UPDATE 1-India cbank:large bank mergers may lower competition

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By Saikat Chatterjee

MUMBAI, Sept 4 (Reuters) - The prospect of India opening up its banking sector to foreigners next year is likely to spur consolidation among local banks, which may lead to a lessening of competition, the central bank said on Thursday.

India is scheduled to release a review of its banking sector in April 2009, which is expected to cover whether to increase the limit on voting rights of foreign shareholders of local banks and whether to allow greater participation by foreign banks.

"The increased presence of foreign banks, by intensifying competition, could accelerate the consolidation process that is underway," the central bank said in its 2006-08 report on currency and finance.

"While this may be the positive outcome, it may, at the same time, also raise the risk of concentration," it said.

India's banking sector is fragmented, and the largest banks are small compared to foreign banks. The combined assets of India's five biggest banks were about half those of China's biggest bank, Bank of China Ltd (601988.SS), the central bank said in its 515 page report.

India had 79 commercial banks at the end of March. Of these, 28 were foreign banks, which held 10.1 percent of the aggregate assets of the sector at the end of June, the Reserve Bank of India said.

There were also 91 regional rural banks, 1,770 urban co-operative banks and 12,834 non-banking financial companies among other financial institutions.

"Consolidation among large banks, in particular, would raise both competition and moral hazard concerns, that is, 'too big to fail'," the central bank said.

As well, any concentration of banking activities in a few "megabanks" could lead to increased operational risks, contagion risks and systemic risks, and have an adverse impact on the yield curve that affected monetary policy transmission, it said.

Analysts say as India opens up its financial sector, the pace of consolidation should increase, and the report said there could be benefits it smaller banks merged.

"While mergers among large banks can undermine competition, competition can be enhanced if mergers take place among the smaller and weaker banks in order to compete with the larger banks," the Reserve Bank said.

Since the nationalisation of 14 banks in 1969, there have been 33 bank mergers in India, of which 25 saw a private sector and public sector banks combine, the report said.

The biggest was HDFC Bank's (HDBK.BO) $2.4 billion all-share takeover of Centurion Bank of Punjab earlier this year.

CREDIT CONCERNS

Allowing more foreign banks to enter the banking sector may lead to reduced lending to the small- and medium-sized companies, and governance standards in most public-sector banks are not up to required levels, the central bank said.

Moreover, the global subprime crisis has raised doubts on the audit and risk management capabilities of some large global banks and their corporate governance standards.

"The approach to the road map may have to take account of these developments whose implications and ramifications are not yet clear," the central bank said.

The central bank said India's growing economy meant the number of Indian companies accessing global capital markets would increase.

"This would also require larger presence of Indian banks overseas, and reciprocity issues would also need to be considered in the expanded entry of foreign banks in India," it said. (Editing by John Mair)