What SBI Should Do Now That Govt Has Cleared Merger Of 5 Subsidiaries

The Union Cabinet today (15 June) cleared the State Bank of India (SBI) proposal to grow to global scale by merging its own five subsidiaries and the Mahila Bank. While talking up the idea, SBI Chairman Arundhati Bhattacharya spoke of cost efficiencies, scale and consolidation in the banking sector as the driving force behind the proposed multi-bank mega merger.

Having already gulped two subsidiaries (State Bank of Saurashtra and State Bank of Indore) without a burp some years ago, SBI surely did not surprise anyone with the announcement on merger on 17 May that it will merge five of the remaining subsidiaries with itself, apart from the Mahila Bank. Three of these five (State Bank of Mysore, State Bank of Travancore, and State Bank of Bikaner and Jaipur) are listed, and two more (State Bank of Patiala and State Bank of Hyderabad) are not.

The absorption of Bharatiya Mahila Bank will be the easiest, for it is a well-capitalised bank, with few branches and very small operations. Creating a special bank for women was one of those meaningless political initiatives taken by the UPA to prove that its heart bled for women after the Nirbhaya rape. With Jan Dhan bank accounts now reaching almost every household, a women-focused bank was a needless duplication.

No bank merger is easy, but if at all any merger was made somewhere close to heaven, it was that of SBI and its subsidiaries. They have the same business DNA, the same backend operations, similar cultures. Costs can be cut by synergies. As Bhattacharya told The Economic Times: “There is a lot of duplication right now. We have six treasuries and all the processes are duplicated. So rationalisation of all these will help us save cost. In fact, I came in with the agenda of reducing cost. And I have also said in the past that the low hanging fruits have been taken and now some real action is needed.”

However, there are two flies in the ointment. One, the unions of the subsidiary banks think they are a species apart and want the subsidiaries to be merged with each other rather than with the parent. Their bluff needs to be called. Hopefully, the prospect of seeing all subsidiary salaries rising to the SBI level will quell this dissent.

The unions can presumably be bought off at some point, for it can be no one’s case that working for one of the world’s biggest banks is somehow worse than working for a new bank created out of the merger of five sub-cultures. That would be a tougher merger to pull off than one with the SBI itself.

The bigger challenge for SBI, though, is to get the tradeoff between scale and business focus right. The question Bhattacharya needs to ask herself is whether size will bring more synergies or stress. She told ET that the merger will help improve SBI’s global ranking “to 55 from 59 in terms of balance sheet size,” but there are costs to growing scale so fast. And inorganically at that.

First, SBI is already overmanned. Adding the excess staff from five more subsidiaries is hardly going to make it nimbler, especially if the unions have to be propitiated to hop on to the merger bandwagon. The total staff strength of the combined entity after merger would be close to three lakh officers and employees (the figure was 2.8 lakh as at the end of 2014-15). SBI and subsidiaries have the worst wage costs to total income ratio in the industry. Wages account for 12.91 percent of total income, against 9.83 for other nationalised banks and 8.73 for private banks. SBI is not going to benefit from the merger unless it also puts in place a systematic manpower shedding plan.

Second, rationalisation of business and branches will also be crucial. As things stand, in many cities, SBI and its subsidiaries have branches in the same areas. To optimise costs, overlapping branches will have to be shut down, and staff and customers (both depositors and borrowers) migrated to the surviving branch. This process itself to could take a year to complete, if not more, and there could be costs associated with this realignment process. A short-term hit in profits cannot be ruled out.

Third, there is the question of raising capital. Given the size of non-performing assets (NPAs) in their collective portfolios, SBI and its subsidiaries are seeing a sharp drop in profits. In the third quarter of 2015-16, SBI’s net profits dropped sharply by 62 percent, and the current quarter could be as bad. Ditto for the subsidiaries. The balance-sheet clean-up means the SBI group will have to tank up on capital soon if it wants to expand lending.

Given this background, it would be better for the SBI to think through its merger carefully before rushing it. The bank should look at more out-of-the-box ideas instead of opting for a plain vanilla, old-style merger. A few possibilities…

#1: Given the huge NPA problem, the SBI could consider retaining one of its smallest subsidiaries as a subsidiary, and transfer the bulk of the unsalvageable bad loans to it. This means one of the subsidiaries could effectively be converted into a bad bank whose only job is to recover what is possible from the bad assets. Once the job is done, it can be wound up and folded back into the main bank.

#2: SBI could offload 26 percent in some of its unlisted subsidiaries by selling a part of its own stake. It could also offload more in listed subsidiaries. This will give it additional capital in the short run, even while building value in the subsidiary for ultimate merger in the medium term. The share sale could help fund a voluntary retirement scheme for excess staff.

#3: Merger is a process and not an event. Since each subsidiary has to be separately digested by the parent bank, the SBI should look at doing the mergers one at a time and not all in one go. This will allow the bank to focus on the market instead of spending an obsessive two or three years just fixing its own internal merger-related issues. The banking market is changing too fast for SBI to waste that kind of time on the uncertainties and costs that come with a multi-unit merger.

#4: Given that the SBI will never be privatised, any merger should focus on generating enough internal profits so that it will seldom need additional capital from the government. The aim of the merger should be to ensure an SBI of size that can be self-sufficient in capital over the long-term. Without this, the merger will make little sense.

Size alone cannot be the goal of the merger. Profitability should be the objective.