M&A’s IN THE INDIAN BANKING SECTOR

By:

Somnath Das Bakshi

IIM Lucknow

Introduction

In mathematics we know that points make up lines and lines make up planes and planes make up space or in common parlance small makes big. In the paradigm of corporate world it is not always bottom up and get big approach. Companies grow, shrink, merge, and acquire in order to gain long term strategic advantages. In this paper we will concentrate on merger and acquisition in banking sector in Indian. First we discuss possible benefits from merger. Next present scenario is discussed along with potential problems due to merger followed by key drivers of merger. The paper is concluded with future merger direction in the country.

Benefits of Merger

The question is why merger? Merger takes place in search of synergywhich takes three forms of operational, financial, and managerial. In case of banking such possible synergies can be classified as below

Operational synergy- Operational synergy can be achieved in four ways. Firstly due to economies of scale; as the fixed cost spreads over larger revenue base. Second in terms of scope economies as the opportunity arises in cross selling different products. Third is bank’s ability to serve larger and complex client base. Fourthly existence of bigger bank can help in resolution of smaller banks in time of crisis

Financial synergy- Financial synergy can be realized in access to lower cost of capital. Bigger banks will have access to wider capital base and diversified operation into various services reduces probability of bank failure. Other benefit is the access of smaller banks to better risk management and control system of larger banks, and tax relief that comes with merging with distressed banks.

Managerial synergy-One of the main benefit in merger is knowledge transfer resulting in superior planning and monitoring ability of the combined entity as a whole. Both Smaller and bigger banks can benefit from each other in term of efficient handling of resources.

Other controversial advantage in banking is the status of “too big to fall”. The idea is fall of big bank will lead to loss of confidence in the sector and widespread panic. So a government is expected to bailout larger banks. This has indeed been the case during crisis in USA and more recently in Ireland. We discuss more about it later.

Success of merger can be attributed to realizing all synergies and should be reflected in performance of banks post-merger in two fronts. One in improves bottom line and second is improved performance in stock market. Academic studies related to post-merger benefit analysis in foreign banks do not find significant benefit from either of two(Jayadev & Sensarma, 2007). Though there has been increased scale efficiency due to technological progress, regulatory change and beneficial effect of lower interest rate.

Merger in Indian Banking Sector

Banking in India has come a long way since the establishment of General bank of India in 1786, first of its kind in India. Important milestone in Indian banking were nationalization of banks, 14 in 1969 and 6 in 1980, and liberalization of Indian economy during early 1990 and subsequent entry of private players in banking sector. As of March 31, 2009, the Indian banking system comprised 27 public sector banks, 7 new private sector banks, 15 old private sector banks, 31 foreign banks, 86 Regional Rural Banks (RRBs), 4 Local Area Banks (LABs), 1,721 urban cooperative banks, 31 state co-operative banks and 371 district central co-operative banks(RBI, 2010).

Narasimham committee report in 1998 suggests merger in banking and creation of stronger banks to support current account convertibility related issues like domestic liquidity and interest rate movement. The committee further suggested existence of two or three banks with international orientation, eight to ten large banks catering to corporate needs and many smaller banks serving local trade.

While merger of domestic companies are guided by company’s law acquisition comes under takeover code of SEBI. In case of foreign companies acquisition requires approval of Foreign Investment Promotion Board (FIPB). Merger requires approval of both FIPB and Reserve Bank of India (RBI). Bank merger needs to take permission from RBI to be effective. Before 1960 only voluntary amalgamation was permitted by section 44A of Banking Regulation Act. Later section 45 was added to prevent weak banks from falling. Under this section RBI has power to reconstruct a weak bank and direct it to merge with other banks. RBI directed Bank of Baroda to merge with South Gujarat Local Area Bank Limited though the former was not keen on merger.

So far Indian banking sector has not seen mega mergers. Most of the past mergers have been driven by dictate of central bank in order to rescue unhealthy banks. The purpose has been to save sick bank’s customers. Post Narasimham committee report discouraging sick merger the trend has so far subdued though not stopped. Very recently Bank of Baroda has acquired Memon cooperative bank which had been non-functional since 2009. A list of recent mergersinvolving Indian commercial and investment banks can be found in appendix.

In Indian scenario four types of merger have taken place so far. First is public sector bank merging with other public sector banks; for example State Bank of Indore was merged with State Bank of India in 2009. Second is merger of private sector bank with public sector bank, this happened in 2004 when distressed Global Trust Bank was taken over by Oriental Bank of Commerce. Third one is merger of two private sector banks which has taken place in regular intervals post entry of private player with HDFC taking over Times Bank (2000), ICICI bank merging with Madura Bank (2001) and recent merger of HDFC bank with Centurion Bank of Punjab (2008) and ICICI taking over Bank of Rajasthan (2010). Fourth type of merger is foreign banks taking over foreign bank which happened in 2000 when Standard Chartered Bank acquired ANZ Grindlays bank. Other type of merger approved by central bank is merger of development financial institute with banks. ICICI limited merged with ICICI bank and IFCI Limited merged with Punjab National Bank.

