Big is becoming increasingly attractive in corporate India. The federal government is pushing a proposal to merge 13 state-owned oil companies. Consultations are underway to get all stakeholders on board. The merger will create a giant which will match U.S. conglomerate General Electric in the Fortune-500 ranking, says business daily The Economic Times. “[It] will have a bigger market value than Russian state oil giant Rosneft” and be the largest Indian company on multiple parameters. (GE is currently No. 11 on the Fortune 500 list with a 2015 turnover of $140 billion.)

India
Image source: Wikimedia Commons

But the mega-merger that is likely to happen before that one is in the banking sector. The government has announced the marriage of the country’s biggest bank — the State Bank of India (SBI) — with five of its subsidiaries, some of which are listed. “It’s a win-win situation for both SBI and its associate banks,” SBI chairperson Arundhati Bhattacharya told the media.

The merger with the state banks of Bikaner & Jaipur, Hyderabad, Mysore, Patiala and Travancore will produce an organization that will enter the list of the world’s top 50 banks by assets. For the year 2015, Bloomberg ranked SBI as No. 52; the augmented bank should make an entry at No. 45. The associate banks are not going to add too much weight. The largest among them is the State Bank of Hyderabad with assets of around $25 billion. The merged entity will have assets of around $550 billion. At the top of the world list is the Industrial and Commercial Bank of China with total assets of $3.6 trillion.

There is one place, however, where SBI figures among the leaders: It has more than 200,000 employees, with the associates bringing in around 70,000 more. The merger will take it to fifth place, below four Chinese banks at the top.

Major Problems

This overstaffing is one of the key hurdles to the merger. Bhattacharya has promised employees that no one will lose jobs, but bank unions and politicians are expressing doubt. There have already been strikes on the issue.

“The real danger lies in proceeding to merge without adequate clarity about the intended strategic goals and desired outcomes.” –Jitendra V. Singh

The other problem is branch rationalization. Currently, an SBI branch could well sit next door to one of its associates, though some of them are wholly owned by SBI. “Obviously, if the same building has branches of three associate banks, it doesn’t make sense to keep them open,” says Bhattacharya.

“According to a World Bank index, India has one of the world’s most fragmented banking industries, possibly next only to the U.S., among major nations,” says Rajesh Chakrabarti, the author of Grit, Guts and Gumption: Driving Change in a State-owned Giant, which charts the cultural turnaround at SBI over the past few years. Chakrabarti is also professor and executive vice-dean at the Jindal Global Business School.

“China has four banks among the world’s top 10, while India may have only one in the top 100 depending on the exchange rate,” he continues. “So some consolidation can only help. Relative to the growth in size of the corporate sector, the banking sector has fallen behind over the years, so now the major borrowers of banks are entities whose needs can no longer be met by individual banks while staying within their prudential lending norms (less than 1% of portfolio to a single company; 5% to a group). So banks need to consolidate to have enough size to serve their corporate clients more effectively.”

Additionally, “the disproportionate clout of SBI among PSBs (public sector banks) can use some reduction,” he notes. “A few mega-banks close in size to SBI can actually enhance competition.” What’s more, the managerial talent and the competitive dynamics of the poorer performing PSBs “have left much to be desired for decades,” he adds. “Consolidation may help reduce wasteful competition and inefficiencies that some of the poorer performing banks have. The risks of consolidation do not appear to be much given the heavy regulation that RBI (Reserve Bank of India) practices over the banking sector. Larger banks will not necessarily get much more leg room to mess up. It is far more likely that efficiency gains in management would dominate.”

SBI has been down that road before. The State Bank of Saurashtra was merged with it in 2008 and the State Bank of Indore in 2010. (The associate banks were originally set up by the princely states pre-Independence.)

The merger and the larger game plan have their critics. A June 2016 report by Moody’s Investors Service notes that efforts to consolidate 27 public sector banks into eight to 10 large lenders create risks that could offset potential long-term benefits. In a report titled “Banks — India: Consolidation of Public Sector Banks Will Face Challenges under Current Conditions,” Moody’s places the blame on non-performing assets (NPAs) – loans given to companies that are now unable to repay even the installments. “No PSB currently has the financial strength to assume a consolidator role without leading to questions regarding its own credit standing, post-merger,” the report says. A Fitch report notes that the banks will need about $90 billion of capital to meet the Basel III norms to be implemented by the year ending March 2019. More than 80% of this will be needed by PSBs.

“According to a World Bank index, India has one of the world’s most fragmented banking industries, possibly next only to the U.S.” –Rajesh Chakrabarti

The government, for its part, is confident. Finance Minister Arun Jaitley had promised in his budget speech that he would make Rs25 billion available for PSBs in 2016-2017 by way of fresh capital. He has already provided Rs23 billion of that to 13 PSBs. The government has also unveiled a plan called “Indradhanush” to infuse Rs70 billion in state-owned banks over four years.

The Next China

What is the objective of all this, and the massive clean-up that is underway regarding bank NPAs? Though skeptics abound, the Indian government sees it as a necessary component of its internationalization plans. India wants to be the next China on the world stage: Its GDP growth rate is set to overtake its northern neighbor this year. World-class and world-size banks are a necessary catalyst in this process.

Talking about the SBI merger, Wharton emeritus professor of management Jitendra V. Singh says: “Clearly, the government must have a logic for this decision, or one would at least hope so. Even before we debate the pros and cons of the decision, it is important to be explicit about what the government hopes to achieve by way of benefits from this merger, and how these benefits can be measured. Next, if the merger does go through, it will be instructive to measure the net benefits after the fact to see how the decision turned out. Otherwise, how can any learning flow from the decision, and how can we make better decisions in future?”

Recently, Air India was merged with Indian Airlines, Singh notes. “Two questions need to be asked: one, what were the objectives of the merger and how best can

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