"However, absent fresh capital infusions from the government, such mergers would not improve public-sector banks' weak capitalisation," it added.
Government owns majority stakes in 21 banks and merger of some of them is being considered for broader economic revival. These lenders account for more than two-thirds of banking assets in India.
"Poor corporate governance has been a structural credit weakness at public-sector banks, and managing all 21 has proven to be unwieldy for the government, which has been unable to pay sufficient attention to key issues such as long-term strategies and human resources. Consolidation would address some of these issues," Moody's said.
The global credit rating agency said that consolidating PSBs would also help from a scale perspective.
PSBs hold around 74 per cent of all deposits, it said, adding that with the exception of State Bank of India, none of the others is large enough to have a competitive advantage.
"This may change with consolidation, given the potential for some of these banks to grow to levels that exceed even large private-sector banks," it said. Notwithstanding the positive effect on corporate governance and scale efficiencies, any proposed mergers would not improve PSBs' weak capitalisation.
Moody's said most them have weak capital levels and merging two or more entities with weak capital levels will create a larger entity with weak capital.
"Until there is clear visibility on the merger process, including which entities would merge with and the terms of such a merger, public-sector banks will continue to have difficulty accessing the equity capital markets as investors demand clarity on these details.
"As a result, we continue to believe that capital infusions from the government remain key to improving these banks' capital levels," it added. The Cabinet approval, it said, is only the first step in the complex process. "However, we believe that there is a high probability that the mergers will take place given the government's apparent willingness to see this through.
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