Consolidation in Banking Industry in India through
Mergers and Acquisitions


Dr. Sudhindra Bhat
MBA, MFM, PGDIR & PM, PGDS & MM, M. Phil, Ph.D**
Associate Professor
Institute of Finance & International Management
# 8p & 9p, KIADB Industrial Area, Electronic City 2nd Phase, Bangalore-560 100

With increasing globalization, attaining "size" advantages will become critical for Indian Banks.  Combined with the need to attain higher capital standards under the Basel II Accord, consolidation in the Indian banking industry will become imminent.  However, the issues that need to be addressed include maximizing synergies in terms of regional balance, network of branches, HR culture, and asset commonality and legacy issues in respect of technology.

1.  Introduction:

Banking scenario since 1991 has been a process of transformation and consolidation.  With financial sector reforms implementation, the overall environment of banking sector has undergone radical change.  Consolidation in the banking sector is crucial from various aspects.  The factors inducing consolidation include technological progress, excess retention capacity, emerging opportunities and deregulation of geographic, functional and other restrictions.  A strong banking sector is critical for sound economic growth.  Since more than one decade, the banking industry has been transformed throughout the world from highly protected and regulated industry to a competitive and de-regulated one.  Especially globalization coupled with technological development, has shrunk the boundaries by which financial services and products are being provided to customers residing at any part of the globe.  Further due to innovation and improvements in service delivery channels, the trend of global banking has been marked by twin phenomena of consolidation and convergence.  The trend towards consolidation has been driven by the need to attain meaningful balance sheet size and market share in the face of intensified competition whereas the trend towards convergence is driven across the industry to provide most of the financial services such as banking, insurance, investment, cash management, etc to the customers under one roof and moving towards universal banking. [Swain, 2005]

In this scenario, if banks are to be made more effective and comparable with foreign banks, they need to be more capitalized, automated and technology oriented in addition to strengthening their internal operations and systems.  Similarly in order to make them comparable with their counterparts from abroad, it is necessary to structure the banks by way of mergers and acquisitions to achieve the requisite size and financial strength in the shortest possible time.

In the light of this, there is a need to understand the forces that have been driving M&As in banking industry.  Therefore this paper focuses on Merger concepts, factors driving M&As,  Indian experience of M&A and current scenario, benefits of mergers, creation of world class banks through mergers, threats and effects of M&A & HRM in Merger process.

2. Clarification of Concepts:

Following are the important concepts generally used in the area of M&A: 

Merger:  Merger is the combination of two or more companies into a single company where one survives and others lose their corporate existence.  The survivor acquires the assets as well as liabilities of the merged company or companies.  Generally, the company, which survives, is the buyer, which retains the identity, and seller company is extinguished.  Merger is the fusion of two or more existing companies.  All assets, liabilities and stock of one company transferred to transferee company in consideration of payment in the form of equity shares of transferee company or debentures or cash or a mix of two or three modes.

Amalgamation: Amalgamation is the blending of two or more companies into one undertaking, the shareholders of each blending company becoming substantially the shareholders in the company, which is to carry on the blended undertaking.

Acquisition:  Acquisition is the process of purchase by one company of a controlling interest in the share capital of another existing company.  An acquisition may be affected by a) agreement with the persons holding majority interest in the company management like members of the board or major shareholders commanding majority of voting power b) purchase of shares in open market; c)  making takeover offer to the general body of shareholders; and d)  purchase of new shares by private treaty. [Shroff, 2005]

Takeover:  Generally, the term takeover is considered to be hostile acquisition.  When an acquisition is "forced" or "unwilling", it is called takeover.  In an unwilling acquisition, the management of 'target' company would oppose a move of being takeover.  When managements of acquiring and target companies mutually and willingly agree for the takeover, it is called acquisition or friendly takeover.  Though the terms merger, amalgamation, acquisition and takeover have specific meanings, generally they are used interchangeably.

