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India's latest state-bank merger plan faces near-term challenges, analysts say

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India's latest state-bank merger plan faces near-term challenges, analysts say

India's latest plan of merging 10 state-owned lenders into four bigger banks will likely face challenges in the near term before the sector's financial health improves further, analysts said.

Analysts in general agree with the government's rationale: By directing the stronger banks to absorb the weaker ones and creating fewer lenders, the sector's capital adequacy, lending capacity and operating efficiency will likely be strengthened.

However, before reaping the fruits, the process of integrating those banks could be long, painful and costly, analysts added.

"The worry is that the mergers will prove distracting to the state-owned lenders which are the biggest pool of liquidity," Kristy Fong, Asian equities investment director at Aberdeen Standard Investments, told S&P Global Market Intelligence in an email.

"At the moment, there is insufficient liquidity in the system and this has had an impact on consumption, which is also hurting market sentiment," Fong added.

In additional to capital injections, India had in recent years engineered a few mergers among state-owned banks in an attempt to help restore the financial health of the bad debt-laden sector. Bank of Baroda absorbed state-owned Vijaya Bank and Dena Bank in April, about two years after State Bank of India completed its merger with five subsidiaries and Bharatiya Mahila Bank.

Yuvraj Choudhary, research analyst at Anand Rathi Securities, said "there could be some growth slowdown" until the integration is complete. The banks could face higher operating costs in the short term due to voluntary retirement of redundant staff, Choudhary added.

Good plan after all

The latest round of mergers will reduce state-owned banks in India to 12 from 18 currently. There were 27 state-owned banks in India in 2017.

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Under the plan, Punjab National Bank will merge with Oriental Bank of Commerce and United Bank of India to create the fourth largest bank in the country by assets — behind State Bank of India, HDFC Bank Ltd. and ICICI Bank Ltd. with 11.92 trillion rupees of assets, according to S&P Global Market Intelligence data. Canara Bank will merge with Syndicate Bank Ltd.; Union Bank of India will absorb Andhra Bank and Corporation Bank; and, Indian Bank will merge with Allahabad Bank.

Three of the banks to be absorbed — Oriental Bank of Commerce, Corporation Bank and Allahabad Bank — emerged from the central bank's prompt corrective action framework early 2019, after showing improvement in various financial metrics. Meanwhile, United Bank of India is still under the plan and is subjected to restorative measures such as restrictions in lending.

The mergers would allow stronger lenders to control the weaker banks, according to Sanjiv Bhasin, executive vice president of markets and corporate affairs at IIFL Securities.

"There is a lot of talk of weak bank plus weak bank becomes a big weak bank, but I don't believe it," he said.

The merger plan also comes at a time when the bulk of legacy bad loans were recognized in the bank books, and the bad-loan cycle seems to have turned around. In its half-yearly financial stability report released June 27, the Reserve Bank of India said all commercial banks' gross nonperforming asset ratio could decline from 9.3% in March to 9% in March 2020.

"The merged banks would have a broader presence, stronger lending capacity, improved operating efficiency through economies of scale as well as better products and technology. This should help strengthen the overall financial sector over the long term," Fong said.