Why creating one large bank or one large oil company isn’t the right strategy

A month after the government announced its intent to merge five State Bank of India (SBI) associate banks with itself, reports followed that another big merger is in the consultation stage.

This is in the hydrocarbons sector, with the government proposing to merge 13 state-owned oil companies into a mammoth corporation. While, in the first case, the government argued the intent was to create a mammoth bank (with total asset size of Rs 28.68 lakh crore) that can compete with foreign banks on a global scale, the second seems to be driven by a desire to bid more aggressively for global hydrocarbon assets.

Both the ideas have more negatives than positives.

In the case of SBI, there are two big concerns. One is purely from the operational point of view. Of the five associate banks, some like the State Bank of Travancore, are already being run efficiently – at least as efficiently as you can expect from a public sector bank.

At a time when private banks have proved to be more effective both in providing better customer services and in keeping their books relatively clean of bad loans, public sector banks have been steeped in inefficiencies and gargantuan bad loans that are fast eroding their profitability.

SBI is one of the worst hit by bad loans and posted a 66 per cent drop in net profit for the March quarter of fiscal 2016 after providing more for bad loans than it had anticipated, under the new RBI guidelines.

Also read: What the fall in IIP numbers means for Indian economy

As per the new guidelines, if the principal or interest on a loan is due for more than 90 days, it becomes an NPA (non performing asset), and banks will need to provide for that in their books.

In fiscal 2016, SBI's bad loans have reportedly touched Rs 98,000 crore. The other concern is on the human resources front, and the spectre of thousands of jobs being lost due to the merger. One can argue that some cuts have to be “unkind” to bring in efficiencies, but the possibility of job losses has already raised an alarm among bank staff.

So what should the priorities of the country’s biggest bank be?

To battle bad loans and focus more on customer acquisition and retention (something that its CMD Arundhati Bhattacharya has been doing more effectively that some of her predecessors, especially in leveraging technology to make the bank more appealing to young customers) or to battle a huge acquisition, and the consequent integration issues? And with Bhattacharya set to retire this October, she will not be overseeing a merger she has set in motion. Add to that the unrest among the affected banking staff, and the problem only aggravates.

The latest buzz around merging PSU oil companies is no different.

Most of the PSUs in question, especially the larger ones such as the upstream ONGC and OIL and the downstream HPCL, BPCL and Indian Oil, have, over the years, emerged as big players in their own spheres. If there was one thing that had clipped their wings and made them less aggressive compared to their overseas counterparts, it had been government interference in fuel pricing.

However, with the prices of fuel mostly decontrolled, except for kerosene, the stage is set for these firms to boost their profits as they will no longer need to sell fuel below cost. The state-owned refiners are setting up state-of-the-art refineries that can equal the efficiencies of refineries owned by Reliance Industries and Essar Oil, and have some of the most well-equipped retail distribution networks in place.

Also read: Is bad loan waiver another 2G scam?

With private companies, who had rolled back their retail businesses as they were unviable in a regime where fuel was subsidied, starting to aggressively spread their retail fuel network (Essar is one such), the PSU refiners and marketers should focus their energies on investing in cleaner fuels, building up sufficient capacities and improving their strategies to compete more effectively in the market place, than waste it over integrating with its peers.

The example of the disastrous Air India–Indian Airlines merger is a grim reminder why being big can be a sure recipe to failure, if such mergers are not effectively managed.

It may also be a pipe dream to think that setting up a giant oil company will help in successful bidding for assets overseas. The experience of ONGC Videsh in its bid for overseas assets has been the aggressive bidding by Chinese state-owned companies, and that can’t be just wished away. The Chinese will continue to do so.

Moreover, the experience of our own downstream companies who forayed into acquiring global upstream assets have shown that they have never been serious contenders.

India will continue to be a net importer of oil despite all its aspirations to be self sufficient. In that context, smaller, more manageable companies with better operational efficiencies would better serve the nation’s cause. It is high time the government recognised that being big is not always beautiful.