Public sector banks’ (PSBs’) stocks had unexpected gains on Wednesday, with the CNX Nifty PSU Bank index gaining over 2 per cent and emerging among the top performers. With the finance minister revealing that an alternative mechanism for the merger of PSBs has been approved by the Cabinet, the stock price of most PSBs went higher by up to three per cent. However, the merger may not be an easy task.
For one, the issue of swelling non-performing assets (NPAs) is already haunting the banking industry, especially public sector banks (PSBs) and corporate-facing private banks. For the quarter ending June 2017, the gross NPA of PSBs was up 18 per cent sequentially and 32 per cent year-on-year to ~7.39 lakh crore. Currently, there are only four banks with NPAs of less than 10 per cent. On the other hand, at least five to six banks have NPAs of about 15-24 per cent.
Even the country’s largest bank, State Bank of India (SBI), has seen its consolidated gross NPA ratio increase from 9.11 per cent in the March 2017 quarter to 9.97 per cent in the June quarter. Its net NPA ratio increased from 5.19 per cent to 5.97 per cent during this period.
Apart from asset quality concerns, there are other factors, such as integration of human capital, technology or processes, which need attention while considering any merger.
Likewise, when mergers will be taken up, the valuation of banks could also prove to be a hurdle given the high NPA levels and the kind of net worth erosion that many PSBs will face if NPAs are to be fully provided for.
According to a report last month by CARE Ratings, the net NPA as a percentage of net worth of PSBs for period ending March 2017 was already at 77.5 per cent. The question is whether shareholders of the acquiring bank are willing to pay current share price of the bank being acquired or its real value of assets.
Some analysts, however, appreciated the government announcement on Wednesday despite the persistent bad loan crisis.
Calling it as the need of the hour, Pankaj Pandey, head of research ICICI Securities says the move is done with the objective of creating large and fewer banks capable of raising money at best cost and channelling them in a profitable manner.
“Investors should hence not question the timing of the merger announcement. Asset quality issues for the banking system is more or less well known to the Street and is priced-in,” he adds. The only concern he points out is on valuations. Therefore, unless more details emerge, it could be tough for the Street to remain positive on such developments.
Without mentioning the finer details, the finance minister said that the merger will be solely based on commercial considerations and that the boards of the respective banks will have to moot the idea of merger.
For now, analysts believe parameters such as capital adequacy and balance sheet growth may be among criteria for merger, apart from regional stronghold that PSBs command. They believe that Punjab National Bank, Union Bank, Canara Bank and Indian Bank may make for attractive candidates to drive the merger process.
Their gross NPA ratio ranged 7.2-13.7 per cent at the end of June quarter. The banks’ grip over their respective regions — north, west and south India support the merger thesis. These banks have in the last 6-12 months expressed their openness to merger and have also demonstrated their ability to raise capital in the market either through additional Tier-1 bonds or rights issue. Bank of Baroda, too, is a strong candidate, though its management has expressed its reservations earlier this year to lead the merger process.
“While the names quoted above seem the right candidates at the moment, PNB needs more capital to gear up for merger and Indian Bank despite being better placed is still relatively small to take the plunge,” says an equities head of a domestic brokerage.
Nonetheless, everyone in-sync agrees that the merger is important for two reasons. PSBs strength is their access to low-cost current account – saving account (CASA) deposits. With the share of CASA deposits at over 35 per cent, many are ahead of their private peers whose average CASA ratio is about 30 per cent. PSBs also hold over 70 per cent share of total banking channel deposits. Lately, they are losing ground to the private peers.
Yet, PSBs still enjoy a higher share of incremental deposit flows, which was demonstrated during demonetisation last year. With savings rate once again plunging, consolidation of PSBs is essential to ensure that money remains with them despite the competition. This is also critical to secure their positions once there is a revival in demand for credit.
Also, consolidating PSBs before a credit demand revival may act as a natural check against the asset quality issues. The banking channel is very fragmented particularly for PSBs, and not all of them hold the stature of SBI or Punjab National Bank. Therefore, the relatively smaller banks have little choice but to improve or merge.