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Merger Mania  - Part I :  An Overview of the Move to Merge PS Banks in India

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It has been widely reported about the proposal to merge some of the PSU banks (Nationalized banks). These merger has been proposed by the government, specifically our Finance Minister P. Chidambaram. In the annual banking summit, the finance minister reiterated this by saying that banks should not fear consolidation and that for being a world economic super-power or for at least being one of the three largest economies, India would at least need a couple of global banks. The centre is nudging the capital infusion demand by the state-run banks with demands for mergers as these mergers would considerably bring down the liability on the centre for capital infusion. Currently the centre has a commitment of Rs 15888 crores of capital infusion towards state run banks to maintain the financial health of the state run banks. Over the next five years it would have to take the burden of another Rs 90000 crores for the same.



 The justification of the need for large global sized banks given by the centre was that these banks could have a larger asset base as their exposure to various sectors would be widened and their scope for financing bigger and larger projects would undoubtedly increase. Certainly the centre is adopting the policy of looking towards the west and drawing some inspiration out their ways. In the financial debacle of 2008, the world has witnessed how the so called global banks of USA and Europe are still gasping for breath. Ultimately many of these financial institutions and banks had to be taken over by others or had to be bailed out by the government through the respective central banks by providing grants and soft loans. Even the biggest of banks in the world, Citibank, was not spared by the recession. The state of these banks were as a result their own making and not because of circumstances that they had to bear the brunt. Indian banks have a large customer base and undoubtedly large amount of public money is involved. A larger loan exposure would only put the public money in unsafe domains. The more fragmented the banks are, the lesser will be the exposure wrt to size, thus making public money secure. We have already seen how the banks are reeling under pressure because of their exposure to the aviation, power generation, infrastructure, mining and agriculture sector. The banking sector is the pulse of the economy and decisions should be taken by keeping the long term implications in view. Even the slightest of jerks in trying times could prove fatal for the economy. Further more in this regard, these proposals are being mulled upon to create 2 or 3 global sized banks. Without doubt, the sizes of banks are being compared by keeping in view their loan books and their asset base. But what the minister is forgetting is that we got to compare apples for apples. If we are to compare the size of our banks with that of the US, converting our financials in terms of dollars and making a pie to pie comparison would be utter foolishness. With my limited knowledge of economics and with due respect to our finance minister, it isn’t rocket science to understand that what 1 dollar means to an American is not what 1 rupee means to an Indian. We got to factor in the purchasing power of both the currencies in their respective economies for the corresponding average citizen of that country before making any comparison. Appropriate weightage should be given to this aspect in any exercise of comparing size of banks in each of these economies. Moreover it will be pertinent to note that the penetration of the Indian banks by their sheer enormity of the reach their customer base is something unparallel world over (SBI being the case in reference). One has to definitely give due consideration and weightage to this fact and not merely be guided by size of loan book and enormity of asset while considering the size of a bank. Thus all these points all the more make it unreasonable and unfavorable for the centre to even think about merger of banks. Apart from all this, the points being raised by the respective unions of all these banks are also to be considered before making any commitments. It would amount to nothing but digging our own grave or to put it more bluntly we would be cutting the hands and legs of the workers who built our very own taj mahals upon which our economy is sustaining and I sincerely hope that our finance minister wouldn’t want to take the wrath of being termed as shahjahan who made all this happen.



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Another very important point of consideration is the proposal of divestment of the PSUs including the nationalized banks. No doubt it is impertinent that the government meets its fiscal demands and divestment of holdings is one of the most easiest and non-cumbersome ways to meet this end. But the unique, never-before tried out model which the centre plans to adopt in the process of divestment is alarming. From what we understood of what was reported in this end is that the centre plans to sell the stakes of these Banking and other PSU stocks to selected Asset management companies (AMC) and mutual funds, and these mutual funds AMCs  in turn would create a special category of securities where in these securities would derive their value from the value of the basket of these PSU stocks. These securities thus created would be issued to the public as units of exchange traded funds (ETFs) listed in the stock market through these mutual funds in the name tradable listed ETF units. The fact that the underlying value of these securities would be derived from that of the PSU stocks which are listed in the exchanges would garner a lot of interest in the common public, who are generally unaware of the ways of the market. This would be so because it is generally understood that PSU stocks are considered to be safe havens of investment for the common man and has a huge upside as it linked to the economy. India being projected as the next big economic super-power and a force to reckon with would furthermore add to such an understanding of the public. Keeping the present proposal in mind, the only earnings out of the securities that the mutual funds and AMCs would issue would be out the dividends that the companies (underlying stock/PSUs) declare and the capital appreciation of these stocks. How often would these companies declare dividends is a question which only time can answer and whether these stocks would ever see any capital appreciation is a question which can, to a large extent be answered by us. Such a possibility is certainly shady. Because the catch is that, the stocks of these public sector undertakings most of which are already listed in the exchanges do not reflect their true price. Their values on the exchanges are not reflective of their true value which ideally should be ascertained by market forces. It was already very well seen how the market reacted to the offer for sale of a few PSUs which were divested. Even though those stocks were being offered at a discount it did not garner much interest. There was hardly any buying for the better part of the period of the trading window. Towards the fag end of the trading window, it was LIC which took a lion’s share of the offer for sale, thus being a saving grace for the government. Seasoned Market players probably knew about the intricacies of these stocks. And that is why it did not garner much interest even though it was being offered at a discount.  Even in the case of the proposed divestment of PSUs through AMCs it would is highly doubtful that it would see an upside resulting in capital appreciation since the values are already fabricated. The reasons for such artificial prices are the low public holding or free float of many these shares. Probably the government does not want to face the same situation and that is why they have devised this new structure where in a mutual fund AMCs would act as an intermediary between the divesting government company and the common public. Ultimately the fiscal needs of the government would be satisfied, the mutual funds would have made their money but it would be the common that would have lost their hard earned money.  The average middle-class and those planning for their retirement would without hesitation enter into such a fund. And after a few quarters of capital stagnation when they decide to encash out of it they are bound to face the road block of not even fetching the face value/ purchase value of the units held by them thereby leading to a downward spiral in the value of these units when these mutual funds face redemption pressure. This is the same model which was the prequel leading to the November 2008 financial debacle where the securities, which derived its value from underlying subprime loans, were being issued as highly secure and AAA rated securities to the average American. They innocently entered such funds as a lucrative substitute for pension funds and got trapped.



Furthermore, the next initiative which the government plans to take in the bid to open up the economy and make reforms is the opening up of the pension sector. The dual combination of opening up of pension funds and allowing pension funds larger freedom to invest in equity and equity based securities and the so called seemingly innocent act of offering these ETFs which has the wide acceptance and belief of being safe simultaneously by the government is the most dangerous cocktail which has the potential of leading to catastrophic results which is likely to affect scores of millions of unassuming individuals, especially senior citizens and pensioners, the most vulnerable of any society.




In order to understand the ‘incentive’ driving the ministry of finance and the various interests pushing it, it is useful to distinguish between the activities of banks as seeding-cum-cultivating agents and as harvesters on the one hand, and the activities of modern banks as over-time seekers of interest from customer activities, and their activities as point-of-time earners of fees. Bank mergers, like many other types of liberalization directed at increasing the wealth of rich shareholders has been a tsunami originating in the activities of US financial corporations. Their role has been that of a harvester of fruits of other institutions’ seeding and nurturing activities, and of looking for product lines involving fees for point-of-time services rather than of durable customer servicing activities. They generally provide usual banking services only to an elite band of up-market customers with whom they have sought to build close relationships.











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