Do we need global size banks or Indian banks that meet the growing needs of economy? Is M&A an answer for improving health of our financial system or will it make systemically important banks a greater strain for the regulator than now?

Banking Sector Reforms Committee in 1998 suggested consolidation of banks –the State Bank of India (SBI) and its Associates into a big state-owned bank and five or six such big banks through consolidation of other public sector banks (PSBs), mergers of private banks and even financial institutions (FIs) with non-banking financial companies (NBFCs). There were noises of consolidation in the United Progressive Alliance (UPA)-1 government too. And now, the Working Group on Mergers and Acquisitions set up by the Ministry of Finance again calls for a similar action. The major issues relating to capital, assets and human resources need to be looked at from the points of view of growth, financial stability and global experiences. Recently, Arundhati Bhattacharya, Chairman of SBI, strongly fielded the arguments for large scale consolidation. Is the Indian financial system ripe for the call?

Since 1969 till date, there has been as many as 34 mergers and amalgamations in banking and finance sector. There were at least 25 cases where private sector banks merged with the PSBs and some of them were induced mergers while several others were voluntary driven mostly by the weak financials of the banks that merged. Post-1999, however, even healthy banks were merged driven by the business and commercial considerations. Post reforms private sector has seen giant size banks taking shape in the private sector.

Post recession global financial architecture required that the Reserve Bank of India (RBI) identify the systemically important banks – the SBI and ICICI Bank. However, emerging developments and the changes that occurred during the last two decades with digital banking making deep inroads, demand a different alchemy of structural transformation in Indian banking.

Capital is the Achilles heel. GoI would be hard put to provide the BASEL III capital requirement through measly budgetary releases. It would do well to restrict its shareholding to just around 51% and this would require strong argument on enhancing the efficiency of the PSBs, more autonomy and transparency in its ownership versus controlling roles.

The diversity of Indian Banking system – PSBs, private sector – old and new, regional rural banks (RRBs), local area banks (LABs), rural cooperative banks, urban cooperative banks (UCBs), Small Industries Development Bank of India (SIDBI), National Bank for Agriculture and Rural Development (NABARD) and Micro Units Development and Refinance Agency (MUDRA), the proposed Payment Banks, the small savings banks is a challenge for reforms. We have the outliers – the microfinance institutions (MFIs) and the NBFCs.

Financial inclusion demands the proximity of the banking system to the vast semi and illiterate customers in rural areas. Several experiments like the business correspondents, business facilitators, primary agricultural cooperative societies, regional rural banks, local area banks have not made a big dent in the most deserving inclusive sphere. Even Jan Dhan has thrown up big numbers and not big services in this direction. The small private banks are still showing up their validated presence closer to many a customer that the big banks like the ICICI or SBI have distanced.

The Financial Stability Report (FSR) of the RBI for June 2015 holds that the weakness in asset quality and profitability remains high compared to the period up to September 2014. “Stress tests on sectoral credit have revealed that the shocks to infrastructure sector, mainly the power and transport sub-sectors, would significantly impact the system,” it says. This stressed portfolio is handled by the large number of big and medium sized PSBs, now sought to be consolidated by the SBI chief.

Need exists but the move requires lot of cleansing the operating environment. Most Banks in India, save exceptions, still view risk management as a scrupulous compliance function rather than as a business tool. Boards of the banks do not devote enough attention on measuring the risks of new products introduced by the banks.

Human resources pose much larger issues. In several PSBs, due to stoppage of recruitment for nearly 20 years and with least willingness for lateral infusion of talent at middle and higher levels, there are going to be several vacant chairs in senior and top management positions. Several banks continue to outsource the retired executives for recovery of NPAs, marketing new products and services and clientele advisory services.

If the banks that would like to merge have the financial muscle, the human resources (HR) would not be on even keel. The distant experience of either new Bank of India merger with the Punjab National Bank (PNB) or the forced merger of Global Trust Bank Ltd with the Oriental Bank of Commerce (OBC) posed HR issues that took decade and odd to resolve. For instance, even the Associate banks of SBI like the State Bank of Hyderabad (SBH) and State Bank of Mysore (SBM), and State Bank of Travancore (SBT) would prefer to be outside the hegemony of the SBI. The staff associations in these Associate banks have made it clear over and over again that they would not agree for any merger with the SBI. As mentioned in the Hindu Business Line editorial of 25 April 2015, mergers in Indian banking have been bail out exercise for weak banks or in some cases failed banks.

The government could start the process of amalgamation of State Bank with the remaining subsidiaries to increase the size of the balance sheet by holding a constructive dialogue with the unions and officers’ associations.

However, the eternal question remains: do we need global size banks or Indian banks that meet the growing needs of the Indian economy? Can they provide depositors their due place? Will mergers be an answer for improving the health of the financial system or will give rise to more systemically important banks proving greater strain for the regulator than now? These questions beg answers from the RBI and GoI more than others.