ECONOMICS SEMINAR 2020

January 18th-19th, 2020

Tipping Point
NPAS – AN IMPACT ON THE MERGER OF PSBS
Mamata Dalai (TYBA)
[UID – 171111]

St. Xavier’s College – Autonomous

Mumbai

Abstract

Public Sector Banks in the Indian banking system have been a crux of the system given the
market sentiment and capitalization it holds. But the increasing rate in occurrences of Non-
Performing Assets has led to distraction from the $5 trillion economy goal. The research thus
aims to study the whether NPAs in turn lead to mergers of banks. Additionally, the paper
also focuses on the health of the Public Sector Banks merged in August 2019. This in turn
intends to check the PCA taken by the RBI and its credibility.
The banking sector of an economy plays an important role in determining the growth of the
economy. Efficiency and stability of the sector verifies its ability to handle liquidity in times of
financial crises, especially in case of underdeveloped and developing economies. The crux of the
banking sector is its commercial banking industry as well as the public sector banks since the
government run sectors have an influence on the development of public finances.

The primary function of a bank is to lend and borrow money i.e. encouraging public savings and
allocating them into different sectors as investments. This ‘savings to investment’ transformation
is known as capital formation in the economy. These investments are given out in the form of loans
to people or businesses after gaging the risks of defaults and benefits in that particular investment.

The Indian banking system comprises of Commercial Banks, Regional Rural Banks and
Cooperative Banks. Commercial banks sector is further shared by Public Sector Banks (PSBs) and
Private Sector Banks. It was the ‘Narsimhan committee (1991) that was set up on ‘Financial
System Reforms’ coined the concept of Non-Performing Assets. Non-Performing Assets (NPAs)
are loans given out by banks to people or businesses that are not repaid in time. Thus, they are
assets that have ceased to perform as assets to the bank. There are three types of NPAs, namely,
Standard Assets, Sub-standard Assets, Doubtful Assets and Loss Assets. NPAs are by far the best
means to judge the health of an economy’s banking sector ("Indian Banking Sector: Current Status
and the Way Forward", 2019). They have a trickle-down effect on the performance of the banks.

Recently, Public Sector Banks we brought down from 27 to 12 ("List of Merger of Public Sector
Banks in India 2019", 2019) in number by merging some banks under the Prompt Corrective
Action (PCA) of the Reserve Bank of India (RBI). Punjab National Bank was merged with Oriental
Bank of Commerce and United Bank of India to form the second largest PSB in India; Canara
Bank and Syndicate Bank were merged to form the fourth largest PSB; Union Bank, Andhra bank
and Corporation Bank were merged to form the fifth largest PSB in India while Indian Bank and
Allahabad Bank were merged to form the seventh largest PSB.

These mergers come ahead of an array of NPAs that came out in public in recent times. The Punjab
National Bank-Nirav Modi default (January 2018, the Kingfisher Airlines scandal(2011),
Kanishka Gold (2007) and some smaller defaults.
 Literature review
The Governor of RBI, Shri Shaktikanta Das, in a speech at the Ahmedabad University says, the
PSBs, sometimes, to fulfil the social responsibility base goal of their functioning end up exposing
themselves to critical sectors like mining, infrastructure, iron, etc. which were in turn affected by
other incidents. Therefore, it has been measured that PSBs account for higher NPAs than the
private sector. (Das, 2019)

At another instance in Pune, the Governor mentions that there are multiple causes to the
deterioration in the quality of assets given out by the PSBs. One of them is the credit boom of
2006-11 when banks lended about 20% more than average lending. Another reason is the poor
post sanction monitoring standards. The bankruptcy regime was weak until May 2016 too. Once
CRILC (Central Repository of Information on Large Credits and AQR (Asset Quality Review)
were setup in 2014 and 2015 respectively, NPAs gained recognition and the gross NPA ratio rose
from 4.3% to 7.5% immediately, peaking in March 2018 to 11.5%. This ratio has declined to 9.3%
in case of Scheduled Commercial Banks during 2018-19 due to the Insolvency and Bankruptcy
Code by the RBI. (Das, 2019)

Prakash Agarwal, Head - Financial Institutions at India Ratings observes that the mergers that
recently happened are amongst banks that are not in a strong health even if they are bigger banks.

Arundhati Bhattacharya, former chairman, State Bank of India, observed and mentioned to
Economic Times, that India needs bigger banking institutions, and the merger of the PSBs will aid
the cause. This helps especially in terms of the returns that comes back as against the huge
technological investments made.