3. Need for consolidation:

Mr. P. Chidambaram, in his recent statement said, "Banks have to consolidate not just to create behemoths but to create synergies.  The footprints of banks ought to cover rural and interior India and the entire process of consolidation would have to be market driven.  Banks also should take into account regional and ethnic considerations and maximize synergies and address HR issues in the drive towards consolidation.  However they should not overlook legacy issues." (Singh, 2005)

One of the statements of Narasimham Committee II recommendations on economic reforms states "There is clearly a need for consolidation of structure which could be brought about essentially through a process of negotiation rather than imposed merger on profitability consideration and also for reasons of business strategy." [Singh, 2005]

Thus, it is clear from the above statements that there is a need for merger of two or more strong banks on commercial considerations, which is market driven to maximize synergies.  The idea is the strong bank can absorb the shocks and survive in the difficult time.

After the consolidation, the new entity will not only have sound financial position but also a large branch net work throughout the country, overseas presence, the large customer base, large resources and big size in terms of assets as well as business figures.  Further, the sound financial position will be in terms of large capital base, increased profitability, higher capacity to tolerate the unexpected loss, better risk management, larger reserves, large asset base, better stability, higher capacity to absorb losses, if any, thereby making higher gains. [Jain, 2005]

In India, we have large number of small banks.  As of March 2004, the number of scheduled Commercial banks in the country was 90.  As a result Indian banks lack global size.  The list of the world's top 1000 banks has only 20 Indian banks, out which only 6 are in the top 500.  At present out of so many banks in India, only one i.e., SBI, figures in the largest 200 banks of the world. Even a small country like Taiwan has many bigger banks when compared to the biggest bank of India [Puri, 2005].  Indian market is over banked but under serviced.  The existence of too many banks splitting customer accounts has resulted in low profitability per customer per bank and higher pricing for customers.

The efficiency ratio is also low due to policies relating to employees and social obligations are preventing leveraging of technology, market based compensation and international levels of profitability.  Therefore from the point of view of the financial systems, we need consolidation.  The objective would be strengthening of banks, economies of scale, global competitiveness, cheaper financial services and retaining of employees for emerging skill sets.

Basel II, released by Basel Committee on banking supervision in 2004, has proposed the adoption of better risk sensitive and balanced portfolio framework for the calculation of capital to risk weight on credit exposure.  It is intended to bring the regulatory capital requirement more in line with economic capital allocation (Raghavan, 2005).   A road map has already been prepared and steps already initiated to make the Indian banks more competitive and prepared for Basel II implementation and compliance.  The compliance of new Capital Accord involves a cost factor and also the preparedness at all levels.  It also requires the technology up gradation by the banks and the change of mindset at all levels.  Indian banks are committed to accept the international standards.  But some of the Indian public sector & private sector banks are having very low level of CRAR and very high level of Gross NPAs.  Consequently some of the banks may face problems in implementing the Basel II Accord.  The complexity involved and additional cost factor for fulfilling various requirements including technology up gradation also exist.  Thus consolidation in banking industry through mergers and Acquisition can only address the issue of implementation of Basel II to a great extent.

The consolidation in banking industry has further become important due to the reasons such as: Unhealthy competition among banks; expansion of branches, unviable branches; clusters of branches of various banks at particular centers, regional imbalance/unequal URS; improper deployment of staff; inter-zone transfer policy of officers up to specified scale in various banks; uneven promotions; and computerization/installation of ATMs/ Networking/ Core banking solution.

4.  Mergers and Acquisitions:  Indian experience

M&A in Indian banking is not new and dates back from Imperial Bank of Indian which was formed by the amalgamation of the three banks-the Bank of Bengal, the Bank of Bombay and the Bank of Madras, in 1921 [Purwar, 2005].  Few mergers have taken place thereafter primarily to protect the interests of depositors of weak private banks.  The mergers were not for economic considerations and usually distress mergers, eg. Mergers of Bank of Cochin and Kashinath Seth Bank with SBI, merger of New Bank of India with Punjab National Bank, merger of Laxmi commercial Bank with Canara Bank, Bank of Karad with Bank of India, Nedungadi Bank with PNB, Global Trust Bank with Oriental Bank of Commerce, and IDBI with IDBI Bank.  But the Times Bank merger with HDFC Bank and Bank of Madhura with ICICI Bank, created new wave of consolidation in the Indian banking industry for mutual benefit.  These mergers are created by market driven forces and are not bail out mergers.

