The SBI merger: is bigger always better?

The process increasingly looks like a shotgun wedding, with not enough opportunity to pause and ponder

The anticipated merger of the State Bank of India (SBI) with its five associate banks and Bharatiya Mahila Bank (BMB) finally got off the ground with the government sending a letter to all seven banks on 20 June. From thereon, the time taken for obtaining individual board approvals, appointing legal and accounting firms as well as investment banks, getting them to conduct due diligence and arriving at a fair share swap ratio, was under two months.

That should be some kind of a record. Deals involving smaller companies or banks have taken far longer. And this is the country’s largest bank, SBI, merging with six other pretty large banks. There are many imponderables involved in such negotiations: for example, the overlap in the combined physical network, the people question, or integrating disparate back-end systems and processes. Clearly, the government is in a hurry to complete this merger.

The merger is being pursued in the belief that larger automatically means better. Vanity is also a motivating factor—creating an institution that will make it to the list of the world’s largest banks confers bragging rights.

There are perceived gains as well: the government, as shareholder, feels it will have six less capital-hungry banks to worry about. There are also expectations that a larger institution will be better equipped to deal with sticky loans, thereby enabling fresh credit outflows to productive sectors. Productivity and efficiency gains are among other expected benefits. But these could turn out to be illusory given the SBI’s legacy and ownership structure. A former SBI chairman had once remarked that reforming SBI was like trying to make an elephant dance. Even after discounting for exaggeration, there are grounds for circumspection; a large and unmanageable bank is getting even larger.

What’s even more worrying is how the process increasingly looks like a shotgun wedding, with not enough opportunity to pause and ponder. Three issues merit wider debate.

One, the merger patently lacks shareholder democracy. Individual shareholders have been discouraged from objecting. Anybody wishing to oppose must own at least 1% of either bank’s share capital (for example, that amounts to 77.6 million SBI shares) or must marshal 100 shareholders irrespective of their shareholding. According to SBI’s annual report for 2015-16, only five shareholders owned more than 1% in the bank on 31 March 2016: the President of India (60.18%), Life Insurance Corp. of India (11.27%), HDFC Trustee Co. Ltd (on behalf of HDFC Mutual Fund, 2.08%), Bank of New York Mellon (as depository for SBI’s outstanding global depository receipts, 1.86%) and Reliance Capital Trustee (on behalf of Reliance Mutual Fund, 1.09%).

Similarly, chances are that mostly institutions own shareholding of over 1% in the three associate banks with public shareholding—the State Bank of Bikaner and Jaipur, State Bank of Travancore and State Bank of Mysore.

While it is safe to assume that the President won’t be objecting, it is also unlikely that any institutional investor will really challenge the process. The SBI owns 100% in the State Bank of Patiala and State Bank of Hyderabad, while the government owns 100% in BMB. Two other associate banks were merged with the SBI earlier: the State Bank of Saurashtra in 2008 and State Bank of Indore in 2010.

In the face of such power asymmetry, in which one set of shareholders has greater rights than another group, the predictable has happened. Left trade unions in Kerala have taken the deal to court; there it might languish for a time.

Two, the merger seems to overlook a critical, post-crisis concern—the too-big-to-fail (TBTF) question. Tremors of the 2008 trans-Atlantic financial crisis were felt all over the interconnected world. The TBTF theory posits that some institutions are so large and intricately interconnected with different parts of the economy that failure can create a systemic shock. This forced many governments to bail out large financial institutions with taxpayer money. It might also be instructive to note that many countries have been formulating preventive TBTF regulations. Australia, for example, has prohibited any merger between the country’s four largest banks. Switzerland, on the other hand, has the world’s most stringent capital norms.

The Reserve Bank of India (RBI)—in keeping with various multilateral agreements at the Financial Stability Board, G20 and the Bank for International Settlements—has designed a risk mitigation framework for dealing with “domestic systemically important banks” or D-SIBs. The framework recognizes SBI and ICICI Bank as D-SIBs, both of which must maintain higher common equity tier I (CET I) than their peers. It allows national authorities greater discretion in the selection and risk mitigation processes than what’s prescribed for global systemically important banks, G-SIBs.

But here’s the thing. Once the merger is completed, SBI could become part of the G-SIB club, ending RBI’s discretionary approach. What happens then? Will the current capital shield be adequate? If no, what impact will additional CET I have on expected efficiencies? Even if it doesn’t get clubbed with G-SIBs, RBI will perforce have to review its D-SIB framework.

Finally, a speculative thought. Rumours are China now wants in on plurilateral trade in services agreement (TiSA) and India has also expressed a similar desire. Leaked TiSA documents show nil barriers to financial services imports, including total freedom to overseas financial companies for acquiring local outfits. Is the SBI merger a pre-emptive move then?

