Moody's: Consolidation of Indian banking system presents greater risks than benefits

Moody's Investors Service says that the Indian Government's (Baa3 positive) proposal to consolidate the country's public sector banks (PSBs) creates risks that -- in the current weak economic environment -- could offset the potential long-term benefits.

"India's banking system has witnessed an increase in stressed assets since 2012, with the result that no PSB currently has the financial strength to assume a consolidator role without risking its own credit standing post-merger," says Alka Anbarasu, a Moody's Vice President and Senior Analyst.

"Barring significant government support to boost the banks' capitalization, we believe the risks arising from the potential consolidation currently outweigh the potential longer-term benefits," adds Anbarasu.

The consolidation of Indian PSBs is gaining policy momentum, says Moody's, as the government aims to strengthen the banking system. In his budget speech for the fiscal year ending March 2017 (FY2017), the finance minister stated that a road map was being formulated and an expert committee would be constituted.

In line with this trend, the State Bank of India (SBI, Baa3 positive, ba1) -- the country's largest PSB -- in May announced that it will merge with six banks, including five associate banks.

From a credit perspective, industry consolidation would strengthen the banks' bargaining power, help save costs and improve supervision and corporate governance across the banking system.

These potential benefits, however, are outweighed by multiple downside risks, says Moody's.

In particular, the banks' weakened metrics since 2012 and weak performance mean that many have difficulties meeting minimum regulatory requirements without regular capital injections from the government. As a result, few public sector banks have the excess capital required to acquire meaningfully sized peers.

Adding to this financial pressure, all listed PSBs are trading at a significant discount to their book value, limiting their ability to attract external capital to support acquisitions.

Therefore, Moody's believes government support will be a crucial driver of the credit outcome of potential mergers, particularly in the form of the equity capital required to shore up capital buffers.

Finally, Moody's also sees considerable challenges from potential opposition from employee unions, which could hamper merger efforts and drive up costs. For example, SBI estimates that its merger with the associate banks will cost up to INR30 million due to differences in employee pension schemes.

The Indian government's ultimate aim is to reduce the number of PSBs to about 8-10 from the current 27.

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