For the mergers to work, realizing staff cost synergies is key
For its sheer magnitude, the scale and the ability to disrupt the status quo, the mega bank mergers announced by Finance Minister Nirmala Sitharaman on Friday must go down as the most significant the banking industry has seen in the five decades since nationalization.
The bottomline is clear: to create banks of global level that can leverage economies of scale and balance sheet size to serve the needs of a $5-trillion economy by 2025. The jury is, of course, out on whether this strategy will succeed. Mergers are driven by synergies — in products, costs, business, geographies or technology and the most important, cost synergies. While there may be some geographical synergies between the banks being merged, unless they realise cost synergies through branch and staff rationalization, the mergers may not mean much to them or to the economy. This is where the government’s strategy will be tested. It is no secret that public sector banks are overstaffed. There is also bound to be overlap in branch networks such as in the Canara-Syndicate Bank merger, especially in Karnataka and a couple of other southern States. Ditto with Punjab National Bank and Oriental Bank of Commerce, both of which have strong networks in the north and the west. The success of these mergers, therefore, will hinge on how well these banks handle the sensitive issue of staff rationalization. The All India Bank Employees Association has already raised the red flag.
It was the Narasimham Committee in the late 1990s that recommended consolidation through a process of merging strong banks. The issue has been the proverbial bee in the bonnet of successive governments since then. What the committee also recommended was shutting down the weaker banks and not merging them with the strong ones as is being done now. But this is obviously not an option politically even for a government with a brute majority in Parliament. The biggest plus of the mergers is that they will create banks of scale — there are too many banks in India with sizes that are minuscule by global standards with their growth constricted by their inability to expand. Yet, this advantage of scale cannot be leveraged without adequate reforms in governance and management of these banks. To be sure, Ms. Sitharaman did announce a few measures to make managements better accountable to the board. But the key reforms to be made are at the board level, including in appointments, especially of government nominees. These are often political appointees, with little exposure to banking. Surely, such practices need to be curbed as the definition of global banks is not just about size but also professionalism in governance. The government will also have to manage the fallout of unleashing four mergers simultaneously which is bound to cause upheaval in the industry. Would it have been better if these mergers had been done one by one? The future will colour the past.
The transfer of Reserve Bank of India (RBI) surplus to the government is a routine matter. Every year after the finalization of the accounts of the RBI its surplus is transferred to the Central government sometime in endAugust; this augments the non-tax revenue of the Central government. Normally, an estimate of such a transfer is decided informally between the RBI and the Central government by January and finds a place in the Budget estimate, typically announced in early February. But this year is an exception. The announcement of a huge transfer of RBI surplus, earlier this week, of ₹1.76 lakh crore to the Central government, seems to have generated quite a bit of media attention.
The two narratives
There are perhaps two caricatured folklore narratives about this increased transfer of RBI surplus.
The first one goes as follows: the government, facing a resource crunch, has arm-twisted the RBI to transfer some of its reserves, which is almost in the nature of family silver. This is not good for the economy. As when and if the economy faces a crisis, the RBI may not have adequate money to protect it. Also it denotes an erosion of the RBI’s independence. This assumes credence in view of the perceived difference of opinion between the RBI and the Central government, that has been highlighted in recent media reports, as well as the resignation of the former RBI Governor, Urjit Patel in 2018.
The second one, on the contrary, runs on the following lines: the central bank is a unique institution; it is backed by the faith reposed on it by the the Central government, and therefore, a huge amount of reserves with the central bank is in the nature of idle cash which could have been utilised more productively in the economy. This year, the Central government has done precisely this. The RBI decided to transfer this increased surplus after following due process and after accepting the recommendations of the Jalan Committee (i.e., the expert committee to review the extant economic capital framework of the RBI, headed by the former RBI Governor, Bimal Jalan and with eminent central bankers, bureaucrats, economists and accountants as its members).
Are these competing narratives reflective of the political prior of the exponent? Or, are there more differences in substance?