So far Indian banks have remained focused on domestic market and have not ventured abroad. Two reasons are attributed for that. One is mature western banking market has not attracted Indian bankers and they instead concentrated on high growth domestic market. Second reason is that Indian banks are minuscule in size with respect to its global peers.

Drivers for Consolidation

There have been several drivers for growth in bank consolidation in US and western countries. The same factors are playing role in India as well

· Increases in global trade- Indian business houses have become big in last decade thanks to global big ticket acquisition by domestic businesses. Coupled with that increased domestic demand has led to more import. Growth in Indian business has led to growth in banking business also as seen from figure 1 which shows growth in NSE 100 index versus bank index since the latter’s inception in 2003.

• Increase in corporate risk management activities in foreign exchange and interest rate market is a direct consequence of increase in both global trade and farm balance sheet. As exposure to foreign exchange and interest rate increases so does need for hedging.
• Increase use of off balance sheet activities- Though RBI limits various off balance sheet activities still private banks have started use it.
• Increase in customer credit through mortgages, home equity financing and credit card debt- Customer credit is linked with consumption. Boom in service sector resulted in Indian middle class people having more disposable income. Consequently demand in credit card and debt has gone up.

Too big to fall

An argument that has been referred against bank merger is that big banks become “too big to fall”. Fall of big banks have been problematic because of four reasons. First is deposits are insured by agencies, in India they are insured by Deposit Insurance and Credit Guarantee Corporation (DICGC) for a value up to `1 lakh , so any fall of big bank means big outlay by insurance agency and further crisis. Second is that most banks are interconnected with balance sheet exposure to other banks. So any fall may trigger a series of crisis. Third is the panic effect. Any big bank fall will result in panic and widespread withdrawal creating systematic bank crisis. Fourth if banks are big enough any trouble in bank may result in sovereign crisis which have been the case in Ireland recently.

Now in India no banks are big enough to trigger sovereign crisis. An indicator measuring bank asset to country GDP shows largest Indian bank has asset close to 24% of Indian GDP far below of what biggest Irish bank had(close to 100%).

Public sector Banks			Private Sector bank
	Asset(`crore)	Asset/GDP		Asset(`crore)	Asset/GDP
St Bk of India	1451219.84	0.260334	ICICI Bank	489827.2	0.0878701
PNB	303594.72	0.054462	HDFC Bank	223045.73	0.0400122
Bank of Baroda	284272.58	0.050996	Axis Bank	180619.29	0.0324013
Canara Bank	266841.6	0.047869	Kotak Bank	55114.81	0.009887
Bank of India	277204.01	0.049728
UBI	195509.44	0.035072

Table 1 Asset and asset to GDP ratio for big Indian banks (source Capitaline)

Challenges & Road Ahead

When compared on size globally Indian banks lack their peers in other emerging countries like China, Brazil according to BCG report on banking(BCG). The same report ranks banks on the basis of total shareholder return (TSR), consisting of capital gain and free cash-flow yield. Relative TSR (RTSR) is used as an indicator and on the basis of that among large cap banks SBI ranks 34^th in 2009 but when compared for the duration 2004-09 SBI climbs to 8^th spot. This proves higher performance of Indian banks during global crisis. Along midcap banks HDFC and HDFC bank takes 6^th and 8^th spot while ICICI bank grabs 22^nd spot on the basis of RTSR during 2004-09. The solid performance of Indian banks it is time to scale up to global peer and merge Indian business conservatism to western world’s best banking practices. Something that Indian companies in other sector like Tata Steel, Hindalco already doing.

Mergers have hit many roadblocks. Trade unions have acted against any kind of merger among PSBs in the past and they have been very strong in banking sector. Also heavy government holding in PSBs rules out any merger between PSB with private and foreign banks in near future. So major merger drives are expected to take place in private sector; which has indeed been the case as seen from appendix. PSB mergers have been driven by RBI dictate rather than being market driven.

Going forward there is little scope of big ticket mergers in Indian scenario happening in short run. But as the restriction on foreign banks are relaxed and Indian market evolves more, and regulatory requirement becomes stringent natural push will be toward consolidation. What needs to be kept in mind that consolidation will happen in Indian way and not necessarily following western models.

Bibliography

BCG. (n.d.). Creating Value in Banking 2010. Retrieved December 01, 2010, from http://www.bcg.com/documents/file39719.pdf

Jayadev, M., & Sensarma, R. (2007, October). Mergers in Indian Banking-An Analysis. South Asian Journal of Management, XIV(4), 20-49.

RBI. (2010). Discussion Paper on Entry of New Banks in Private Sector.