The Indian government's reported plan to sell majority stakes in its relatively weak banks will require changes to the law and private buyers may not be keen. Instead, the government may need to consider another round of consolidation among state-run banks, analysts say.

The government said in May that it will formulate a new public-sector enterprise policy and have no more than four government-owned companies in strategic sectors. Recent media reports said state-owned banks will be included in the policy and the federal government may sell its majority stakes in some of the dozen banks it still owns.

"I think there are merits to consolidation in the fragmented Indian banking sector. It will be easier for the government to allocate capital to fewer banks," said Nikita Anand, credit analyst at S&P Global Ratings. Having an oversight and making board appointments for fewer companies will also be easier, she said.

The government is considering selling majority stakes in Bank of India, Central Bank of India, Indian Overseas Bank, UCO Bank, Bank of Maharashtra and Punjab & Sind Bank to cut the number of state-owned banks to four or five, Reuters reported July 20. All the six banks reported net losses for the fiscal year ended March 31, with double-digit nonperforming loan ratios, according to S&P Global Market Intelligence data.

Difficult hurdle

Allowing the private sector to take over state-owned banks is a "difficult hurdle" as it involves amendments to an act of Parliament that requires the government to keep a minimum of 51% ownership stake in state-owned banks, Anand said.

Sri Karthik Velamakanni, analyst for banks and financials at Investec India, said the government selling these banks "is out of the question," as they have high distressed assets that very few private companies would be willing to take on. He said perhaps the only solution available to the government is to push for further consolidation among state-owned banks.

Four or five big state-owned banks can develop their own areas of specialization, Velamakanni said. "The right thing to do — the only solution available to the government — is for these mega mergers to happen. The big public banks can be the experts in their particular field," he said.

Rounds of consolidation

In the last few years, India has pushed for greater consolidation to strengthen its state-owned banks. As part of the most recent round of mergers, 10 state-owned lenders were merged into four banks, effective April 1, bringing the number of state banks to 12 from 18. Previously, Bank of Baroda absorbed Vijaya Bank and Dena Bank, and State Bank of India absorbed five subsidiaries and Bharatiya Mahila Bank.

Krishnan Sitaraman, senior director at CRISIL, said mergers of stronger state banks with relatively weaker ones will "mean some offset for the weaker capital position of the latter and consequently lesser capital infusion requirement from the government."

The drive to bolster India's state banks has become more urgent as the COVID-19 pandemic has battered the country's economy, indicating a potential pileup of more bad loans. The Reserve Bank of India estimates that the gross nonperforming asset ratio of local commercial banks may rise to 12.5% by March 2021, from 8.5% in March. A further deterioration in the macroeconomic environment may push the ratio to as high as 14.7% under a "very severely stressed scenario," the RBI said in a July 24 report.

S&P Global Ratings on July 28 said the path for recovery for India might be more painful than that for some other Asia-Pacific banking jurisdictions. "We expect [India's] banking sector's weak assets to shoot up to 13%-14% of gross loans by the end of fiscal 2021 from an estimated 8.5% as of March 31, 2020."

Limited options

Another option may be to transfer the nonperforming assets of the state-run banks to a new bad bank, which won't make any new loans but instead focus on collecting existing debt and ultimately be wound down.

"A merger of bad banks and then runoff maybe another way to contain the problem and prevent systematic risk," said Vikram Kuriyan, executive director at Indian School of Business. "Private-sector banks could buy and run select parts of the bad bank. This could be a source of revenue and less headache for the government in winding down the bad bank."

The proposal for a bad bank found support from State Bank of India, the nation's biggest public-sector lender by assets, as also from the Indian Banks' Association, according to a June 12 report in The Economic Times. However, the government's chief economic adviser Krishnamurthy Subramanian is not in favor, noting that the banks have not been able to sell their bad loans to existing asset reconstruction companies.