Singh (2013) in his paper titled Recovery of NPAs in Indian commercial banks says that the origin
of the problem of surging NPA’s lies in the credit risk management by the banks. The pre-
sanctioning approval and appraisal responsibility must be updated along with an improvised post-
sanction supervision. Also, the process of monitoring loans must happen more frequently to gage
an NPA at its root.
Das and Ghosh, 2006 proved that a high level of NPA not only affected bank efficiency, but also
the loan growth of the bank’s lending. This led to creation of banks with a high capital but a low
risk absorption criterion.
 Hypothesis
H0: Growing NPAs lead to mergers of banks.

H1: Not H0

Objectives
1. To check whether Mergers of banks are dependent on growing NPAs in a bank.
2. To examine the explanation of the PCA to merge banks

Methodology
For the sake of this research, substantial number of secondary sources of data have been used
extensively. Data has been collected from Indian Government websites, journals and press
releases. In addition to that, previously done research on similar topics, news report and articles
do form a part of the secondary sources of data.

The research does not encompass any source of primary data since it is rather challenging to gather
unbiased data on the topic from the public. Also bank officials and loan sanctioning authorities
were considered for the same, but it must be noted that their statements match the statements out
in public and hence does not hold significant information.
 Analysis
Non-Performing Assets (NPAs) are loans or advances that are given out to people or businesses
and whose principal or interest amount has stopped coming to the bank, or, have remained overdue.
Now considering the fact that NPAs occur in Public Sector Banks more than in Private Sector
Banks (Das, 2019), the research aims to focus on public sector commercial banks in India that
have been merged recently in August, 2019 by the Finance Minister Ms. Nirmala Sitharaman.

Public Sector Banks own about 72.9% share in the entire banking industry of India. ("List of
Merger of Public Sector Banks in India 2019", 2019). Therefore, they have a large customer base.
But the growth of these banks is slower compared to private banks. While NPAs in Public Sector
Banks is seen to be on a rise, NPAs in private banks are reducing over the years.

To check the impact of NPAs on the overall performance of the banks, following important
financial ratios are considered.

a. Return on Assets(%): The return on assets are calculated by dividing the bank’s net income
by total assets. It is an indicator of how profitable a bank is compared to its total assets. It
can be used to determine how well has the bank been able to use its assets to generate
earnings.
b. Capital Adequacy Ratio: Also known as Capital to Risk Assets Ratio, is calculated by
dividing a bank’s capital to its risk. This ratio determines how much can the bank absorb
shocks in case of crises.
c. Current and Quick Ratios: The current and quick ratios of a bank determine the ability of
the bank to pay off its short-term obligations, especially within the financial year. Current
ratios are current assets divided by current liabilities while quick ratio is calculated by
dividing current assets minus inventory by current liabilities minus overdraft.
Keeping these factors in mind, the net NPAs of top 4 public sector banks have been checked against
their respective NPAs below.

1. State Bank of India

2019 2018 2017 2016 2015

net NPA % 3.01 5.73 3.71 3.81 2.12
return on assets 247.53 245.53 236.14 185.85 172.04
Capital adequacy 12.72 12.6 13.11 13.12 12
Current Ratio 0.09 0.08 0.07 0.07 0.06
Quick Ratio 18.06 13.83 11.94 10.89 11.02
Source: moneycontrol.com

The country’s top Public Sector Bank is the State Bank of India and its 7 associates. NPAs in SBI
have been on rage since SBI has lost money in multiple default cases. SBI’s NPA have been
increasing drastically before beginning to fall in 2019. Through this course the return on assets
ratios over the years have continuously scaled up despite the growing defaults. Whereas the risk
bearing ability of the bank increased the years it had a good increasing return on its assets.
Liquidity in the bank has been pretty stable despite the growing NPA. State Bank’s disparity
against NPAs cannot be justified by capital infusion since from 2008 to 2015, it was not infused
with any capital from the government. But in the year 2015, about Rs. 5393cr was infused into the
bank against preferential shares to the government.
 2. Punjab National Bank

2019 2018 2017 2016 2015

net NPA % 6.56 11.24 7.81 8.61 4.06
return on assets 97.28 148.79 196.65 195.1 210.72
Capital
9.73 9.2 11.66 11.28 12.89
adequacy
Current Ratio 0.05 0.05 0.03 0.03 0.02
Quick Ratio 35.77 22.72 28.98 28.09 24.23
Source: moneycontrol.com

