{"id":2643,"date":"2014-02-26T14:34:40","date_gmt":"2014-02-26T09:04:40","guid":{"rendered":"http:\/\/teekhapan.wordpress.com\/?p=2643"},"modified":"2014-02-26T14:34:40","modified_gmt":"2014-02-26T09:04:40","slug":"why-merger-of-united-bank-with-another-bank-makes-no-sense","status":"publish","type":"post","link":"https:\/\/vivekkaul.com\/2014\/02\/26\/why-merger-of-united-bank-with-another-bank-makes-no-sense\/","title":{"rendered":"Why merger of United Bank with another bank makes no sense"},"content":{"rendered":"

\"unitedlogo\"<\/a>
\nVivek Kaul <\/span><\/span><\/span>
\nNothing works like the formula. And the formula to rescue a bank which is in trouble is to merge it with another bank. <\/span><\/span><\/span>Reports in the media seem to suggest<\/span><\/span><\/a><\/span><\/span> that there might be plans to merge the troubled United Bank of India with the Union Bank of India.
\nIn fact, on February 24, 2014, the share price of United Bank jumped by 13.75% on this possibility, in the early morning trade. It finally closed the day 6% higher at Rs 25.8 , from its closing price on February 21, 2014.
\n<\/span><\/span><\/span>As has been reported before<\/span><\/span><\/a><\/span><\/span>, the United Bank of India is in major trouble. For the period of three months ending December 2013, the bank reported a loss of Rs 1,238 crore. This, after it had provided Rs 1,858 crore against bad loans.
\nDuring the period, the bank’s gross non performing assets (NPA) increased by a whopping 36% to Rs 8,545.5 crore. This amounted to nearly 10.8% of the total loans given out by the bank. In fact, in December the Reserve Bank of India(RBI) had asked United Bank not to give a loan of greater than Rs 10 crore to any single borrower. <\/span><\/span><\/span>A recent report in the Mint newspaper<\/span><\/span><\/a><\/span><\/span> points out that the bank has issued an internal directive not to make any fresh loans, unless they are backed by the mortgage of fixed deposits.
\nIn this scenario it is not surprising that there is speculation of the bank being merged with the Union Bank of India. Having said that, the United Bank has denied any such possibilities.
\nBut given the past record of the government merging a bank in trouble with another bank, the merger of the United Bank with the Union Bank(or any other public sector bank) is a possibility that remains. The troubled Global Trust Bank was merged with the state run Oriental Bank of Commerce in 2004. In 2002, the Benares State Bank was merged with the Bank of Baroda. Before this, in 1988, the Hindustan Commercial Bank was merged with the Punjab National Bank. The Punjab National Bank also came to the rescue of Nedungadi Bank in 2003.
\nSo there is a clear trend of a failing bank being merged with an existing bank. In the examples given above, all the failing banks were private sector banks and they were taken over by public sector banks. The United Bank of India is a public sector bank in which the government has a stake of 88%.
\nThis makes it even more likely that the government will try and do everything to save the bank. The total assets of the United Bank as on March 31, 2013, amounted to Rs 1,14,615 crore. The Union Bank is around 2.7 times bigger and has total assets of Rs 3,12,912 crore.
\nIf the banks had been merged on March 31, 2013, the total assets of the new bank would amount to around Rs 4,27,527 crore. The assets of the United Bank would form around 26.8% of the merged entity. Given this, the erstwhile United Bank would form a significant part of the merged entity.
\nHence, with nearly 10.8% of its total loans being classified as gross non performing assets, it is possible that the bad loans of United Bank may dramatically pull down the performance of the merged entity.
\nLet’s take the case of Oriental Bank of Commerce. In August 2004, the Global Trust Bank, which had run into trouble due to bad lending, was merged with the Oriental Bank of Commerce. For the year ending March 31, 2004, the Oriental Bank of Commerce had reported a profit of Rs 686 crore.
\nThe merger destablized Oriental Bank of Commerce and the net profit fell to Rs 557 crore for the year ending March 31, 2006 and took a few years to recover.
\nA similar thing will happen with the Union Bank of India, if the United Bank is merged into it. Also, it is worth pointing out that most public sector banks are already in trouble, given the mounting amount of bad loans on their books. <\/span><\/span><\/span>As the latest RBI Financial Stability Report<\/span><\/span><\/a><\/span><\/span> points out \u201cAmong the bank-groups, the public sector banks continue to have distinctly higher stressed advances at 12.3 per cent of total advances, of which restructured standard advances were around 7.4 per cent.\u201d
\nSo, merging United Bank with Union Bank or any other public sector bank for that matter means destablizing the Union Bank as well and in the process creating more trouble for the entire banking sector.
\nIt will also bring to the fore the issue of \u201cmoral hazard\u201d. Before we get into discussing this, it is important to understand what moral hazard means. As Alan S Blinder writes in <\/span><\/span><\/span>After the Music Stopped <\/i><\/span><\/span><\/span> \u201cThe central idea behind moral hazard is that people who are well insured against some risk are less likely to take pains ( and incur costs) to avoid it. Here are some common non financial examples: …people who are well insured against fire may not install expensive sprinkler systems; people driving cars with more safety devices may drive less carefully.\u201d
\nGiven this, insurance companies must take into account the fact that insurance may induce people to take on more risk. \u201cIn financial applications, moral hazard concerns arise whenever some third party\u2014often the government\u2014intervenes to insure against or lessen the consequences of, the risk of loss,\u201d writes Blinder.
\nIn fact, the American economy is a great example of all that can go wrong because of moral hazard. Since the 1980s, scores of financial institutions in trouble have been rescued by the government. The signal this sends out to the participants in the financial system is that they can take on more and more risk, and if something does not work out well, the government will come to their rescue.
\nThis is precisely what happened in the United States, where banks took on more and more risk, confident of the fact that if something went wrong, the American government would come to the rescue.
\nIf the United Bank is merged with the Union Bank (or any other public sector bank), this is the signal that will be sent out. Hence, it is important the United Bank not be rescued by the government.
\nThis does not mean that the bank should be allowed to fail. The government needs to protect the depositors of the bank. <\/span><\/span><\/span>As has been suggested before here <\/span><\/span><\/a><\/span><\/span>the government should look to sell the bank to any private businessman for Re 1, who can then run it. Also, India currently has 21 public sector banks, and one less public sector bank will really not make much of a difference to the overall financial system.
\n<\/span><\/span><\/span>The article originally appeared on www.FirstBiz.com <\/a>on February 25, 2014
\n<\/span><\/span>(Vivek Kaul is a writer. He tweets @kaul_vivek)\u00a0<\/span><\/span><\/span><\/p>\n","protected":false},"excerpt":{"rendered":"

Vivek Kaul Nothing works like the formula. And the formula to rescue a bank which is in trouble is to merge it with another bank. Reports in the media seem to suggest that there might be plans to merge the troubled United Bank of India with the Union Bank of India. In fact, on February … <\/p>\n

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