Currently, Large Indian banks such as State Bank of India, Bank of Baroda and ICICI Bank are planning their strategies to increase their balance sheet size through M&A.  Medium sized banks such as HDFC Bank, Corporation Bank, PNB are looking out for suitable merger targets.  Small banks such as UTI Bank and Vysya Bank are also in the fray for acquisition of banks.  Bank of Baroda is on the look out for a bank with presence in north, east and south.  Bangalore based Vijaya Bank is keen on buying a northern bank while PNB is looking southwards.  The Chennai based Indian Bank has already begun the process of identifying two new targets (Lobana, 2005).  The bank consolidation/merger process should come voluntarily from the banks themselves, depending on the organizational synergy and market share.

5.  Motives and Benefits of M&A:

The main goal for M&A is the maximization of owners' wealth.  Specific motives, which are consistent with owners' wealth maximization, are:

Economy of scale: When larger volume of operations is performed for a given level of overhead of investment, average cost will be reduced.  So by increasing the volume of business it is possible to reduce cost.

Economy of scope:  The cost of offering various products and services by different units will be greater than that of the cost when one unit provides them.  Thus by providing various services, it is possible to increase the revenue.

Growth or Diversification:  Merger or acquisition can be used to fulfill the desire of rapid growth in size or market share or diversification in range of products and services by merging or acquiring an existing firm that provides services other than what are provided by the acquirer firm.  It can save lot of funds, time and various risks by acquiring suitable going concern.  It is also possible to increase the products and services for the benefit of firm's existing customers.

Avoid or Reduce competition:  Competition among the units providing the same products/services in same area of operation may be reduced through M&A.  Use of best human resources available in both the firms can result in maximizing the profit.

Rehabilitation of Sick units might allow claiming of tax concession u/s 72 of Income Tax Act 1961.  Tax benefits may be allowed in the form of carry forward of loss and unabsorbed depreciation in case of sick unit with a healthy unit.  Thus, M&A can help in granting certain amount of tax benefits also.

Mergers and Acquisitions are also influenced by motives of reduction of costs, efficiency gains, economy of scales, increasing customer base and market coverage, to bring in new products and specialization thereof.  It is observed that most of the banks increased their ranking immediately after merger.  [Lakshminarayana, 2005]

6.  Creation of World Class banks through Mergers:

Global corporations today expect their bankers to have the expertise, products and presence to serve them anywhere.  Even retail customers are expecting wider reach from their banks as the new generation is more mobile and convenience conscious.  Banks do need greater resource base and presence across a wide range of markets to satisfy their corporate customers and therefore, the necessary environment must be created to enable the development of institutions with the size and resources to complete globally.

In India this line of thinking is gaining speed in recent times.  A world-class bank should have global reach and resources coupled with world-class service.  Other routes may be resorted to create world-class banks.  But, risk absorbing capacity and good governance practices are required to attract funds from international market for which size plays vital role.  To become a world-class bank, a bank need wide array of products and world-class technology as most part of the banking now a days is driven by technology.  World-class technology requires world-class infrastructure.  Thus, size, good governance and technology are interrelated to each other and part and parcel of creating world-class banks.

7.  Threats and Effects of mergers and Acquisitions:

The Indian banking industry expects consolidation to bring in several future benefits.  But many fear that the desire for size is leading to unhealthy creation of super banks.  Sectoral consolidation and reduction in competition do not give immediate benefits for customers or staff who are directly affected by rationalization of jobs.  A study by the Bank for International Settlements (BIS) reports the experience of majority of the mergers as "disappointing" with organizational problems almost inevitably underestimated and most acquisitions overpriced, noting the creation of banks "too big to fail" [Reddy & Sree 2005].  Such super banks may encourage complacency and also may lead to inefficiency.  When such banks fail, the host Governments may be forced to use taxpayers money to bail out such banks.  As a result such banks are encouraged to pursue imprudent credit and investment policies, and may also carry systematic risk along with them.

Mergers can also result in poor credit flow to small business segments and major share may go to corporate sector, thus affecting the economic cycle.  It is also found that larger financial institutions tend to charge more and higher fees than smaller banks.

In majority of the cases merger related restructuring is accompanied by announcement of closure of banks, unprofitable branches and also job cuts.  Thus M&A process directly affects the interests' of employees.  People from rural and sub urban areas are the most affected when the branches are closed in these areas. 