As can be observed in the table, as against the high percentage of NPA in the year 2018, due to
the Nirav Modi-Mehul Choksi default, the Return on Assets ratio drops from an average of 200 in
the previous years to 148.79. This is due to the low transformation of assets into earnings. The
assets the bank had with the borrowers did not perform. Similarly, the Capital adequacy ratio too
drops from around 11 to 9, i.e. the bank’s ability to absorb shocks was low for the year. The
liquidity ratios-current and quick ratios show a similar pattern of fall in the year 2018. But it is
worthy to note the difference in the slopes of these two ratios. This arises because of the deduction
of stock and overdraft from the current asset and liability numbers. This implies that the overdraft
huge or the stock with the bank is less both of which imply an adverse crisis situation of the
bank.(moneycontrol.com). Amidst these, PNB was infused with Rs. 500cr and Rs. 1732cr in the
years 2013 and 2015 respectively keeping in mind the lending it had made to Kingfisher Airlines.
(Performance Audit Report No. 28, 2019)
3. Bank of Baroda

2019 2018 2017 2016 2015

net NPA % 3.33 5.49 4.72 5.06 1.89
return on assets 173.66 163.64 174.92 174.46 180.13
Capital adequacy 13.42 12.13 13.17 13.17 12.6
Current Ratio 0.05 0.05 0.04 0.05 0.02
Quick Ratio 21.94 21.18 19.38 18.27 20.78

Source: moneycontrol.com

With the 3rd largest bank in Indian public sector banking, the NPAs have been high in the years
2016 and 2018. During these two years the profitability and risk-taking ability of the bank fell
with an increase in NPA and rose with a fall in defaults. On the other hand, liquidity has
continued to rise gradually. Bank of Baroda has had a strong backing of capital infusion by the
government previously. A total sum of over Rs. 6000cr (Performance Audit Report No. 28,
2019) has been infused into its system in the last decade making it have a stronghold over its
assets as well as capital adequacy. Besides, the bank has had its market capitalization jumping
high due to the local reach and technologically updated means of banking.
 4. Central Bank of India

2019 2018 2017 2016 2015

net NPA % 7.73 11.1 10.2 7.36 3.61
return on assets 46.79 68.7 90.78 104.63 105.27
Capital adequacy 9.61 9.04 10.95 10.41 10.9
Current Ratio 0.08 0.08 0.06 0.06 0.04
Quick Ratio 29.45 28.07 24.57 17.77 16.46
Source: moneycontrol.com

In case of the Central bank of India, the 4th largest PSB until before the mergers happened, over
the last 5 years, the NPAs have been increasing and have fallen in 2019. The return on asset ratio
seems to be increasing until 2017 and starts declining thereon; implying that the profitability of
the bank didn’t follow according to the NPAs because if it did, the return on assets should have
begun to decline in the years 2018 and 2019. But in this case, it fell right in 2017. Similarly, the
capital adequacy ratio follows no fixed pattern to tag along with the NPA pattern in Central Bank.
The bank is not in a state to bear high risks in the year the NPA was the most, i.e. in 2018. But in
the previous years, when the NPA was increasing gradually, the capital adequacy ratio did increase
initially but fell again in 2017. The liquidity ratios do not comply with NPAs at any point within
the 5 years of data collected. In the last decade, Central Bank has been infused with some amount
almost every year.
 Year wise and Bank wise capital infusion(Performance Audit Report No. 28, 2019)

Most of these banks were given a capital backing after the Kingfisher Airlines scandal that came
out in 2011. All 4 top banks had lost a huge sum in the loans landed to the airline despite
discussions and evidences on how badly was the airlines industry performing and surges in crude
oil prices.

Taking into account the fact that NPAs do affect the performance of a bank to an extent, banks
begin to move off track from the goals determined for them- lending and borrowing as the main
function, and eventually leading the economy to a 5 trillion $ economy. The mergers of banks
converting 10 banks into 4 was reasoned into 3 points-enhancing credit facility, increase national
and global reach and to increase cost efficiency.
Let us take into account the overall scenario,

Punjab National Bank to be merged with Oriental Bank of Commerce and United Bank now forms
the 2nd largest PSB of India. With reference to the table given below, the 3 gains as stated by RBI
can be verified.

