On Dalal Street, the story about banks is not that their windfall treasury profits have vanished, or that their quarterly financial declarations are beginning to reveal a badly-mauled bottomline.
The bigger wonder is that bank stocks have not declined as much as they ought to have when most analysts are neutral (a thin line away from saying that they are bearish), especially against the backdrop of rising interest rates and a falling bond prices that will affect the government securities portfolio severely. They have merely under-performed the market, ie last 500-point rally having done nothing to the share price of State Bank or Punjab National Bank. Even smaller private banks have been dealt with kid gloves. Although UTI Bank announced a severe decline in net profit thanks to a loss in securities portfolio and had to pull back money from reserves to mitigate the picture of vastly lower profitability, the stock price has hardly budged. Since the capital market usually moves ahead of events, why have banks stocks not been re-rated downward in anticipation of lower profits? Is it merely because all stock prices have moved upwards due to the steady flow of foreign institutional investment? Or does the market know something that is not apparent? As usual, market circles have several explanations.
The first is the usual conspiracy theory. It says that a leading industry group that likes to dabble heavily in the market is stuck with an enormous quantity of bank scrips through various investment vehicles. Since the group does not want to book a loss and the floating stock is low and prices have declined much less than anticipated, with minor support operations from this group. A second theory is that banks themselves are keeping their stocks in play with talks of imminent mergers and acquisitions. That the government has blessed such mergers by nationalised banks and even offered tax sops is lending credibility to every merger rumour. But very few mergers have actually materialised (Bank of India with Union Bank is a recent report), while even older ones (Punjab National Bank with IFCI) are unraveling.
It is increasing being felt that takeover stories are just a ruse to keep stock prices buoyant or to boost the chairman’s image. In some instances, chairmen have briefed the media about ambitious plans when their tenure is nearing an end. If the possibility of bank mergers is what is keeping stock prices up, then it is worth examining what makes for a successful merger and whether mere announcement of a merger means much. Traditionally, the emphasis of a bank merger has been on matching the work cultures of the two organisations and to increase the geographical spread of the new entity.
The M. Narasimham Committee (1991) had recommended mergers among nationalised banks to form fewer and larger banks that could compete with the State Bank of India (SBI). It even prepared a grid of possible alliances. But this was not included in the final report in order to avoid needless controversy. A lot has changed since 1991. The big difference is that most banks have computerised their operations adopting different technologies. They also offer customers a diverse range of sophisticated services with electronic linkages between them. Leading bankers say that compatibility of technology has become a big consideration these days, because homogenisation of systems and secure transfer of sensitive financial information is a complex business. Another issue is the quality of accounts and assets owned by potential partners. Banks have become choosy about asset quality and they are often uninterested in a bigger branch network if it brings with it bad loans and dubious banking practices. In fact, technology has reduced the emphasis on a big branch network. Take, for instance, ICICI Bank. Immediately after it converted from a development finance institution to a bank, it needed the leverage of a big branch network. So it acquired Bank of Madura and also expanded rapidly in the last 1990s and early 2000-01. But not anymore. Its CEO K.V. Kamath is now looking at ‘‘a lean organisation with less branches and the best technology.’’ Meanwhile, there is a perceptible difference in the work culture of the new ICICI Bank branches and the ones taken over from Bank of Madura.
Kamath says, ‘‘In the last two years we have added only 80 branches instead of the planned 150.’’ ICICI is also going easy on installation of ATMs (Automated Teller Machines). It already has 1,650 ATMs and hopes to stop in a couple of years at around 1,900. Nationalised Banks planning to merge will grapple with technology and will also have to deal with excessive branches in certain locations. Some mergers may even end up giving the new entity two branches on the same street. Since closure of branches is unlikely, there will have to be a policy to deal with this. Ideally, banks should look at selling specific branches to rationalise the branch network. Foreign and private banks, which are constantly seeking to grow their network through acquisitions, may be potential buyers.
In most cases, this may also help employees by giving them a chance at upward mobility. From the investors perspective however, size does not matter, the bottomline does. That is why HDFC Bank shares, issued at Rs 40 in May 1995, have risen 10 fold in less than 10 years while State Bank of India shares have risen to just Rs 462 from Rs 180, just 2.3 times over the same period. Besides, almost the entire rise came only in the last two years, when interest rates have declined continuously and substantially, creating treasury profits.
In the final analysis, the bottomline depends on a bank’s skill at asset origination or the ability to grab new markets and always being one jump ahead of the competition. This requires great marketing coupled with aggression, innovation and strong leadership. Clearly, merging nationalised banks will create bigger banking entities, not necessarily better ones. On the contrary, mergers may have their own problems unless there is a clear policy to guide post-merger requirements of rationalising branches, streamlining operations and even pruning staff.