“It is an axiom nowadays that no bank fails for lack of capital; unprofitable lending is always the underlying cause.”
– James Grant
Introduction
Mergers and Acquisitions are two different kinds of transactions, often used interchangeably. However, the basic difference between the two is that, in Merger there is a consolidation of two or more different entities into one entity. In Acquisition one entity takes ownership of another entity. In beginning of 2010, there were 21 Public Sectors Banks (PSB) and State Bank of India had 5 associate banks. In 2021, there number of PSB has fallen to 12. Read Part 1 here.
What is the reason behind merger of banks, specifically, PSB?
Loans or advances allow individuals, companies, small businesses, facilitate growth. The interest on the lending, is the earning for the Banks. However, recessions and economic depression can be triggers for a Bank not only not earn the interest but also not receive the amount lent.
Mechanics of Lending
The loan given to a borrower is borrower’s liability and asset for the Bank, which yields return in form of interest to the Bank. If the borrower fails to pay the interest and principal amount, he turns the asset of the bank, into non-performing asset (NPA).
As per Reserve Bank of India (RBI),a loan or advance which remains overdue for a period of 90 days is declared an NPA. NPAs are further classified as:
| NPA | DURATION |
| Substandard assets | NPA for a period less than or equal to 12 months |
| Doubtful assets | NPA remained in the substandard category for a period of 12 months |
| Loss assets | uncollectible and of such little value that its continuance as a bankable asset is not warranted, although there may be some salvage or recovery value |
Once an NPA, the recovery for a Bank is through litigation, civil suit for recovery, enabled with the following enactments:
- The Recovery of Debts Due to Banks and Financial Institutions Act, 1993;
- Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002;
- Insolvency and Bankruptcy Code, 2016 (IBC).
All corporate lending, require Banks to approach the Tribunal under IBC. A recent RBI[1] report reveals, total 1,953 cases were referred to the Tribunal involving INR 2.32 trillion, out of which INR 1.05 trillion was recovered during fiscal year 2020. A 45% recovery rate under the IBC with recovery from top nine cases stood at around 56%, and remaining 24% was from the rest.
In the recent acquisition of Videocon Industries and its subsidiary by Twin Star (part of Vedanta Group) under insolvency process[2] for a sum of INR 2,962 Cr. against the total admitted claim of INR 64,838 Cr. the total haircut was about 95.85% at the hands of the creditors of Videocon Group with recoveries even less than total interest amount.
The Videocon Resolution Plan indicates that even litigation fails to be an effective recovery tool for Banks causing them to bear losses and increasing financial stress..
In the popular case of Yes Bank, the loan outstanding on March 31, 2014, was INR 55,633 Cr, with deposits of about INR 74,192 cr. The outstanding has grown to about four times, at INR 2.25 trillion as on September 30, 2019, with deposits lagging way behind at less than three times to INR 2.10 trillion.
The Bank’s asset quality has eroded with substantial exposure to several troubled borrowers, including Anil Ambani-led Reliance group, DHFL and IL&FS. On March 5, 2020, the RBI imposed a 30 days moratorium on Yes Bank and suspended the Board and proposed a restructuring scheme. Interference of RBI saved Yes Bank from a crash capable of bringing the economy to a halt.
This makes managing NPAs a big challenge for Banks, to avoid disruptions like Yes Bank, the Government seems to prefer Merger of Banks.
But is Merger & Acquisition an effective solution to combat the NPA menace?
Positive aspect: Banks’ Merger & Acquisition and NPA
The burden of NPAs slows down credit outflow, reducing business, erodes trust of customers and keeps the economy jilted. To revive from disruption, Banks need funds, which is not flowing to them from their prime business line- earning from interests. For instance, State Bank of India invested INR 7,250 crore (US$1.0 billion) in Yes Bank amid a financial crisis for a 49% stake.
The Government also believes that increased credit growth is essential to achieve its target of growing India into a $5-trillion economy in the next few years. It announced an infusion of INR 55,250 cr. to help these newly merged banks extend more loans to their customers and meet crucial regulatory norms.
Resorting to merging weaker banks with strong banks, is GoI’s effort in preserving weaker banks against the onslaught of NPAs. Mergers result in operational efficiency and reduces legal, ancillary and other operation costs. The cumulative customer base of the merged entity benefits from the synergy.
Success Story
In Laxmi Vilas Bank (LVB), the Gross NPA of LVB was 10% in 2018 which increased to 15.3% in 2019 and 25.4% in 2020.[3] Thereafter, LVB amalgamated with DBS Bank India (DBIL) in November, 2020, even with the impact of second wave, the net revenue of DBIL grew by 85% from Financial Year 2020 and profit before tax rose to INR 679 cr. despite absorbing losses of LVB of INR 341 cr. from November 2020 to March 2021.[4]
Negative aspect: Banks’ Merger & Acquisition and NPA
Mergers are not the “magic wand” one would prefer. Structural problems persist in mergers.
