PSU banks merger: For the merged bank focus ought to be strategy, not size

He may have struggled to mend India’s broken banking system but at least Prime Minister Narendra Modi is shrinking the number of state-run to 19 from 26.

Although, that’s nowhere close to the original idea of ending up with just six, it’s a good start. The next step will be to nudge most taxpayer-funded away from me-too corporate lending, the reason for their $210 billion bad-loan debacle.

The latest plan, announced Monday evening, calls for moth-eaten Ltd., which has a bad-loan ratio of 22 per cent, and a far more pristine Vijaya Bank Ltd. (less than 7 per cent of the total) to be swallowed by

Baroda, whose deposit franchise is more than twice as large as the other two combined, could then stake a claim to being the country’s third-largest bank. Strategy, however, matters more than size.

PSU banks merger: For the merged bank focus ought to be strategy, not size

Minority have reasons to grumble. The will have soured loans of about 13 per cent, worse than Baroda’s 12.4 per cent in Plus the acquirer’s current employee count of 56,000 will balloon by half. All jobs are deemed safe, so the only way to achieve cost efficiencies would be to prune surplus branches and wait for excess staff to retire.

There’s a way, however, for ex-Citibanker P S Jayakumar, Bank of Baroda’s current boss, to make a success of the merger: Reduce the emphasis on lending and embrace investing.

ALSO READ: Merger negative for Vijaya Bank, BoB; don’t rush to buy PSBs, say analysts

State-run banks’ strength lies in their branch network, especially outside of metropolitan areas. About 62 per cent of India’s savings deposits originate in smaller cities, towns and villages, according to Bernstein analysts Gautam Chhugani and Gaurav Jangale. This is the most lucrative source of funding because even as borrowing costs rise, can take their time to reprice the rates they pay on In the past seven years, state-run banks have lost only 5 percentage points of market share in savings deposits, compared with an 11 percentage point drop in their share of lending, Bernstein’s data show.

PSU banks merger: For the merged bank focus ought to be strategy, not size

While privately run lenders would love to make deeper inroads into their state-run rivals’ 78 per cent share of household deposits, the cost of setting up a in smaller towns and rural areas is too high. However, just because the in Bank of Baroda’s three-way merger would have Rs 2 trillion ($28 billion) more in deposits than its gross assets, it shouldn’t look to boost its own lending.

A smarter strategy for would be to drive growth via securitisation. There are now plenty of new-age, specialist retail lenders in India. Some of them, such as Bandhan Bank Ltd. and AU Small Bank Ltd. are among the most valuable lenders in the world because of their expertise in selecting creditworthy borrowers. If they, plus specialist nonbanks like Shriram Transport Co. and Bajaj Ltd., can pool everything from loans for truck purchases and working-capital finance against property, then could earn decent returns on spare deposits by buying parcels of retail loans presented to him as securities.

Let big-ticket corporate exposure move away from the banking system to direct fundraising by companies in the bond market, and let state-run banks become financiers to retail lenders. Just because the subprime crisis in the US featured dodgy packaging of risky interest-only mortgage loans as AAA-rated securities doesn’t mean all securitisation must end in disaster.

ALSO READ: BoB, Dena, Vijaya Bank to merge; process completion may take 4-6 months

PSU banks merger: For the merged bank focus ought to be strategy, not size

The industry is booming: Securitisation transactions in India doubled in the June quarter from a year earlier. So if bankers like such endeavours to iron out legal and accounting issues, there’s no reason why suchendeavours shouldn’t help channel the idle deposits of state-run lenders away from chunky corporate loans and toward small shopkeepers, cold-storage owners, farmers, horticulturists and students. That might even be a more profitable way of making money than hobnobbing with the likes of the Gupta family in South Africa – a relationship that was partly responsible for pulling out of that country.

For state-run banks that are used to lending against collateral, it’s near-impossible to start evaluating retail borrowers’ future cash flows. The kind of data mining that’s needed to safely underwrite these (mostly) unsecured loans is more readily available with specialist lenders.

Jayakumar’s real opportunity in the three-way merger is not the bloated balance sheet, but the chance to create a very different bank, one that’s more of a savvy investor than a traditional lender.

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