Bank Mergers No Silver Bullet, Gains May Take Years To Show

With every passing day, India’s economic indicators are turning a little bleaker. The situation is bad enough to warrant using the word “crisis,” arriving just as the government’s fiscal ammunition is spent.

The announcement Friday of 5% GDP growth in the June quarter showed the economy growing at its weakest pace in six years. On Sunday, the top six carmakers reported a 29% drop in August sales, stoking fears that the slowdown could get still worse. The Rs. 98,200 crore ($13.7 billion) collected in August via the goods and services tax, the main tax on consumption, was the smallest in six months.

This adds pressure on the central bank — both to cut its policy rate and to ensure that commercial lenders pass them on to borrowers. To the extent that the more inefficient state-run banks are a drag on credit, New Delhi said Friday that as many as 10 of them will be merged into four.

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Whether folding one weak bank into another will make the combined entity any stronger remains to be seen. What’s clearer is that these lenders will spend the next six months on integration. Putting their balance sheets to work may take a backseat. Pending consolidation, the lenders might also be hesitant to issue new bank guarantees, especially to private-sector bidders for road projects. Thus, one of the few areas where there’s new investment may be affected, especially with a sharp rise in debt levels of the government agency that gives out the contracts.

A hefty injection of Rs. 55,250 crore of taxpayers’ money into the merged banks will only help them provide for the bad loans that will get lumped together. Capital for growth remains elusive. State Bank of India, the largest lender, will require Rs. 15,000 crore in the current fiscal year, according to ICRA Ltd., an affiliate of Moody’s Investors Service.

The benefits will only be evident in a few years. The new round of consolidation will bring down the number of state-run banks to 12 from 27 just a few years ago. These lenders will have no choice but to become more competitive because they’ll have to price consumer loans by linking them to the central bank’s policy rate. Since they aren’t very good at lending against cash flows, the government wants them to originate loans together with non-bank financiers. Currently, even the shadow banks are stressed. Over time, though, this should help boost the underwriting standards of state-controlled lenders. Credit flows to smaller firms, which supply goods and services to larger companies, will improve.

Making the most of vendor finance will require plugging India into global supply chains first. By offering the likes of Apple Inc. and Ikea less restrictive access to its billion-plus population, New Delhi is hoping for long-term sourcing wins from the rapidly deteriorating trade relations between Washington and Beijing.