Notes on the RBI
The narrative that the RBI is an overcapitalized institution has been in currency for some time. The Economic Survey of 2016- 17 found that the RBI is one of the most capitalized central banks in the world and noted, “There is no particular reason why this extra capital should be kept with the RBI”. Later, the former Chief Economic Adviser, Arvind Subramanian in his book Of Counsel: The Challenges of the Modi-Jaitley Economy (2018) has caricatured the syndrome of treating the government’s capital at the RBI by RBI officials as “prudence or paranoia”. Folklore estimates of excess capital of the RBI in the range of ₹4.5 lakh crore to ₹7 lakh crore seemed to have been blowing in the wind. The issue became all the more controversial after the resignation of Mr. Patel in December 2018 citing personal reasons.
Against this backdrop, the RBI, in consultation with the Government of India, constituted the Jalan Committee to assess the quantum of economic capital of the RBI (in end-November 2019). The committee submitted its report on August 14 and the RBI’s Central Board in its meeting held on August 26, 2019 accepted all the recommendations of the committee; accordingly it finalized its accounts for 2018-19 using the revised framework.
According to the accounts, the RBI has ended with an overall surplus of ₹1,759.87 billion in 2018-19 as against ₹500 billion in 2017-18, representing an increase of more than 250% .
But what are the constituents or purposes of the RBI’s excess capital? There are two distinct types of items under it. While “Contingency Fund (CF) and Asset Development Fund (ADF) represent provisions made for unforeseen contingencies and amount set aside for investment in subsidiaries and internal capital expenditure respectively”, components such as, “Currency and Gold Revaluation Account (CGRA), Investment Revaluation Account (IRA) and Foreign Exchange Forward Contracts Valuation Account (FCVA), represent unrealized marked to market gains/losses” (RBI, Annual Report, 2017-18).
In assessing the economic capital framework (ECF) of the RBI, the Jalan Committee justifiably went by the key premise, “As a central bank is a part of the Sovereign, ensuring the credibility of the RBI is as important, if not more, to the Government as it is to the RBI itself”.
Insofar as the methodology is concerned, the committee adopted the Expected Shortfall methodology (instead of the existing Stressed Value-at-Risk) for measuring market risk.
But what are the risks to the RBI? In view of the RBI’s function as a lender of last resort, it needs to maintain some Contingent Risk Buffer (CRB) to insure the economy against any tail risk of financial stability crisis. The Jalan Committee recommended that the CRB needs to be “maintained at a range of 5.5 per cent to 6.5 per cent of the RBI’s balance sheet which is above the available level of 2.4 per cent of balance sheet as on June 30, 2018”. Applying its recommendations to the RBI’s 2017-18 balance sheet would result in RBI’s risk equity levels in a range of 25.4% to 20.8% of balance sheet. In line with the methodology of the Jalan Committee, the amount of transfer of the RBI’s surplus to the government has been placed at ₹1.76 lakh crore this year.
In the lingo of a caricatured two-handed economist, several pointers can be flagged towards deciphering the folklore narratives.
First, the Jalan committee does not seem to have compromised on arriving at the economic capital framework of the RBI and has calculated the extent of excess capital of the RBI under a set of fairly standard and conservative assumptions.
Second, at this juncture of the Indian economy — when the spectre of a slowdown is looming large and when channels of credit disbursements are choked because of a lack of capital with the commercial banks — a transfer of such additional money to the government could enable the government to go in for bank recapitalization in a big way and would be good for the economy. Third, the transfer of the additional surplus from the RBI could enable the government to pursue efforts towards stimulating the economy while maintaining budget discipline. Remember, in pursuing the fiscal stimulus of 2007-08, fiscal deficit went up from 2.5% to 6%. Of course, the final impact of such actions on the independence of the RBI would crucially depend upon the future course of such transfers. After all, we all know the story of the goose that laid the golden eggs.
Just before the G-20 meeting in Osaka in June this year, Russian President Vladimir Putin made headlines in the world media with an interview to the Financial Times in which he stated that liberalism had “become obsolete”. He went on to say that liberal ideas about refugees, migration and LGBTQ issues were now opposed by “the overwhelming majority of the population”. Even some western nations, he went on, had privately admitted that multiculturalism was “no longer tenable”. There was a swift and critical response from the President of the European Council, Donald Tusk: “Whoever claims that liberal democracy is obsolete also claims that freedoms are obsolete, that the rule of law is obsolete and that human rights are obsolete.” This was in fact not what Mr. Putin had alleged, but the wider question is why the Russian President is saying this now and whether he had a point.
