New Delhi: Efforts to consolidate 27 public sector banks into 8-10 large lenders create risks that could offset potential long-term benefits in the current weak economic environment, Moody's Investors Service said Tuesday.
Moody's said India's banking system has witnessed an increase in non-performing assets (NPAs) since 2012, with many public sector banks (PSBs) having suffered significant deterioration in balancesheets as demonstrated by their asset quality metrics and capitalisation profile.
"As a result, no PSB currently has the financial strength to assume a consolidator role without leading to questions regarding its own credit standing, post-merger," it said in a report titled 'Banks -- India: Consolidation of Public Sector Banks Will Face Challenges Under Current Conditions'.
Its hypothetical analysis of acquisition of a weak bank by several larger PSBs in the system pointed to a likely significant deterioration in credit metrics for the surviving entity, which underscored the current broad weakness in the system's balancesheet.
"Adding to this financial pressure, all listed PSBs are now trading at a significant discount to their book value. This limits their ability to attract external capital to support potential acquisitions as doing so will be dilutive to current shareholders, particularly the Indian government," it said.
"Therefore, we believe that government support will be a crucial driver of the credit outcome in potential mergers, particularly in the form of equity capital, which will be required to shore up buffers of the acquiring bank before a merger is complete."
Moody's also expected strong challenges to come from employee unions who would react negatively to the prospective loss of jobs.
"The risk is the government and bank management would yield to these reactions and maintain the status quo, thus limiting the ability of the banks to extract meaningful synergies even if consolidation proceeds in a superficial sense," it said.
Furthermore, differences in employee compensation packages and other benefits could add to potential costs of a merger.
These concerns, it said, are reflected in the current proposed merger put forward by SBI, which has already met opposition from employee unions. The estimate is the merger of the associate banks would cost it up to Rs 3,000 crore due to differences in employee benefit schemes.
"Another credit driver is whether the government could facilitate the brokering of agreements with key stakeholders, including labor unions, which would allow the merger to realise the benefits mentioned above," it added.
The government is considering consolidation of public sector banks (PSBs) in order to strengthen the banking system.
However, it needs to provide significant equity capital support to such mergers in the current environment, Moody's said, adding that "the government's ultimate aim is to have about 8-10 large PSBs, down from the current 27."
PSBs currently operate in a highly fragmented industry structure, but have largely homogeneous revenue streams because they tend to focus on loans to the same set of corporate borrowers.
According to the rating agency, significant consolidation among India's PSBs could create a more stable industry structure in the long run. Surviving banks could gain stronger bargaining power in their loan pricing, enjoy cost cuts from streamlining overlapping operations and branch networks and see improved supervision quality and corporate governance.
Alka Anbarasu, Moody's Vice-President and senior analyst, said 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".
In his Budget for 2016-17, Finance Minister Arun Jaitley stated that a road map was being formulated for consolidation of PSBs and an expert committee would be constituted.
Accordingly, the State Bank of India -- the country's largest public lender -- in May came out with a proposal to merge six banks, including its five associate banks, with itself.
"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," Moody's said.
These potential benefits, however, are outweighed by multiple downside risks, added Moody's.
In particular, the banks' weakened metrics since 2012 and weak performance mean that many have difficulty meeting minimum regulatory requirements without regular capital infusion from the government.
As a result, a few public sector banks have the excess capital required to acquire meaningfully sized peers, it said further.