Mergers do not lead to a decrease in the absolute size of the NPAs in a bank’s books. The size of NPAs in a bank’s books drop if the bank succeeds in improving the recovery of loans, or if these loans are written off their balance sheets. The bad loan recovery process still remains slow in India due to the slow judicial system. Banks are unwilling to aggressively write off bad loans as that would evidence recognizing greater losses.
As per the RBI’s Financial Stability Report released in January 2021, the Gross NPA ratio of all Scheduled Commercial Banks (SCBs) may increase from 7.5% in September 2020 to 13.5 % by September 2021 under the baseline scenario; the ratio may escalate to 14.8 % under a severe stress scenario.
Impact of Banks’ Merger & Acquisition on Economy
For a larger bank, mergers give the landscape to retain its identity as a larger bank. Post merger, the biggest benefit is, acquisition of brand-new customer base and business enhancement through increased market share and reduction in cost of operations and opportunity to technology upgrade.
Reduction in credit risk is beneficial for business. Chances of survival of underperforming banks increases which restores customer trust. It results in an overall benefit to the economy.
As per studies[5] conducted, most of the mergers done in the past, have proved to be an overall success for the weaker banks although there are no concrete parameters to verify this observation.
The modalities of a Merger play an important role in the environment of trust that it can potentially build among the people of both the organizations.
Contextualizing with Budget 2021 on Banks’ NPAs
In Budget 2021-22, the Finance Minister of India proposed to form “Bad Bank” which is named as “National Asset Reconstruction Company Limited” (NARCL).
NARCL is a bad bank created to house bad loans (NPA) of banks and will resolve or liquidate bad debt (stressed debt) to recover as much as possible.
The Government will guarantee the security receipts issued by NARCL, which will buy the bad loans from banks. It[6] has also earmarked INR 31,000 cr. for the guarantees. NARCL will pay 15% of agreed value in cash and remaining 85% in form of government guaranteed security receipts. This will clean the NPAs from the Banks’ balance sheet and make Banks ready for fresh lending.
Conclusion: Key Highlights
Banks which are significantly burdened with bad loans are merged with banks with at least good profits and good administration. Banks’ NPAs rise due flawed management programmes, thus the integration can lead to better management and mitigate other crises. Post-merger, the merged bank, in association with the other bank’s management, improves service through better recovery measures, transfer of NPA accounts to specially designated branches, such as Asset Recovery branch or with permission of top management, subject to legal restrictions, sell NPAs to an organization specialized in recovery at a discount. [7]
It is to be noted that the percentage of NPAs is also reduced due to the integrated capital of the two merging banks. Thus, with the merger of an indebted bank with a bank of good business and healthy deposits, improvement in good total business can take place.
In financial year 2020-21, PSBs reported a combined net profit of INR 31,817 Cr. for the first time in five years. Only 2 of the 12 PSBs, Punjab & Sind Bank and Central Bank of India, reported a net loss for the year. Post-merger, an improvement in profitability has seen in the PSBs despite of coronavirus pandemic disruption.[8]
This being said, the long-term effects of the mergers of these PSBs on the country’s overall NPA load will be watched with much keenness.
The Special Editions are only for better understanding of various subject matters and is only for information purposes. Nothing contained herein is, purports to be, or is intended as legal advice and you should seek legal advice before you act on any information or view expressed herein. Endeavoured to accurately reflect the subject matter of this alert, without any representation or warranty, express or implied, in any manner whatsoever in connection with the contents of this. This isn’t an attempt to solicit business in any manner.
[1] https://www.livemint.com/industry/banking/recovery-from-ibc-cases-at-24-in-fy21-11623138082661.html
[2] https://www.business-standard.com/article/companies/total-haircut-of-95-85-to-all-the-creditors-in-videocon-resolution-plan-121061600573_1.html
[3] https://bfsi.economictimes.indiatimes.com/news/banking/here-is-all-you-need-to-know-about-what-went-wrong-with-lakshmi-vilas-bank/78404094
[4] https://www.financialexpress.com/industry/banking-finance/dbs-bank-india-grows-profitability-despite-lvb-merger-impact/2286767/
[5] https://www.jsscacs.edu.in/sites/default/files/Fil es/Merger_of_banks.pdf
[6] https://www.thehindubusinessline.com/money-and-banking/bad-bank-is-legally-born-as-narcl-gets-incorporated-with-corporate-affairs-ministry/article35286994.ece
[7] https://www.theindianwire.com/banking/merger-and-acquisitions-an-ultimate-plan-to-end-indias-npa-crisis-316843/
[8]https://www.newindianexpress.com/business/2021/jul/25/post-merger-little-to-cheer-for-public-sector-banks-2334934.html