Merger to test large bank’s absorbtive capacity

With the government having finally set the ball rolling for the long awaited consolidation among public sector banks, by announcing its intention to merge Bank of Baroda, Vijaya Bank and Dena Bank, all eyes will be on the proposed amalgamation to see how successfully the combination works.

Investors and bankers will be keen to see if this may end up serving as a template for further mergers among state-run lenders, especially given the asset quality issues plaguing several of these banks.

The success of this exercise, according to analysts, is crucial for future such attempts. In particular, the proposed merger is seen as a test of the capacity of a large bank, which itself is facing pressure on asset quality, to absorb a weaker peer.

“Merger integration risk is high from a HR standpoint but further mergers would be contingent on the success of this one and the strength of the larger PSU banks to absorb smaller ones,” Kotak Securities wrote in a note to its clients.

Bank of Baroda, the largest among the three with total business of ₹10.3 lakh crore, is more than five times the size of Dena Bank — the weakest of the three with business of ₹1.73 lakh crore. Dena also faces certain operational restrictions as it is currently under the Reserve Bank of India’s prompt corrective action framework after a rise in NPAs resulted in the lender’s return on assets turning negative.

Vijaya Bank, also smaller with business of ₹2.8 lakh crore, is, however, a relatively healthy bank. The Bengaluru-based lender is one of only two public sector banks that reported a profit in the last financial year, the other being Chennai-based Indian Bank.

One of the crucial positive aspects of the merger is the timing. While bank officials expect the merger to be completed in 4-6 months time, banking industry veterans expect it would take at least one year to complete the amalgamation. The recognition and resolution of stressed assets, which is currently under way, is expected to help improve asset quality over the next six to 12 months.

The finance ministry recently said the stock of non-performing assets were ‘no longer rising’ as it had reduced by ₹21,000 crore in the April-June quarter.

“We do expect this transaction would take more than a year to consummate which implies that the probability of negative surprises on asset quality (post-merger) should be largely contained,” Kotak Securities said.

Bank of Baroda’s net NPA ratio is 5.4%, Vijaya Bank’s is 4.1% and Dena Bank’s is 11.04%. The combined entity will have a net NPA ratio of 5.7%.

Improvement in operational efficiency is one positive that could emerge from the merger that is set to create the country’s third-largest lender. This is because a significant number of branches can be rationalised particularly in States like Gujarat, where both Baroda and Dena have a significant presence; Maharashtra, where all the three have significant presence; and Karnataka, where Vijaya enjoys dominance.

In addition, cost of funds for the merged entity is expected to come down since Vijaya Bank has a high dependence on short-term bulk deposits, which are typically high cost in nature.

There are a few challenges too including, particularly, the handling of human resources. HR is a key challenge for any merger, be it between private or public sector entities, as it could be difficult for employees to adapt to a new corporate culture. And that is where the role of top management and their communication to the employees assumes importance.

One silver lining though could be the lower likelihood of employee retrenchment as an ageing workforce is leading to significantly higher numbers of retirements. And this at a time when they are expanding into new areas where there is a need for more specialised hands.

The other challenge is customer retention. SBI’s recent merger with its associate banks saw customers of associate banks opting to move their business to rival lenders as result of a lack of comfort in banking with the larger parent. The merged entity from the latest proposal will, for instance, likely face a challenge in retaining customers particularly that of Vijaya Bank, which is dominant in south India.

Ultimately, how well the three banks combine could well end up determining the future of consolidation among public sector banks.

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Printable version | Oct 16, 2021 8:58:22 PM |

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