State Bank of India (SBI) may be nowhere near the top of the heap of this magazine's Best Banks survey-it's somewhere down there at #29, albeit an improvement over the previous year's #36-but as far as size goes, SBI is easily numero uno by far (unfortunately there's no BT-KPMG award for the largest bank this year). After all, with a deposit base of Rs 3,67,048 crore as of March 2005, SBI-minus its associates and subsidiaries-is head and shoulders above the rest of the Indian banking pack, Punjab National Bank coming in a distant second, with a deposit base of a little over Rs 1 lakh crore.

Now consider SBI on the global stage, and suddenly it doesn't appear that large anymore. If you go by the 2005 study of The Banker, the Indian behemoth just about makes it to the list of top 100 banks of the world, with a #93 ranking. The good news for A.K. Purwar, Chairman, SBI, of course, is that his is the only Indian bank to feature in The Banker's top 100. If Indian banking is today at the crossroads, it's not because there aren't enough of them going around (there were close to 300 of them at last count, including foreign, PSU and regional banks). The problem is there aren't enough of global scale and size going around. And that's one reason why India remains an over-banked, under-serviced market. As Malcolm Knight, General Manager of the Basel, Switzerland-based Bank for International Settlements (BIS), an international organisation that fosters international monetary and financial cooperation, puts it: "India's banks must realise they have to be able to compete with foreign banks (globally)." That clearly calls for a frenetic bout of mergers & acquisitions (M&As), with public sector banks either merging or acquiring their state-owned counterparts, and foreign banking groups being allowed to acquire local banks. But as Usha Thorat, Deputy Governor, Reserve Bank of India, pointed out recently at a FICCI seminar: "Banks still have to work on this."

"We are focussing our strategy towards well-rounded organic growth in both our corporate and consumer businesses by leveraging our deep local understanding and global presence" Sanjay Nayar CEO (India) and Area Head, Citibank

Thorat's dead right. According to a Morgan Stanley study, in 1997 India had 58 banks, excluding foreign bank subsidiaries and regional rural banks. Now compare that figure with Malaysia, which had all of 54 banks eight years ago. The figure at the end of 2004: Just 10. That's one reason why the top five banks in Malaysia control three fourths of the assets in that market, up from 58 per cent in 1997. In India, however, the asset share figure barely inched upwards from 41 per cent to 43 per cent between 1997 and 2004.

If you're wondering about the merits of such rationalisation, well there are many compelling ones: One, there are just too many banks competing for the same share of the pie, which may be growing rapidly today, but that growth rate will some day in the not too distant future whittle down as the base factor comes into play. Two, if Indian banks want to arrive on the global map and compete on a global level, they need to develop size fast, as barring the top few, none features even in the global 300. Inorganic growth via mergers is one way to develop that size. From the capital point of view, a merged entity will be better placed to meet the Basel II norms, to invest in technology and to penetrate deeper on a regional basis. Customers, in turn, will benefit via lower transaction costs, as the merged banks gain from economies of scale. The bottom line: With banks becoming more efficient on the distribution, technology and capital fronts, they will be a lot safer.

Consolidation will also help Indian banks spruce up on the profitability front. Although return on assets- a key measure of a bank's profitability-has improved from 0.6 per cent to a little over 1 per cent between 2000 and 2004, it's still below the global benchmark of 1.5 per cent. Return on equity too is a couple of notches below the global norm (18 per cent as against 20 per cent-plus).

"Organically we have been growing fast at more than 35 per cent on a year-on-year basis, yet we will not hesitate to seize the first opportunity that's large enough for us to grow faster than that" Chanda Kochhar Executive Director, ICICI Bank

Indian public sector banks, for their part, appear to have recognised the benefits of consolidation. Quips K. Cherian Varghese, Chairman & Managing Director, Union Bank of India (UBI): "UBI was seen as a bridegroom; I would not like to remain a perpetual bridegroom, and I hope something happens." Varghese agrees that consolidation is an attractive proposition and a lot of opportunities do exist. In fact, a merger proposal with Bank of India was blueprinted, but nothing's come of it yet thanks to opposition from the most likely quarters. "We are opposing the merger as we do not see the need for it," says P.K. Sarkar, General Secretary, All India Union Bank Officers' Federation.

