Andy Mukherjee is a Bloomberg Gadfly columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.

The overhaul of the Indian banking system is inching forward, but the way ahead is so foggy that it's hard to assess where the project is going, much less when it will be done.

The current strategy seems to have split the country's $167 billion bad-debt problem into two halves.

For state-run banks, which account for the bulk of total loans and are in terrible shape, a government-appointed Banks Board Bureau is deliberating a fix. It had better hurry: On Friday, Bank of Baroda announced another surge in provisions for soured loans, which have quadrupled to nearly 10 percent of credit from less than 2.5 percent three years ago. Add restructured loans, more than a third of which had to be downgraded or written off over the past year, and stressed assets climb to 13.38 percent of total advances for India's second-largest state-run bank by market value. That's the kind of implosion naysayers are predicting for China. A decisive solution to the Indian crisis is nowhere in sight.

Then there's the more easily solved problem of small, privately controlled banks. Eight of them together are worth $4.4 billion, just one-tenth the market value of top-ranked HDFC Bank. Not all are doing well, though. Dhanlaxmi Bank had a Tier 1 capital ratio of 7.42 percent in March 2015, according to data compiled by Bloomberg.

Cushion Wearing Thin
Dhanlaxmi Bank's Tier 1 capital has fallen faster than its risk-weighted assets
Source: Bloomberg

It's hardly a surprise the bank's shares have lost 85 percent of their value over the past five years. And Dhanlaxmi isn't alone: This group of banks has seen returns on assets drop far more than their bigger rivals. Lack of scale makes them inefficient, and the solution is not just new capital but also better technology and management.

Small Is Worse
Collapse in returns on assets of these banks suggests an efficiency problem
Source: Bloomberg
*Market capitalization weighted index of Federal Bank, City Union Bank, Karur Vysya Bank, DCB Bank, South Indian Bank, Karnataka Bank, Lakshmi Vilas Bank and Dhanlaxmi Bank.

The monetary authority said last week that it would allow foreign lenders that have branch networks in India a greater role in situations where private-sector banks are consolidating or restructuring. Currently, they can't own more than 10 percent; the RBI didn't specify a new ceiling.

In theory, this would let the likes of Citigroup, HSBC and Standard Chartered speed up their Indian expansion, circumventing restrictions on how many branches they can have and where. In practice, global banks' frail finances makes them unlikely to jump at the chance. If they were permitted majority ownership, that might be another matter. 

There, however, things get knotty. The Reserve Bank of India may be perfectly happy to see a strong domestic lender swallow a relatively weak one -- Kotak Mahindra Bank, founded by billionaire Uday Kotak, completed a $2.4 billion takeover of ING Vysya Bank last year, the nation's largest bank deal.

It's not clear that the central bank, which also is the banking regulator, would be comfortable granting that privilege to, say, Singapore's DBS. The reason is that the RBI wants foreign banks to convert their Indian operations into local subsidiaries. If they did, they could own up to 74 percent of a privately run bank. However, since the central bank dangled that carrot in November 2013, not one foreign institution has made the switch. DBS, the first to apply, was put on hold, according to local media reports.

A section of the Indian financial bureaucracy believes that allowing a Singapore bank to grow in a country of 1.2 billion people is a favor that requires a quid pro quo: an Indian lender must be granted the same privilege in Singapore.

Letting economic nationalism get in the way of fixing the undercapitalized domestic banking system is a mistake. India needs rapid consolidation led by strong banks, regardless of their ownership or origins. Anything less would be unrealistic and counterproductive.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Andy Mukherjee in Singapore at

To contact the editor responsible for this story:
Paul Sillitoe at