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What is the priority – mergers or NPA reduction?
In its long history of up and downs, the banking sector’s performance last year was dismal. What should be the nature of corrective actions to be taken?

Hints for bank mergers to create bigger, though not necessarily stronger, banks are being often made. Since banks are in bad shape, the priority should be to improve their health. Focus should be on recovery of advances, particularly from the big defaulters. There should be no further delay in reducing NPAs.

The Financial Stability Report published by the Reserve Bank of India has rightly referred to the performance and risk of the banking sector during FY 2016. It reported: “The business of scheduled commercial banks (SCBs) slowed significantly during 2015-16. The Gross Non-Performing Advances (GNPAs) ratio increased sharply to 7.6 per cent from 5.1 per cent between September 2015 and March 2016, mainly reflecting a reclassification of restructured standard advances as non-performing due to asset quality review (AQR). The restructured standard advances ratio declined but with a marginal increase in the overall stressed advances ratio from 11.3 per cent in September 2015 to 11.5 per cent in March 2016. The capital to risk-weighted assets ratio (CRAR) of SCBs showed some improvement across the bank groups. However, the profitability of SCBs declined significantly, and the public sector banks (PSBs) recorded losses during 2015-16.”

In 2013 and 2015, the banking industry wrote off Rs. 1.14 lakh crore as irrecoverable advances. The situation is so alarming that it may have a disastrous impact on the banking sector, as the possibility of faster recovery appears to be bleak. Though the banking industry has been extending various types of lending programmes to reach out to the unreached,  the villain of the piece has turned out to be the significant advances. The share of large advances in the total advances is 58 per cent, while they contribute to 86 per cent of the gross NPAs. About nine sectors including infrastructure, construction, aviation and the cement industry account for 74 per cent of the gross NPAs.

To show their interest in recovery, some banks have targeted the small borrowers by publishing their photos in local newspapers. Ironically, the cost of the public notice is added to the total amount due from the helpless borrower. A small borrower who cannot repay the loan can also see his photo displayed in the branch. In the case of big defaulters, however, the banks appear to be soft-pedaling. Big defaulters, when ‘invited’ by banks for discussion, rarely respond.

With the current system of recovery of bad debts, it’s hard to assume that the banks would be able to reduce their gross NPA ratios over the next couple of years. The support from the asset reconstruction companies in reducing the banks’ growing volume of stressed advances has not been very significant.

Why bank mergers?

Bank mergers are presumed to improve the efficiency of the merged banks. But in reality, it would make only the banks bigger in size. In the 1960s, there was a spurt in bank mergers blessed by the Reserve Bank of India for weeding out a large number of small and weak banks. One of the major concerns then was to prevent the liquidation of banks, voluntarily or otherwise. In the absence of government ownership and deposit insurance in those days, it was an expedient means of reducing the number of weaker banks, addressing thereby the miserable plight of small depositors and shareholders.

It would be futile to consider mergers as a means of improving the efficiency of banks. It is not often recognised that its immediate impact would be the neglect of recovery efforts. After a merger, assimilation of staff and functional reorganisation would be the main concerns of the top management, as expecting total support from the team might be an unrealistic assumption. As a result, the recovery of the NPAs of the merged bank is bound to get lower importance.

The priority of the regulators at this juncture should be to improve the health of banks. Only after that the marriages of banks - arranged or forced - should be considered.

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