To start with, since liberalism means different things to Mr. Putin and Mr. Tusk, what is liberalism? This complex term, much used in India today in various contexts of opposition to the present Union government — and used in a derogatory sense by supporters of the government in respect of its detractors — might broadly encompass three definitions. There is economic liberalism, which ‘emphasizes free competition and the self-regulating market, and which is commonly associated with globalization and minimal state intervention in the economy’. There is political liberalism, which for most commentators is founded on ‘belief in progress, the essential goodness of the human being, the autonomy of the individual, and standing for political and civil liberties’ as laid out in various United Nations Covenants. And then there is social liberalism, ‘linked to the protection of minority groups, and such issues as LGBTQ rights and same-sex marriage’.
Mr. Putin appeared critical of the ‘approach of some western governments by specifically mentioning immigration, multiculturalism and LGBTQ issues, and therefore seemed to focus on social and political liberalism’. By no means is Mr. Putin the only world leader who dislikes this aspect of liberalism. The leaders of India, China, Turkey, Brazil, the Philippines and several others, even in Europe, believe highly centralized political systems work better for political stability and economic progress than western liberal democracies.
Nevertheless, liberalism has been the dominant socio-political ideology in the West since the end of the Second World War, where it has been regarded as the norm until recently. However, many even in the West now believe it could be in decline, as evidenced by support for Brexit in the United Kingdom, or support for populist leaders such as President Donald Trump in the U.S., Hungarian President Viktor Orbán or (former) Italian Deputy Prime Minister Matteo Salvini. David Runciman, professor of politics at Cambridge, contends that voters everywhere increasingly dislike and distrust elected representatives because western democracy has ceased to work and failed to deliver, and is headed for a long-drawn-out demise. The financial downturn in 2008 marked a major turning point, with impunity for corrupt bankers and an attempt to return to status quo globalization that allowed markets to determine everything and led to major questions of identity and culture. Now globalization is heading for a backlash, leading to protection, local solutions and stronger nation states, and the growing conclusion that liberalism needs urgently to justify itself by addressing issues of inequality and the loss of a sense of community.
Mr. Putin said Germany made a mistake by admitting more than one million refugees. He said: “This liberal idea presupposes that nothing needs to be done…because their rights as migrants have to be protected… It has come into conflict with the interests of the overwhelming majority of the population.” There is little doubt that Mr. Trump in America uses the immigration and minority issues, with their racial undertones, to bolster his core support. In European countries such as Greece, Germany and Italy that have been entry points for the recent wave of asylum seekers, attitudes towards immigrants have hardened since 2014. Poland and Hungary do not favour the admission of refugees even fleeing from violence and war, and nearly all European Union members are convinced that the EU has badly mismanaged the question of admission of refugees, which in turn has led to questioning the very basis of Europe’s integration project.
Mr. Putin also deplored liberal governments dictating LGBTQ values that “millions of people making up the core population” opposed. “We have no problem with LGBT persons… but some things do appear excessive to us,” he stated. Gender parity issues are strongly promoted in the British media and entertainment industry, and a storm arose in England recently over the teaching in primary schools of same sex relationships and gender identity. Boycotts of various kinds, including of major sporting events, have been threatened because of alleged anti-gay sentiments or legal restrictions. Nevertheless, same sex marriage is recognized only in some countries, others have the death penalty for homosexuality, and laws regarding LGBTQ rights vary widely across jurisdictions. As a generality, it can be stated that they are disfavoured in the vast majority of the non-western non-secularized world.
