THE GIST of Editorial for UPSC Exams : 19 September 2018 (Banking on mergers)

Banking on mergers

Mains Paper: 3 | Economic Development
Prelims level: Merger of Banks
Mains level: The move to merge banks is understandable, but shareholders should have been consulted

Introduction

The Union government proposed the merger of three public sector banks Bank of Baroda, Dena Bank and Vijaya Bank to create an amalgamated entity that will become the country’s third largest lender.
The healthy banks to take over weak banks appears to be the strategy to handle the bad loans crisis.
The merger is part of the government’s efforts to consolidate the banking industry with an eye on overcoming the bad loan crisis.
After the announcement of the merger, shares of Bank of Baroda and Vijaya Bank shed a significant part of their value, while Dena Bank gained sharply to hit upper circuit.
Dena Bank is the bank in the worst financial situation among the three entities and is currently under the Reserve Bank of India’s prompt corrective action framework.
Unlike the other two banks, its shareholders are set to gain from being part of a new bank with greater financial strength.

Challenges will faced by the Banking system

Forced mergers such as the current one make little business sense for the stronger banks as the weaker banks tend to be a drag on their operations.
It is important to ensure that such mergers do not end up creating an entity that is weaker than the original pre-merger strong bank.
The bad loan crisis that has gripped the banking system as a whole.
The fact is that mergers are one way of managing the problem and therefore cannot be discounted totally.
The trick lies in ensuring that the merger fallout is managed prudently; identifying synergies and exploiting scale efficiencies will be crucial here.
There is no denying the fact that there are too many public sector banks in India.
The mergers ought to be between strong banks but these are not normal times and with many banks in a precarious situation.

Conclusion

The immediate compulsions for merging the weak Dena Bank with the stronger Bank of Baroda and Vijaya Bank are clear.
From a corporate governance perspective the merger sends out rather poor signals.
Here is a dominant shareholder in the form of the government that is dictating critical moves that impact the minority shareholders, who are left with no say in the matter.
A merger as significant as this one ought to have been first discussed and approved in the board rooms of the banks concerned.
If the shareholders of Bank of Baroda, whose share fell by 16% on Tuesday, feel unhappy, that is perfectly understandable.

UPSC Prelims Questions:

Q.1) With reference to the Systemically Important Financial Institutions, consider the following
statements:
1. These are institutions whose failure will cause disruption in the wider financial system and economy.
2. These institutions enjoy an implicit sovereign guarantee against failure.
3. In India, RBI has declared ICICI and SBI banks as domestic systemically important banks.
Which of the statements given above are correct?
(a) 1 and 2 only
(b) 2 and 3 only
(c) 1 and 3 only
(d) 1, 2 and 3

Ans: D