Some of these conversations need to happen now, not post-merger. Especially whether bigger is always better.

This appeared in Mint newspaper on September 21, 2016, and can also be read here

The Legacy: Raghuram Rajan is leaving the battlefield just when he was getting the better of his rivals

India’s debonair central banker, Raghuram Rajan, leaves behind many broken hearts and disappointed souls. Chronicles of his legacy will list many achievements, but will also note that he left the battlefield just when he was getting the better of his rivals; what’s surprising is that the commander-in-chief agreed to his pre-mature withdrawal even though the general’s strategies could be seen bearing fruit.

Equally perplexing will be the choice of his replacement.

Both the government and Rajan personally have been advocates of an alternative global financial architecture. He has also been proposing for a while that it was time for a new Bretton Woods mechanism. And Rajan had taken the battle to the enemy camp. At the April 2016 spring meetings of the International Monetary Fund and the World Bank, Rajan observed how deeply multilateral financial institutions were in thrall of western economic orthodoxies. He even wryly remarked how ideas from emerging economies were dismissed as “crankiness.”

He was prescient about the trans-Atlantic financial crisis. He took on former US Federal Reserve chairman Ben Bernanke when US domestic monetary policy spilled over into the global economy and led to severe volatility in emerging markets. He is unlikely to have fond memories of the period: he had to douse this particular fire soon after his appointment in Sept. 2013.

So, here is question number one: Will his successor have the same zeal about promoting an alternative global financial architecture that is sensitive to emerging economy needs and is not partisan about any particular economic ideology?

Rajan also quits before another crusade could be brought to its logical end. He’s been battening down the hatches that allowed a cosy nexus between large corporate borrowers, bankers, politicians, and bureaucrats, to bleed public sector banks through questionable debt write-offs. Rajan had taken a large broom to bank balance sheets and forced them to take drastic action against defaulters.

Many large—and over-stretched—corporate borrowers have been carping about Rajan’s reluctance to reduce interest rates, which, when lowered, would have certainly helped moderate their interest burden. These same corporates also turned into quack economists on the matter of interest rates: in their collective view, only lower interest rates could bring back high rates of economic growth. This view is oblivious to the fact that the low interest rates in the US, or negative rates in Europe and Japan, have failed to promote any economic growth.

Time for question number two: Will Rajan’s successor have the stomach (or benign sanction from the government) to continue with the clean-up act? Or to hold rates steady when required?

So, what does Rajan’s legacy look like? Apart from the well-documented success in fending off volatility from the US Fed’s tapering in 2013, his tenure will be remembered for three systemic changes he fostered.

One will be the differentiated banking landscape that he designed and left behind. As RBI governor, he grandfathered the emergence of a new breed of universal, small, and payments banks. He was in the process of adding two more categories—custodian banks and wholesale (or long-term) financing banks—to the mix. We will now have to wait and see if his successor has the same enthusiasm for a differentiated banking model.

These new categories come in addition to existing myriad forms of cooperative banks, regional rural banks, local area banks, public sector scheduled commercial banks, State Bank of India group of scheduled commercial banks, old-generation private sector banks, new-generation private sector banks, and foreign banks.

Restive signs mark the payments banks space—three companies which received in-principle approval to launch payments banks (Cholamandalam, Tech Mahindra, and Dilip Shanghvi of Sun Pharma) returned their licences stating that the project was not economically feasible. Undeniably, and in true RBI style, the initial architecture is anti-profit and has flaws in it.

The second marquee item is his strict action against non-performing assets (NPAs) that continue to impair bank balance-sheets. This was viewed as his struggle to end Indian-style crony capitalism: large volumes of loans remain unpaid every year and yet defaulting borrowers manage to get fresh loans unfailingly with some help from politicians, bureaucrats, and complicit bankers.

The staggering amount of NPAs is a direct drain on taxpayers, since loss to state-owned bank balance sheets must be compensated with fresh equity infusion by the largest shareholder—government— every year.

Finally, the outgoing governor will be remembered for installing a new monetary policy framework, which uses inflation-targeting as its driving philosophy. It also includes a monetary policy committee comprising three government representatives and three central bankers, with the RBI governor getting the casting vote. This new structure overhauls the old belief that the economy’s fiscal (the government) and monetary policy (central bank) sides should remain out of each other’s hair.

While the government has been uncomfortable with Rajan’s public comments about governance and broader political economy trends—saying that central bankers should not interfere with the fiscal side—it has not shown the same restraint when trying to influence monetary policy.

It will have to be seen how future central bankers and monetary historians view Rajan’s acquiescence to large government presence in monetary policy making.

The article first appeared in www.qz.com/india and can also be read here.