Liberty vs. protest
Why has Mr. Putin expressed his opinions now to a newspaper considered a flag-bearer of liberalism? The Russian President’s position is that ‘his country has a specific and different kind of civilisation, where sovereignty trumps democracy and national unity, and stability trumps human rights’. Western-style liberalism that prioritises individual rights over those of society is regarded as a ‘challenge to his style of government’, which presents an alternative model. The same view is shared by China. The desire for liberty is recognized as universal, but the freedom to protest in unauthorized demonstrations and wilfully shatter the economy and tourism as in Hong Kong, or the freedom to blaspheme and outrage the sentiments of the devout, as in the French Charlie Hebdo case, or the freedom to bear arms as enshrined in the U.S. Constitution, are only random examples that show that liberty has limitations, even if they are self-imposed. Russia and China, with good reason, believe that unauthorised demonstrations open the way to foreign interference and ‘colour revolutions’. No country has found the golden mean between free-range liberalism and statism. When liberal government and liberal models are under pressure even in the flagship West, it is probably ‘as good a time as any for Mr. Putin to make his case’.
PNB gets lion’s share of recapitalisation
‘After reviewing banks’ fundamentals, we see no reason for recapitalization to exceed ₹70,000 crore’
Finance Minister Nirmala Sitharaman on Friday laid out the broad strokes for the recapitalization plan for public sector banks, providing the approximate allocation breakup for about ₹55,000 crore of the ₹70,000 crore promised in the Budget.
Ms. Sitharaman, while speaking at a press conference to announce the merger of 10 public sector banks into four entities, said that the final figures for the allocation would be decided following consultation with the banks themselves, but that the figures provided on Friday were reasonably accurate.
Finance Secretary Rajiv Kumar said, as of now, the recapitalization amount would remain at ₹70,000 crore, and added that the mergers announced on Friday were all that the government had envisaged so far.
“As the Finance Minister said, the government is fully committed to making the banks robust,” Mr. Kumar said at the press conference. “However, after seeing the fundamentals of the banks before and after the merger, we see no reason for the recapitalization amount to exceed the ₹70,000 crore announced.”
“As of now, the roadmap for mergers is final,” Mr. Kumar added. “Twelve is the right number of banks which should remain.” Punjab National Bank, which will now be merged with Oriental Bank of Commerce and United Bank, will receive the highest share of the capital infusion of about ₹16,000 crore. Union Bank of India, which is to be merged with Andhra Bank and Corporation Bank, will receive about ₹11,700 crore.
Punjab National Bank will, post-merger, become the second-largest bank in the country, after State Bank of India. The amalgamated Union Bank of India will become the fifth-largest bank.
Bank of Baroda, which had earlier been merged with Dena Bank and Vijaya Bank, will likely receive ₹7,000 crore, and will be the third-largest bank in India.
Canara Bank, to be merged with Syndicate Bank, will receive about ₹6,500 crore of the capital infusion. It will be the fourth-largest bank in India, post-merger. Indian Bank, which will be merged with Allahabad Bank, will receive about ₹2,500 crore, and will be the seventh-largest bank.
The government also announced the tentative recapitalization breakup for the remaining smaller banks. Of these, Indian Overseas Bank is to receive about ₹3,800 crore, Central Bank of India ₹3,300 crore, UCO Bank ₹2,100 crore, United Bank of India ₹1,600 crore, and Punjab & Sind Bank will get about ₹750 crore.
The Finance Minister had announced the ₹70,000 crore recapitalization package for public sector banks in the Budget, and had said that given the stronger financials of the banking sector, this amount would be used as growth capital and to increase credit outflow.
India, Pak. to join SAARC event in U.S.
India and Pakistan are expected to participate in the Foreign Minister-level meeting of the South Asian Association for Regional Cooperation (SAARC) in New York on September 26, a diplomatic source has confirmed. The meeting has remained on track despite the state of tension between the two countries.
“We have asked both India and Pakistan informally and formally if they would proceed with the planned meeting of September 26 in New York and they have communicated that there is no change in the previous plans,” said the source. The meeting is an annual affair that takes place on the sidelines of the UN General Assembly’s session. It will be the first occasion since August 5, where the Foreign Ministers will be seen in a single venue.
The person concerned said India had confirmed participation of External Affairs Minister S. Jaishankar before the current tensions erupted over Kashmir. On Thursday it reminded Pakistan to tone down rhetoric and urged it to behave like a “normal neighbour”.