India banking: The power of the micro

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The problem with India’s state bank mergers.

Bank-of-Baroda-logo-R-780
Bank of Baroda


September brought a sign of progress in India’s ambitions to transform its debt-addled state-owned banking sector. We are a long way from the endgame of six state banks prime minister Narendra Modi once mentioned – there are still more than 20 of them in fact – but the recommended merger of Bank of Baroda, Vijaya Bank and Dena Bank is at least a step in the right direction.

This is what the market wanted: fewer banks, resolving bad loans through the new bankruptcy court process, recapitalized and ready to start lending again. But there is one nagging doubt about the whole process. A culture is emerging where the dismal are rewarded and the able are impeded.

Acquisition

Although the recommendation, from a panel chaired by finance minister Arun Jaitley, is billed as a three-sided merger, what is really happening here is that Bank of Baroda is acquiring the other two. Baroda’s deposit base is more than double that of Vijaya and Dena combined.

But the two banks Baroda must absorb are very different animals. Vijaya is, by Indian state lender standards, in great shape: its non-performing loans are below 7% (at Baroda, it’s 12.4%). But Dena? 22%.  


State bank reform is vital and nobody said it was going to be pretty 

One only has to look at the share price reaction to the news to see the consequences. Baroda’s share price fell off a cliff. It lost 16% in a day. And Dena? It went up 20% and would have done more, but that is the daily limit. Dena, which is hopeless, has not only been saved but handsomely rewarded. Baroda, which was working its way through difficult times with some sense of traction, has been put back at least two years. 

The problem is Baroda has almost no tools at its disposal when it attempts to absorb the two new banks. It will be a bloated institution when complete: with loans of Rs6.8 trillion ($88 billion), almost 9,500 branches and its current headcount of 56,000 will increase by half again, putting it up towards the level of, for example, Deutsche Bank worldwide. But it cannot fire any of them; the state has guaranteed all the jobs are safe. So what is Baroda supposed to do? Wait for them all to retire? 

Smart trade

The rest of the sector, and those investing in it, have noticed. There are 22 listed state lenders in India and between them they lost $2.8 billion equivalent in market cap in a single day on the news of the Baroda plan. The smart trade would be to buy the worst banks on the assumption that they won’t be closed but merged into far stronger institutions. The good banks? Better sell them.

And yet what options does Jaitley really have? State bank reform is vital and nobody said it was going to be pretty.