Case: Baroda-Vijaya-Dena Bank Merger

The announcement to merge Bank of Baroda with Vijaya Bank and Dena Bank comes at an
interesting time. The government evidently believes that the merger will send a message to
the world about its reformist zeal and improve investor sentiment. Whether it constitutes
meaningful reform at the present time is, however, open to question. Rajiv Kumar, secretary,
department of financial services, contended that the new entity is “positioned for substantial
rise in customer base, market reach, operational efficiency and a wider bouquet of products
and services for customers.” Well, that is always the hope in any merger. In this case, the
hope is that one plus one plus one will make four. However, a wide body of research casts
doubt on this proposition. According to a McKinsey study, only 30 per cent of mergers
capture the expected synergies.

Other consulting studies point to an even lower success rate – 20 per cent. Academic research
on bank mergers in particular is at best equivocal on the subject: some succeed, others don’t.
In opting for a merger, management often hopes that it belongs to the category that succeeds.

Mergers are expected to deliver cost economies – in the case of banks, say, through
rationalisation of the work force and bank branches. They are also expected to deliver
economies of scale. The cost savings may kick in varying degrees. The benefits of economies
of scale are doubtful because, beyond a certain minimum size (say, Rs 150,000 crore in bank
assets in India), the benefits of size seem to taper off. Most importantly, however, the
presumed benefits do not materialise because management is overwhelmed by the human
resource and cultural challenges posed by merger. There is a cost to managing complexity
that management tends to overlook in weighing the benefits of merger. This happens even in
economies where people can be retrenched easily and where there are no linguistic and other
barriers between the entities that merge. It follows that for a merger to succeed, at least one
entity must be very strong – it must have depth in financial resources as well as management.

Doubtful outlook

It’s hard to make out a case that the proposed bank mega-merger meets these conditions.
Bank of Baroda (BoB) is in better shape compared to many other public sector banks,
including the two entities it is merging with. But, by no stretch of imagination, can it be
considered a strong bank today. BoB’s return on assets on an annualised basis is 0.3 per cent,
which is way below the benchmark of 1 per cent in banking. Its capital adequacy ratio (the
ratio of risk-weighted capital to assets) is 12.13 per cent today. The combined capital
adequacy ratio of the three entities would be 12.25 per cent. The regulatory minimum today
is 10.875 per cent and will go up to 11.5per cent in March, 2019. A strong bank would have
capital that is four or five percentage points above the regulatory minimum. Even to stay two
percentage points above the minimum, the merged entity may require infusion of capital from
the government. Gross non-performing assets at BoB are over 12 per cent, so the bank has its

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work cut out when it comes to recovery. Vijaya Bank is on roughly the same footing as BoB,
but Dena Bank is among the weakest in the banking system today. All three banks should
have been focusing on reducing stress on their balance sheets in the next couple of years.
Now, they have to grapple with the challenges posed by merger as well.

Sorting out the HR issues itself will consume time and energy: which general manager
reports to which general manager, how portfolios will be assigned to executive directors and
so on. Systems and processes could be different and would have to be harmonised. Branch
rationalisation without shedding any staff is quite a task. Public sector bankers have told me
that it takes two to three years at a minimum to sort out these issues. Under its current
Managing Director, BoB has undergone restructuring over the past two or three years with
the help of management consulting firms. It is likely that the merger will throw the present
system into disarray. If anything, the merger may spell new business and fat fees for
consulting firms.

Some government officials have been drawing comfort from the seemingly smooth merger of
SBI with its five subsidiaries. Any comparison with that merger is flawed. SBI and its
subsidiaries had a common technology platform for years, their culture, systems and
processes were the same and there was a flow of senior personnel from the parent to the
subsidiaries and back. Even so, it’s not obvious that merger of all subsidiaries with the parent
was the right strategy for the parent. SBI may have been better off merging the weaker ones
while divesting its stake in the stronger ones and ploughing back the resources into the
merged entity. The parent SBI was a formidable player. It was reckoned to be as efficient as
some of the better private banks. It has since been dragged down by the problems of its
erstwhile subsidiaries. Still, SBI has the management depth to make a success of the merger.
The same cannot be said of other public sector banks (PSBs).

What, then, could have been the motivation for the merger? The point about 23 PSBs being
far too many is a fatuous one. The US has nearly 7,000 banks, Germany over 1,800 and Spain
300. It does not make sense to be fixated on a right number of banks an economy should
have. An important motivation for the merger would certainly have been the difficulty in
finding chairmen, MDs and EDs for PSBs. As a result, it was common for many PSBs to
remain headless for long periods. Having fewer PSBs reduces the demands on the finance
ministry. But the problem itself is the result of years of neglect on the part of successive
governments – not addressing issues of succession and other HR issues at PSBs, faulty
composition of boards, poor incentives for board members, etc.

And the answer to these problems is not increasing concentration in Indian banking,
measured as the share of the top five banks in assets. The SBI merger increased concentration
in Indian banking and the proposed merger will increase it further. With greater concentration
comes higher systemic risk: the failure of a large bank is a bigger problem than the failure of

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a small one. Concentration also means lesser competition and less choice for customers. The
proposed merger substitutes one problem with, perhaps, a bigger one.

Alright, the deed is now almost done. How do we ensure accountability for results? Let the
government or the lead bank, BoB, give estimates of cost savings and synergies and build
these into the earnings projections. They must be asked to provide the consolidated earnings
per share of the merged entity and projections for the next five years. Investors, analysts and
parliament can then measure performance against these projections and judge whether the
merger has succeeded or not. The merger must be judged by the touchstone of performance.
Unless the projections for performance are met, parliament and the investor community must
firmly discourage more mergers of this sort.

Source: Business Standard.