A merger or takeover upsets the links between implicit and explicit contracts in a company based on trust between managers and workers; between employer and employees.  Integration of links requires harmonization of various aspects of terms and conditions of employment to ensure common practice in the combined organization that may change existing human resource management.

8.   Consolidation and Human resource management:

In order to meet the global standards and to remain competitive, banks will have to recruit specialists in various field such as Treasury management, Credit, Risk Management, IT related services, HRM, etc. in keeping with the segmentation and product innovation.  As a complementary measure, fast track merit and performance based promotion from within would have to be institutionalized to inject dynamism and youthfulness in the workforce [Shroff, 2005]. To institutionalize talent management, the first priority for the banking industry would be to spot, recognize and nurture the talent from within.  Secondly the industry has to attract the best talent from the market to maintain the required competitive edge among global players.  The critical issue is how talent is integrated and sustained in the bank.  Therefore proper system of talent management should be put in place by all the banks.

9.  Size challenges and Final balance of opportunities and threats:

Many banks experience post merger profitability below the industry average.  The reaction of the related parties to the merger announcement is significantly negative.  The success of mergers depends on four factors, that is Profitability (ROA, ROE), Credit quality, Asset mix and control of operating expenses.  The performance and controllability pose a challenge to the management in the merger process.  Most retail banks try to obtain economies of scale by expanding-either by extending their networks or widening their range of products and services.  But there is not automatic link between size and profitability.  Sometimes, this attempt to expand can produce opposite effects.  The complexity of managing large operations can nullify the benefits, and losses related to top-heavy organization are often underestimated.  The lack of transparency of financial activities and fragmented nature of debts and capital, especially mega banks prevent creditors, shareholders and regulators from imposing discipline.  Internet banking is also a challenge with which large banks have to contend.  Moreover, in the present framework, regulation is essential to avoid system failures that have devastating consequences, as was the case in South East Asia in 1977.

Hence big size poses challenges to Government, ownership, management, and regulatory and regulatory bodies in management or control of its operations.  But the final balance of cost and benefits associated with mergers favour the creation of universal banks.  The possible benefits of scale or scope economies, the revenue enhancement, and the added stability all favour the movement toward universal banks.

10.  Conclusion:

Consolidation through M&A may be requirement of future.  M&A of future should aim at creation of strong entity and to develop ability to withstand the market shocks instead of protecting the interests of depositors of weak banks.  The M&As in the banking sector should be driven by market related parameters such as size and scale; geographical and distribution synergies and skills and capacity.  The emerging market dynamics like falling interest rate regime which makes the spread thinner; increasing focus on retail banking, enhanced quest for rural credit, felt need for increasing more profits especially from operations, reduction of NPA's in absolute terms, need for more capital to augment the technology needs, etc are the major drivers for mergers and acquisitions in the banking sector.

M&As are no substitute for poor assets quality, lax management, indifference to technology up gradation and lack of functional autonomy and operational flexibility.  The banking system will have to be managed by competent and independent people having adequate power and full operational autonomy.

While the merger process is certainly a change initiative, the human element is more vital for its success.  Without the positive mind set of the human beings no change initiative can be successful venture.  In order to achieve the desired results of the merger exercise, especially in banks, it is necessary to recognize the complexities and to draw and implement a viable plan for change in the collective behaviours, attitudes and mind set of the workforce which translate such merger plan into workable solutions.

With increasing globalisation, attaining size advantages will become critical for Indian banks.  Combined with the need to attain higher capital standards under Basel II Accord, consolidation in the Indian Banking industry will become imminent. However, the issues that need to be addressed include maximizing synergies in terms of regional balance, network of branches, HR culture, asset commonality and legacy issues in respect of technology.  In the present scenario, we must develop small number large banks of global size instead of large number of smaller banks as we are having now.


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Dr. Sudhindra Bhat
MBA, MFM, PGDIR & PM, PGDS & MM, M. Phil, Ph.D**
Associate Professor
Institute of Finance & International Management
# 8p & 9p, KIADB Industrial Area, Electronic City 2nd Phase, Bangalore-560 100

Source: E-mail June 30, 2006


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