An Ill-timed Intervention

At a time when India’s public sector banks (PSBs) are laden with debt that companies are unable or unwilling to repay because of their own stressed balance sheets (also called the twin balance sheet problem), the union cabinet chose to announce an “alternative mechanism” to hasten the merging of PSBs last month. This will entail providing in-principle approval to proposals received for mergers from bank boards. Such a policy proposal cannot be more ill-timed. The most important concerns for the banking sector in India today are to find ways to recover the amortisation and interest payments due from companies, and to mobilise capital so that their capacity to lend is restored, thereby facilitating investment in the economy. A quicker mechanism to merge PSBs will serve no purpose. Worse, any such move at this time runs the risk of merged banks gaining little, except a higher concentration of stressed assets.

Successful mergers entail, among other things, good timing. Merging two stressed assets-laden banks will mean not just a larger balance sheet, but could also mean a higher proportion of stressed assets. It is unclear how the merged entities will be in a better fi nancial position, other than having larger combined balance sheets, which is no indication of improvement. How will concentrating the stressed assets help at this time? More importantly, how will this reduce the amount of additional capital needed to recapitalise banks?