Yet, with consolidation having the blessings of the Finance Minister and the central bank, the feeling amongst industry circles is that the inevitable can only get delayed, not shelved. Already whispers of mergers proposed along regional lines can be heard in bank corridors. For instance, there's talk of UCO Bank and UBI Bank, both of which have their headquarters in Kolkata, along with possibly Allahabad Bank, being merged into a single entity. Similarly Indian Overseas Bank and Indian Bank in the South could be amalgamated. But what looks the most probable is the merger of SBI's seven associate banks into the parent.

The private banks, for their part, are on the lookout for potential targets. HDFC Bank CEO Aditya Puri agrees there are too many banks chasing the same set of customers, which is resulting in piecemeal bits of the pie for each player. Chanda Kochhar, Executive Director, ICICI Bank, doesn't have any targets on her plate, but that doesn't mean she will let opportunity pass her buy. "Organically we are growing very fast, at more than 35 per cent on a year-on-year basis, but we will still seize the first opportunity that is large enough for us to grow faster than that," is how Kochhar puts it.

"We are looking at opportunities within the foreign bank fold in the short term" Neeraj Swaroop CEO (India), Standard Chartered

The foreign banks, meantime, too want a part of the action, but they have to bid their time, although last fortnight reports surfaced about Citibank having sent a proposal to RBI, showing interest in the troubled Ganesh Bank. Also Australia and New Zealand (ANZ) Banking Group is reported to be contemplating a re-entry into India (after selling its operations to Standard Chartered six years ago), by possibly buying into IndusInd bank. Both Citi and IndusInd declined to comment on the opportunity for M&As. That may well be because RBI has chalked out a roadmap to 2009, which will allow foreign banks to acquire stakes in domestic ones in a phased manner (currently foreign banks can go up to 49 per cent in private ones, and only up to 20 per cent in PSUs). The FM, however, appears more enthusiastic about consolidation than a cautious RBI (which wants to give Indian private banks more time to shape up), and it remains to be seen whether the 2009 date is advanced at a time when foreign direct investment is becoming a burning priority.

Perhaps worn out by the rather long wait, foreign bank honchos sound lukewarm about the prospect of acquisitions. "RBI has a clear roadmap for the Indian banking sector and we are accordingly focussing our strategy towards well-rounded organic growth in both our corporate and consumer businesses by leveraging our deep local understanding and global presence," says Sanjay Nayar, CEO (India) and Area Head, Citibank. Standard Chartered has been relatively more in the thick of the action, having acquired two branches of Sumitomo Mitsui Banking Corp. towards end-2004, and prior to that Bank of America's retail banking portfolio as well as Grindlays in India. "In the short term, we are looking at more such opportunities," points out Neeraj Swaroop, CEO (India), Standard Chartered.

"UBI was seen as a bridegroom. I would not like to remain a perpetual bridegroom, and I hope something happens" K. Cherian Varghese Chairman & Managing Director, Union Bank of India (UBI)

The Indian banking sector would do well to take a look at the pace of consolidation in the rest of Asia. South Korea began its second round of consolidation in 2001, and that's helped its banks to improve their credit rating by creating economies of scale and scope, even as they reduced financing costs, and did away with duplication of investments in it. In Japan, the once very crowded domestic banking sector has undergone significant consolidation, which has resulted in the emergence of five key banking groups. These banks now hold approximately 46 per cent of total bank deposits in Japan. Similarly, the Malaysian banking industry has brought down the number of banks from 55 to 10 and is poised to enter its second phase of consolidation. This will involve mergers between banks and their finance company subsidiaries.

If there's one stumbling block to India following down the same path, it's the unions. Although FM P. Chidambaram has assured that no retrenchment will take place and there will be effective redeployment, people like Sarkar of the All India Union Bank Officers' Federation aren't convinced. "Successful redeployment is not possible," scoffs Sarkar. His other fears include clashes of culture, narrowing down of career prospects and stagnation on the promotion scale. The challenge, though, is for the managements and promoters (who are the government in many cases) to recognise the benefits of consolidation, and convince their employees about those advantages. If they fail to do that, the realities of the marketplace might show the way. As G. Sankarnarayanan, Senior Vice President, Indian Banks Association (IBA), points out: "Even if two stakeholders don't agree, the market will force them." Hopefully, it shouldn't come to that.