India wants to create bad banks—maybe as many as three more of them. New Delhi has set up a top ministerial panel that will clear merger plans proposed by lenders’ boards.

Investors who plowed into state-run banks on Wednesday, pushing an index of their shares 2% higher, are deluding themselves if they think this is some sort of reform.

Warehousing non performing corporate loans, currently spread over a score of banks, into fewer, bigger piles will serve no purpose unless there’s some guarantee of extra capital for the unlucky institutions that will end up absorbing the weaker ones, or at least a go-ahead for the merged entities to shed superfluous workers.

State Bank of India (SBI), the country’s largest commercial lender, has set a template for a de facto bad bank.

After absorbing smaller associated lenders, it now has 280,000 employees—70,000 more than before the merger—and a cost-to-income ratio of 54%.

Its non-performing asset (NPA) ratio is approaching 10%, almost 3 percentage points higher than pre-transaction.

Expect the same misery to befall Bank of Baroda, Punjab National Bank (PNB) and Canara Bank, identified by Elara Securities as the “likely scapegoats" of further consolidation.

Headquartered in western, northern and southern India respectively, they would be expected to acquire weak lenders from their regions.

Assume, like Elara does, that Bank of Baroda is asked to pick up Bank of Maharashtra Ltd. and/or Dena Bank. With its own bad loans at 11.4% of the total, how can it take on the burden of lenders with ratios of 17 to 19%?

Nobody on Canara Bank’s board will be pining for money-losing Indian Overseas Bank, which has almost 30,000 staff.

Payments to employees accounted for 77% of Indian Overseas’ net interest income in the June quarter. Given how strong bank unions are, reducing surplus workers by letting them retire is no recipe to rein in a cost-to-income ratio of 61%.

As Gadfly has argued, India’s state-run banking system now resembles one giant bad bank. Unless it can pony up extra capital, there’s no need for the government to create a new institution to park soured loans. By the same token, the push for weak banks to be merged with the not-so-weak is also senseless.

Nothing that the central bank and the government have thrown at cleaning up the $191 billion mess has worked. News that something is being done makes investors happy for a while and then, with another quarter of bad earnings and lousy asset-quality reports, the optimism dies. Bloomberg Gadfly

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