MEMBERS' REFERENCE SERVICE LARRDIS LOK SABHA SECRETARIAT, NEW DELHI REFERENCE NOTE. No.63/RN/Ref./December/2017

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1 MEMBERS' REFERENCE SERVICE LARRDIS LOK SABHA SECRETARIAT, NEW DELHI REFERENCE NOTE No.63/RN/Ref./December/2017 For the use of Members of Parliament NOT FOR PUBLICATION 1 MERGER OF PUBLIC SECTOR BANKS Prepared by Smt. Parama Chatterjee, Additional Director ( ) and Shri Pradeep Kumar, Research Assistant of Lok Sabha Secretariat under the supervision of Smt. Kalpana Sharma, Joint Secretary and Smt. Anita Khanna, Director. eference r personal use of the Members in the discharge of their Parliamentary duties, and The Reference Note is for personal use of the Members in the discharge of their Parliamentary duties, and is not for publication. This Service is not to be quoted as the source of information as it is based on the sources indicated at the end/in the text.

2 MERGER OF PUBLIC SECTOR BANKS Introduction The banking scenario in India has changed since the 1970s when banks were nationalised, with an increased banking presence from Private Sector Banks, nonbanking Financial Companies, Regional Rural Banks, Payment Banks and Small Finance Banks. In 1991, it was suggested that India should have fewer but stronger Public Sector Banks (PSBs). Since 2016, effective action has been undertaken to consolidate Public Sector banks by amalgamation of five Associate banks of State Bank of India (SBI) and Bharatiya Mahila Bank (BMB) into the SBI. There are now 20 PSBs other than SBI in the country. The merger of banks is expected to facilitate the creation of strong and competitive banks in the Public Sector space to meet the credit needs of a growing economy, absorb shocks and have the capacity to raise resources without depending unduly on the State exchequer. It is in keeping with the Indradhanush Action Plan of the Government and will improve the efficiency and profitability of the Banking Sector 1. Committees related to Merger of PSBs The issue of consolidation in PSBs is not a new idea. It has been discussed by various committees. Narasimham Committee (1998) recommended a three tier banking structure in India through the establishment of three large banks with international presence, eight to ten national banks and a large number of regional and local banks. In 2004, the Indian Banking Association (IBA) report suggested corporatization of PSBs to accelerate the process of consolidation. In 2008, a Planning Commission Report also stated that given the fragmented nature of the Indian banking system and the small size of the typical bank, there was a need to encourage but not force consolidation of banks in India. Leeladhar Committee (2008) observed that there 1 PIB release dated 23 August 2017 and 15 February 2017.

3 -2- were adequate legal provisions available which encourage and promote consolidation within the PSBs through the merger and amalgamation route. In 2014, Nayak Committee further emphasized the importance of governance in PSBs and thus stated that the decision of a merger or an amalgamation in the PSBs must be through the respective boards of the banks keeping in view the synergies and benefits of merger. 2 Legal framework for consolidation among PSBs Nationalized banks, other than SBI and IDBI Bank, fall under the purview of Banking Companies (Acquisition and Transfer of Undertakings) Acts of 1970 and The objectives of the Banking Companies (Acquisition and Transfer of Undertakings) Acts 1970 and 1980 are: to provide for the acquisition and transfer of the undertakings of certain banking companies, having regard to their size, resources, coverage and organization, in order further to control the heights of the economy, to meet progressively and serve better, the needs of the development of the economy and to promote the welfare of the people, in conformity with the policy of the state towards securing the principles laid down in clauses (b) and (c) or Article 39 of the Constitution and for matters connected therewith or incidental thereto. (underlined portions appear in the 1980 Act). Clearly, the need to re-size PSBs to enable them to become more competitive, improve their capacity for greater geographical coverage, diversify their product offerings and access resources more effectively is in line with the objectives of the nationalisation acts. The relevant provisions relating to amalgamation of these banks are given in Section 9(2)(c) and section 9(6) of the said Act, which read as follows: Section 9(2)(c):The Central Government, in consultation with RBI, may make a scheme which may provide for: (a) The reconstitution of any corresponding new bank into two or more corporations, (b) The amalgamation of any corresponding new bank with any other corresponding new bank or with another banking institution, or 2 Inputs from Department of Financial Services, Ministry of Finance, October 2017.

4 -3- (c) The transfer of the whole or any part of the undertaking of a corresponding new bank to any other corresponding new bank or banking institution or the transfer of the whole or any part of the undertaking of any other banking institution to a corresponding new bank. Further, as per Section 9(6) of the Act: Every Scheme made by Central Government under this Act shall be laid, as soon as may be after it is made, before each House of Parliament while it is in session for a total period of 30 days,(which may be comprised in one session or in two or more succesive sessions, and if before the expiry of the session immediately following the session or the successive sessions aforesaid) both Houses agree in making any modification in the scheme or both Houses agree that the scheme should not be made, the scheme shall thereafter have effect only in such modified form or be of no effect, as the case may be; so, however, that any such modification or annulment shall be without prejudice to the validity of anything previously done under that scheme. 3 Alternative Mechanism for Consolidation of PSBs The Cabinet has given in-principle approval for Public Sector Banks to amalgamate through an Alternative Mechanism (AM). It would facilitate consolidation among the Nationalised Banks to create strong and competitive banks. The proposals received from banks for in-principle approval to formulate schemes of amalgamation will be placed before the Alternative Mechanism. A Report on the proposals cleared by Alternative Mechanism will be sent to the Cabinet every three months. Alternative Mechanism may also direct banks to examine proposals for amalgamation. Alternative Mechanism will receive inputs from Reserve Bank of India (RBI) before according in-principle approval. Alternative Mechanism shall devise its own procedure for appraisal of amalgamation proposals by banks, and be guided overall by the objectives of the 3 Inputs from Department of Financial Services, Ministry of Finance, October 2017.

