SINGAPORE  - India's three-way state bank merger offers a glimmer of reform. Prime Minister Narendra Modi's government surprised its own bankers on Monday with a plan to fold together three government-controlled lenders, leaning on Bank of Baroda to form a group which Financial Services Secretary Rajeev Kumar said will have $200 billion of assets. With an election coming next year, it’s encouraging to see ministers tackling the overdue restructuring of the sector. The details, though, are less inspiring.

India's state-run lenders hold two-thirds of the country's banking assets, but also house the bulk of a $150 billion pile of suspect loans. Though the government announced a $32 billion bailout last year and has hinted repeatedly at long-awaited consolidation, progress has been slow. The only significant tie-up to date was State Bank of India absorbing its subsidiaries last year.

That makes Monday's move significant - not least because New Delhi is also grappling with an emerging market rout that has dragged the rupee near record lows against the dollar, as well as protests by farm workers.

Though the announcement was short on detail, it contained some less reassuring elements. New Delhi is effectively bailing out loss-making Dena Bank by folding it into Bank of Baroda, the country's second-largest state lender, along with mid-sized Vijaya. Bank of Baroda shares fell over 16 percent, wiping close to $1 billion off the lender’s market value.

Mashing together three balance sheets helps hide some problems: Dena's net bad loans stood at 11 percent of advances at the end of June, while the combined bank's score will be 5.7 percent. Less clear is whether the combination will be better placed to avoid extending new questionable loans. There will be few if any job cuts - a sop to problematic unions - and the resulting group will have 9,500 branches. All three brand names could remain.

More worrying still is the government-led character of the deal. State bankers had expected to find their own partners. Yet according to local newspaper reports, even executives at the merging banks were caught off-guard. Minority investors were blindsided. It is also unclear why Dena was rushed into a shotgun wedding ahead of other problem cases. There is plenty of tidying up left to do.

CONTEXT NEWS

- The Indian government said on Sept. 17 it planned to merge three state-run financial institutions: Bank of Baroda, Dena Bank and Vijaya Bank. The combined group would be the country’s third-largest lender, with 14.8 trillion rupees in assets ($204 billion), 9,500 branches and almost 86,000 employees, India’s financial services secretary said.

- India owns majority stakes in 21 banks, which account for more than two-thirds of the industry’s assets.

- The three-way deal requires approval from the cabinet of ministers and parliament, a process expected to be completed by the end of March 2019.

- In Indian afternoon trading, shares in Vijaya Bank were down 3 percent and Bank of Baroda’s fell more than 13 percent; Dena Bank’s were up nearly 20 percent.

(Editing by Jeffrey Goldfarb and Sharon Lam)

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