It is not clear that we need so many public sector banks. The system could be better off if they are consolidated into fewer but healthier banks," said Patel while delivering a lecture in New York last month. He added that since India has a number of cooperative banks and microfinance institutions to provide community-level banking, "some banks can be merged, as a quid pro quo for timely government technical injection".

Acharya has struck a similar note in his public comments.

In a speech delivered at a technology conference organised by Indian Banks’ Association in Mumbai, in February 2017, Acharya too had pointed out that the system would be better with fewer but healthier public sector banks.