Merger of Public Sector Banks and Competition Concerns

[Kruthika Venkatesh is a 4th year B.B.A., LL.B. (Hons.) student at School of Law, Christ (Deemed-to-be) University in Bangalore]

Background

The media has reported that the Government of India is all set to ask the Reserve Bank of India (“RBI”) to prepare a list of candidates for merger among the 21 government controlled lenders with the primary agenda of overcoming bad debts. It all began two months ago when the Government had been engaged in discussions concerning the merger of at least four state-run banks, including IDBI Bank Ltd., Bank of Baroda, Oriental Bank of Commerce and Central Bank of India. According to certain reports, if the plan is sanctioned, then the merged entity would become the second largest bank in the country after State Bank of India, with a total of combined assets of Rs.16.58 trillion. This is effect would mean reducing the number of public sector banks (“PSBs”) from 21 to 12. It appears that this move follows the example of the grand merger of the State Bank of India (“SBI”) with its associate banks and the Bharat Mahila Bank, all of which took place in April 2017. Moreover, the Government has now turned to the RBI to realize the possibility of consolidation among the PSBs by way of setting up the Alternative Mechanism (AM) as a fast track procedure to achieve synergy and scale operation, where it is believed that such a step would allow for amalgamation of regional rural banks (“RRBs”) within a State and bring down the number of such RRBs to 38 from the present 56.

The main agenda for such a merger among the PSBs would be a sincere attempt towards deviating from the rise in bad loans or non-performing assets. The process becomes necessary given the exorbitant losses incurred by the four PSBs to the tune of Rs. 21,646.38 crore in the year ended March 31, 2018.  While the intention behind this move may have been to secure robust financial health and ensure better scale efficiency, it is to be noted that this process of fast-track consolidation allows for exemption, for a period of 10 years, from the approval of the Competition Commission of India (“CCI”), in the case of mergers involving such PSBs and nationalized banks. Here, the legal ramifications and competition concerns that it poses must be paid heed to.

Subsequent Impact of PSB Mergers

According to reports, India features in the world’s largest 10 economies, having banks with the highest bad loan ratio after Italy. This is due to the continued existence of non-performing assets (“NPAs”) where the government-controlled lenders are estimated to be holding approximately 90 percent of such non-performing loans.  While the benefits may loom large, in terms of scale and operations efficiency, higher productivity and filling business products or technology gaps; it may nevertheless prove to be detrimental to the general public in a situation where the tax payer’s money is used to rescue the ailing private banks by capitalizing these banks. Other difficulties on that front would include execution risk in bringing the two new banking entities on the same platform, situations of mismatch in compliance consistency and risk culture negatively affecting the profitability of the business and loss of local identity of small banks in the event they are chosen by PSBs for a merger.

The Legal Implications of PSB Mergers

Generally, the leading legislation to govern private banks and other related banking companies is the Banking Regulation Act of 1949(“BR Act”), where such a merger between banking companies is guided by section 44A of the BR Act. Under this provision, a scheme of such amalgamation is required to be approved by a two-third majority of shareholders of each amalgamating company, present either in person or proxy at the respective general meeting so convened for the consideration of the scheme. What is to be noted here is the non-absolute applicability of the provisions of the Act as regards government-owned and state run-banks, including RRBs. Furthermore, while the Companies Act 2013 may not have much to say regarding exclusive bank mergers (except for those highlighted under Chapter XV of the Act), any merger proposed between a bank and company (not engaged in banking business) would, at first instance, require the approval of the High Court and then subsequently by the RBI in order to put the scheme into effect, as mandated only under the erstwhile Companies Act of 1956.

Competition Concerns Arising from PSB Mergers

The main objective behind introducing the Competition Act of 2002 was to eliminate practices having appreciable adverse effect on competition (“AAEC”), promote and sustain competition, protect customer’s interests and ensure freedom of trade carried on by other participants in the market. With this, the Competition Act aims to prohibit anti-competitive agreements and abuse of dominate position, provide for regulation of combinations (i.e., mergers, amalgamations, acquisitions, etc.) and to enjoin competition advocacy. While the general norm would be in rendering any combination void where it causes or is likely to cause any AAEC, section 6(4) mandates that the share subscription or financing facility or any acquisition, inter alia, by a bank pursuant to any loan or investment agreement enjoys exemption from the rigours of combination provision; however, the disclosure of such combination is required to made before the CCI within 7 days.

Competition issues concerning the banking sector would arise on account of barriers to entry which may be in the form of regulatory barriers (in terms of capital requirements or licensing, etc.) or substantial state ownership of banks (where foreign firms are disallowed from taking over domestic banks of any substance). This may be further encouraged by the presence of switching costs and asymmetric information regarding credit risks, which are not shared with the new entrant. Another issue would be that of economies of scale and branch networks, which would be of a bigger concern in situation where it involves PSB mergers since they have huge capital and customer base, thereby allowing PSBs to assert themselves absolutely and acquire deep presence in the market. Furthermore, competition concerns may arise in terms of loans provided to small and medium-sized business. Moreover, where such bank mergers are present in sufficiently concentrated markets, it may lead to neutralization of any anti-competitive effect, more so in a scenario that has the presence of nationalized banks in the market.

Conclusion

While the new move by the Government to merge the top PSBs to do away with the mounting debts seems encouraging, it certainly gives rise to alarming issues that may prove to be detrimental for the general customers as well as the possible new entrants to the market, being either foreign or private entities. The enforcement of the Competition Act meant that its applicability extended to all sectors, including banking and other financial sector activities, and its competency to inquire into horizontal or vertical agreements entered into including situations involving abuse of dominant position. Reference was hitherto allowed to be made by the RBI before the CCI and the latter could initiate suo moto inquiry into such anti-competitive practices. Now, section 2A introduced by the Banking Laws (Amendment) Act, 2011 provides for the non-applicability of the provisions of the Competition Act to any banking company, the State Bank of India, any subsidiary bank, any corresponding new bank or any regional rural bank or cooperative bank or multi-state cooperative bank in respect of the matters relating to amalgamation, merger, reconstruction, transfer, reconstitution or acquisition. By this amendment, the Government has removed scrutiny of the CCI, with an attempt to place all such issues under the scanner of the RBI. This move has been motivated to secure the interests of the depositors while maintaining proper management of the bank during the time of merger. While it may be so, exempting PSBs from any requirement of approval from CCI would definitely bring forth competition and general public fund concerns.

Under the sole jurisdiction of the RBI, it proposes certain possible combinations of bank mergers, such as merger based on geography, of weak banks, to create niche banks and lastly, to create large banks. Although the Government has been proactive in its approach, by introducing the Financial Sector Legislative Reforms Commission (“FSLRC”) so as to harmonize financial sector legislation and analyze bank mergers, it is pertinent to mention here that the legislature is come up with an integrated modern banking law so as to facilitate clarity and address issues arising through competition and other mergers and acquisitions transactions. At present, with limited applicability of the BR Act (where only certain provisions of the Act are made applicable to such banks through the operation of  section 51), it is all the more necessary to incorporate necessary merger provisions concerning PSBs within the ambit of the aforementioned Act, so as to make it an all-encompassing legislation, dealing comprehensively with both the public as well as private banking companies.

– Kruthika Venkatesh