These 4 banks face investors' backlash as govt plans merger; Is consolidation really a solution?

Consolidation of public sector banks (PSBs) have once again hit the headlines, with latest news suggesting that government might be planning to merge Bank of Baroda, IDBI Bank, Oriental Bank of Commerce and Central Bank of India. This news was not taken positively by investors as the banks mentioned saw massive selling pressure on stock exchanges. The Finance Ministry has been working with an Alternative Mechanism (AM) panel in regards to consolidation of PSBs. Currently in India, our state-owned banks'  operations and credibility is at stake, with latest fraud cases and divergence in NPA. Lending has become such a fraught exercise for them, that each quarter PSBs have witnessed weak earnings, higher provisions and NPA. 

Consolidation of PSBs comes at the backdrop of rising non-performing assets or bad loans. Bad loans in PSBs has resulted in higher provisions, deterioration in asset quality, higher slippages and thus lower earnings for banks -- not to forget their future lending is at stake.

On the four mentioned banks, two people familiar with the matter told Livemint, if the plan goes through, the merged entity will become the second-largest bank in the country after State Bank of India, with combined assets of Rs 16.58 trillion.

Reportedly, they also added, with the merger, the government hopes to help stem the rise in bad loans in their books at a time when poor asset quality has crippled the lending ability of some of them. 

On Monday, share price of IDBI Bank tumbled by 6.41% with an intraday low of Rs 56.8 per piece, before ending at Rs 63.9 per piece down by 4.38%. This bank has been government’s target of privatisation for nearly two fiscal. 

Meanwhile, share price of Bank of Baroda tumbled by 4.48% with intraday low of Rs 131.25 per piece, before ending at Rs 131.90 per piece below 4%. 

Similarly, OBC share price plunged by 2.3% ending at Rs 78.35 per piece. The bank’s share price overall slipped by 2.87% with intraday low of Rs 76.10 per piece. 

It was only Central Bank of India that closed on a positive note by 1.44% at Rs 74.05 per piece.

Shockingly, among the mentioned banks, Bank of Baroda is one of the largest state-owned lender on basis of asset base and market capitalisation. Merger of this bank will not be accepted well by any analysts and investors. However, the bank has failed to do good in it’s FY18 performance. 

At present IDBI Bank is under the RBI’s Prompt Corrective Action(PCA) Its asset quality has been deteriorating for the last 12 quarters. Its stressed assets are now ~35% of its loan book. 

BoB posted net loss of Rs 1,887.10 crore with gross NPA of Rs 56,480.39 crore in FY18. While Central Bank saw loss of Rs 5,139.6 crore with GNPA at Rs 38,130.70 crore this fiscal. OBC and IDBI recorded loss of Rs 5,871.74 crore and Rs 8,157.11 crore, along with GNPA of Rs 26,133.64 crore and Rs 55,588.26 crore respectively. 

Therefore together these four banks have  showcased loss of Rs 21,055.55 crore. They GNPA cumulatively stands at Rs 1,76,332.99 crore by end of FY18. 

In terms of percentage, BOB GNPA stands at 12.26%, Central Bank at 21.48%, IDBI Bank at 27.95% and OBC at 17.63%. 

The concept of consolidation is not entirely new in India. In 1991, it was suggested that India should have fewer but strong PSBs. 

Though it was only in May 2016 that effective action to consolidate state-owned banks struck headlines with six associate banks getting merged into State Bank of India.

It needs to be noted that analysts do not believe consolidation in entirely the solution for PSBs. 

Jignesh Shial, analyst at Quant Broking last year explained, we remain cautious towards all corporate lenders (especially PSU banks) considering their subdued growth, mounting quantum of losses and weak adequacies. 

Shial highlighted that, for PSU banks, rise in provisioning charges along with inability to raise capital, consistent loss of marketshare and rising probability for sector consolidation through mergers would keep pressurizing earnings and market valuations.

There are 21 PSBs and through consolidation, the government plans to bring the number down to 10 - 12 PSBs. 

Nirmal Bang recently had a discussion with Arun Tiwari, former chairman and managing director of Union Bank of India regarding the key problems faced by public sector banks. Here’s what the report said. 

Firstly that, the NPA crises is not new to PSBs. The problems can be tracked back to the unbridled expansion spree between 2003 and 2008, the financial crisis in 2008, judicial activism in 2012 and the state governments going back on signed power purchase agreements or PPAs in the power sector. 

Shivaji Thapliyal and Shreesh Chandra analysts at Nirmal said, “The stress in PSBs is not worse than what we witnessed in 2002 (last economic slowdown). Stress is largely concentrated in the power and steel sectors, and the steel sector is already witnessing a turnaround.”

The duo mentioned, “The government should recapitalise PSBs as private sector banks will not fully replace the role of PSBs.”

According to Nirmal, the solution to improving the state of PSBs does not lie entirely in divestment or recapitalisation, but rather it lies in bringing about a change in the banking culture and in improving ownership and corporate governance.  

Further, the tenure of the managing director of any PSB is restricted to just three years (subject to extension). There have been periods where the position of the managing director has remained vacant for a significant period of time. Such a situation would not have arisen in a privately owned bank, where most of the managing directors are associated with the organisation since inception. 

Nirmal said, “PSBs play an important role in funding growth, particularly infrastructure. PSBs are major lenders to the two biggest and most important sectors of the economy – Power and Infrastructure.” 

Therefore, analysts believes the the problem of non-performing assets or NPAs is tangible and can be quantified, the benefits that accrue to the economy as a whole should also be taken into account.

Talking on BOB, Asutosh Kumar Mishra analysts at Reliance Securities said, “Strong improvement on all major operating metrics clearly suggests that Bank’s organisational transformation effort is yielding the desired outcome. Further, analysis of stressed assets clearly suggests that the Bank is approaching the end of recognition of stressed loan cycle, which along with higher PCR clearly indicates sharp moderation in credit cost from FY19E onwards.”

In case of IDBI, Yuvraj Choudhary and Aurella Machado analysts Anand Rathi said, “ With its loan book shrinking over the last six quarters, there would be tremendous pressure on its operating performance through FY19-20. Hence, we lower our rating to a Sell.”

From above one thing is clear, consolidation cannot be considered a one-stop solution PSBs rising NPA crises. There are many methods like IBC and recapitalisation, which have been seen as  good moves for PSBs.