Mumbai-based journalist Niranjan Menon, a deposit holder with Bank of India, has reason to feel more secure than ever before as the bank is set to merge with its peer Union Bank of India [Get Quote] to become the second-largest bank in the country.

"There are studies which suggest that chances of bank failures reduce substantially with consolidation," says Kshitiz Prasad, senior analyst at Anand Rathi securities.

Apart from the additional cushion, Menon and the rest of the depositors with the two banks may be delighted about accessing the 4,600-odd branches and 1,000-odd ATMs (if those additional branches are in newer areas).

However, the new bank will have a problem of plenty in a few areas, especially in the western region, while being sparse in others. For customers, the merger does not necessarily mean greater access or better services. And for the bank, it may not mean additional customers or a larger reach in the real sense.

That is one of the reasons why some stock investors do not call the couple a perfect match. But there are others who think this marriage makes two plus two five. "It is a merger where both the banks have significant advantages," says Amitabh Chakraborthy, head of research at Kotak Securities.

When size matters

The two banks when merged will have combined assets of Rs 1,43,000 crore (Rs 1,430 billion) based on numbers recorded for last year. Since the merged entity will have a larger net worth {about Rs 7,096.80 crore (Rs 70.97 billion)}, it can lend more confidently.

Last year, the total lending by the two banks stood at Rs 75,280 crore (Rs 752.8 billion), nearly half of State Bank of India' [Get Quote] loan book. BoI and UBI also have comfortable capital adequacy ratios (the ratio of capital to risk-weighted assets) at 13.05 per cent and 12.12 per cent respectively.

A higher CAR means that the bank has the capacity to repay its depositors in case of a liquidation against its assets. Also, with Basel II norms calling for higher capital adequacy, banks will need to provide more for operational risks. Thus, more capital infusion will enable the new bank to lend more, aiding growth.

Who scores where?

Analysts say both the banks have their distinct strengths. BoI has been among the first-movers in international markets and derives about 20 per cent of its revenues from abroad. It also has a strong rural network with 60-70 per cent of its branches in villages and semi-urban areas, which may be useful if the merged bank has to lend more to farmers.

BoI has the advantage of size - its loan book is about 35 per cent larger than UBI and its total assets are about 32 per cent more. It has a capital of Rs 488.6 crore (Rs 4.49 billion). Size, unfortunately, does not always ensure profitability.

That is where UBI scores over BoI. UBI earns a return of 1.32 per cent on its assets while BoI earns just 0.49 per cent. Net interest margins - the difference between the interest the bank pays on its deposits and what it earns on its loans, which is a key determinant of profitability - stood at 3.3 per cent (FY04) for UBI. For BoI, the same was lower at 2.84 per cent.

Even worse is the amount of bad loans or non-performing assets. At the end of September, BoI's NPAs as a proportion of total advances stood at 4.17 per cent while the same were 2.06 per cent for UBI.

NPAs are undesirable for a bank as it does not earn anything on the loans while it has to make provisions for the loss in its annual profit and loss statement, which drag down earnings.

One of the key issues in integrating two banks is the technology platform they work on. Both BoI and UBI work on the same platform - Finnacle by Infosys [Get Quote] - which means the new bank will not have to incur any additional cost to integrate technology.

The challenge for the new bank will be to deal with BoI's NPAs to keep overall NPAs down (according to analysts, NPAs of less than 1 per cent are an ideal situation).

However, analysts are confident that the bank will be able to handle NPAs. The bigger issue is how the new bank will deal with employees. Since both banks are west-based, there are bound to be overlaps of employees.

The two banks may have branches too close to each other in many areas, making some branches redundant. The key challenge will be to rationalise branches and manpower to become leaner and meaner. Can this happen given the strength of bank unions?

"Rationalisation of manpower will take place," says a confident analyst. But how soon it will happen is anybody's guess.

Value guesses

Currently, UBI commands a market-cap of Rs 4,972 crore (Rs 49.72 billion) while BoI is valued at Rs 4,535 crore (Rs 45.35 billion). The combined adjusted book-value (total net worth less net NPAs) of the two banks for FY04 stood at Rs 6,482 crore (Rs 64.82 billion).

Based on prevailing market-cap of the banks, the merged entity is valued at 1.46 times adjusted book-value. For State Bank and Punjab National Bank [Get Quote], the same are 1.57 and 2.04, which means there could be some more steam left in the shares of these banks post-merger.

But if you are to bet on the future of the second-largest bank now, where should you put your money - UBI or BoI? Near-term gains will depend on the merger ratio for that will determine the relative stakes of the shareholders of the two banks in the new entity.

"The ratio should be in favour of UBI, given its low NPAs and better margins," says an analyst from a domestic brokerage.

There are rumours that equity shares in the new entity will be issued in a manner that every one share of UBI equals 1.8 shares of BoI.

However, based on the current price of UBI (Rs 107) and BoI (Rs 93), the markets are implying a ratio of 1:1.15. In all likelihood, the final ratio should settle somewhere in between.