(Ministry of Finance, 2019)

(Ministry of Finance, 2019)

(Ministry of Finance, 2019)

 (Ministry of Finance, 2019)

The mergers have an anchor bank and the rest are amalgamated into it. In case of PNB, OBC and
United Bank, the anchor bank is almost 3-5 times stronger in terms of business. While PNB has
an approaching 70% PCR ( provisional coverage ratio), United bank has a high CASA (Current
account Savings Account) implying it has a huge market base from where it gets its capital at a
very cheap price. The two amalgamated banks have previously been under PCA by RBI. Evidently
the OBC was tagged in to the merger so that it survives along the bigger players. It has nothing to
contribute to the merger since either of the two banks are better than it in by all means and has had
major losses in loans. Here, all the three banks have had a history of losses in the Kingfisher
Airlines scandal or being frauded by Modi-Choksi duo.

Union Bank merged with Andhra and Corporation bank seems to be a balanced pit combining
banks of half sizes with a bigger bank. They are at par with each other in terms of everything-
business, lending, deposits, PCR also CASA. The CASA is as low as 30% in all the 3 banks which
does not in any way demonstrate reach into the local zone since it does not prove its market base
by CASA. Also, the profitability of the bank automatically is low since its costs of capital lent out
is high.
Similarly, in case of Canara and Syndicate banks, the CASA is very low. Therefore, merging the
banks together does not improve costs of lending in any way because the cost of capital in itself is
very high. In all other means, Canara bank will act as an anchor to Syndicate despite both being
affected by major NPAs in the past.

Indian bank and Allahabad Bank are 2 banks which have an equal performance, but the latter’s
high CASA indicates cheaper capital for the amalgamation. Also, the PCR of Allahabad bank is
above the desirable 70%. But in this case, it cannot be understood by Indian bank is the anchor
where Allahabad bank is slightly deep-rooted to anchor Indian bank on contrary.
 Conclusion
Considering the 4 public sector banks of the Indian commercial banking industry act as a sample
of the entire industry and the 3 performance ratios used to gage the performance of the banks, it
seems to be that the performance of banks is not solely dependent on NPAs. Especially in case of
public sector banks, the fact that in times of crises or after that the government infuses some
amount of capital into the banking nerves to enable them to sustain the adverse effects of the
situation. This is because these banks hold a huge share of customers and the market. Because
when certain capital is not infused and the bank is not helped, the burden shifts on to the other
account holders of the bank. Similarly, Punjab Maharashtra Corporation bank had to pause
functioning and has no capital left with it to pay the account holders back since 75% of its advances
were with HDIL ("RBI restricts banking operations of Punjab & Maharashtra Co-operative Bank
for 6 months", 2019).

Therefore, the objective to check NPAs impacts on a bank’s performance holds true since the
numbers do not comply because of the capital infusion into the banks by the government.

With the analysis of the mergers, it can be concluded that not all the intents of the RBI behind the
mergers seem justified. Firstly, the Union bank-Andhra bank-Corporation bank and the Canara-
Syndicate mergers do not in any way get capital cheaply to lend out, other than getting it infused
by the government itself. While in case of Indian-Allahabad and the PNB group, one of the banks
shows out a way to get capital at lower costs. Therefore, enabling cost efficient lending as
mentioned under PCA. In terms of branch network and the national and global reach claim of the
PCA, these banks already have a huge network individually. They cover about 2/3rd of the country
already. And considering global reach, Indian banks lack a lot. Also, since the RBI mentions that
no retrenchment in expected from the mergers, then it is worthy to consider the extra costs incurred
in repetitive branches in an area. The final big claim from the mergers is of the operational
efficiency of the banks increases with mergers as, with reference to the earlier mergers, banks
imitate the good in the other banks of a group and pull themselves up. PSBs way of operations is
outdated in comparison to what a private bank can provide to a customer at this point along with
stability. Thus, the merged banks have a lot of catching up to do in terms of its operational
efficiency.
Therefore, the aim to check the impact of the bank’s performance on the mergers can be stated as:

Because of a surge in NPAs, the banks had been performing roughly. This led to a Prompt
Corrective Action to pull up the banks to their normal position and thereon move ahead to achieve
the 5 trillion $ economy. Simply put,

A hit to
PCA-Merger of
A rise in NPAs performance of
banks
banks

Normalizing of 5 trillion$
the banks economy

As calculated by Economic Times, the banks’ NPAs are estimated to fall to 8% by March 2020
keeping in mind the exposure of scams and frauds leading to the bank’s carefulness hereon. ("Gross
NPAs of banks may fall to 8% by March 2020: Report", 2019). This also will be contributed by
the bettering situation of the NBFCs.

Therefore, the Hypothesis, that Growing NPAs lead to merger of banks does hold true. We do not
reject it.
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