5 -4- Nationalisation Acts {Banking Companies (Acquisition and Transfer of Undertakings) Acts, 1970 and 1980}. The Final Schemes formulated will be approved by the Central Government, and laid in both the Houses of Parliament. Salient features: The salient features of the approval Framework for Consolidation of Public Sector Banks are as follows: The decision regarding creating strong and competitive banks would be solely based on commercial considerations. The proposal must start from the Boards of Banks. The proposals received from Banks for in-principle approval to formulate schemes of amalgamation shall be placed before the Alternative Mechanism (AM). After in-principle approval, the Banks will take steps in accordance with law and SEBI s requirements. The final scheme will be notified by Central Government in consultation with the Reserve Bank of India. Composition The composition of the Alternative Mechanism will be as under: Chairperson: Shri Arun Jaitley, Minister of Finance and Corporate Affairs. Member : Shri Piyush Goyal, Minister of Railways and Coal. Member : Smt. Nirmala Sitharaman, Minister of Defence. 4 Merger of PSBs Ever since the Narasimham report made this recommendation, there have been several rounds of discussions on mergers and consolidation of banks in India at periodic intervals. While the objective has, all along, been building scale and 4 PIB release dated 23 August and 01 November 2017

6 -5- strengthening the risk-taking ability, the trigger for the latest round of discussion is the mounting non-performing assets (NPAs) affecting the Public Sector Banks. Since 1969, when Bank of Behar was merged with State Bank of India (SBI), and till Kotak Mahindra Bank Ltd took over ING Vysya Bank Ltd in 2015, most bank mergers have been an offshoot of the central bank s efforts to protect the financial system and depositors money, and very few of them have been driven by the need for consolidation and growth. 5 There is only one instance of the merging of two PSBs: the takeover of New Bank of India by Punjab National Bank (PNB) in The RBI had forced this merger under Section 45 of the Banking (Regulation) Act, 1949 as New Bank of India reached a precarious state of liquidity. PNB had been a strong bank with an uninterrupted record of profits, but it had to face several problems following the merger. It reportedly took PNB five years and more to get over the merger effect. SBI Merger Once known as the seven sisters, the Associate Banks of SBI * had been established by princely states before the country s independence to serve local populations. These came under the fold of SBI as Associate banks after the government passed the State Bank of India (Subsidiary Banks) Act in Merger of State Bank of Saurashtra with SBI (2008) In 2008, the State Bank of Saurashtra was the first to merge with the SBI. After the banking sector was opened to foreign banks in 2009, consolidation of SBI with associates was actively considered in order to increase its competency vis-à-vis entry of foreign banks. Bank of Saurashtra was chosen first as it was fully owned by SBI, * State Bank of Bikaner & Jaipur, State Bank of Hyderabad, State Bank of Mysore, State Bank of Patiala, State Bank of Travancore, State Bank of Indore and State Bank of Saurashtra. 5 The whys and hows of bank consolidation in India, The Mint, 24 July Economic & Political Weekly (EPW), 22 July 2017

7 -6- was smaller than other associates and it would enhance SBI s limited presence in Saurashtra region. State Bank of India and State Bank of Indore (2010) It was the second merger of an associate bank with SBI after a similar exercise with State Bank of Saurashtra. The State Bank of Indore officially merged into State Bank of India in August SBI merger with Associate banks and Bharatiya Mahila Bank (2017) As the largest lender and mega bank, State Bank of India was already designated a systemically important institution. The bank became even bigger since April 2017 after its merger with five associate banks and the Bharatiya Mahila Bank. The consolidation helped SBI gain a spot among the top 50 banks globally in terms of assets. However, as the June quarter results show, there has been a deterioration in SBI's asset quality. The overall picture of the impact of merger will become clearer in the coming quarters. 7 Conclusion Consolidation of Public Sector Banks (PSBs) are expected to be advantageous for reasons like improved profitability, rationalization of operational costs, improved ability to deal with external shocks, reduced geographical concentration risk, greater capacity to invest in technology and to raise capital from the market 8. But there could be challenges of resistance from trade unions, integration of human resources, technological systems, accounting practices etc. India needs a mix of efficiently run PSBs, small finance banks, Payment Banks and Private banks to achieve growth and development along with social justice. 7 Bank Consolidations: 5 mergers from the past, The Mint, 24 Aug 2017 and EPW 22 July Rajya Sabha Starred Question No.230, dated

8 -7- REFERENCES: 1. Inputs from Department of Financial Services, Ministry of Finance, October PIB release dated and Rajya Sabha Starred Question No.230, dated Public Sector Bank Mergers: a reality check by R Krishnamurthy, Economic & Political Weekly, 22 July Bank Consolidations: 5 mergers from the past, The Mint, 24 Aug The Whys and Hows of bank consolidation in India, The Mint, 24 July 2017