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The financial system plays a crucial role in mobilizing funds and savings and the use of these
funds and savings into more productive use. Banking sector as a major part of the financial
system plays an effective role in accelerating the path of economic growth. A sound and
efficient financial system has been considered as a pre-requisite for the growth of any
economy. This sector plays a very crucial role in promoting the payment and settlement
system of an economy. Banks also play an important role in discharging social
responsibilities such as poverty eradication, balanced regional development, employment
generation etc. The main cause behind the outcome of industrial revolution in Europe during
18th and 19th century was the growth of commercial banking. The banking sector in India as
well as in the world continues to be one of the primary engines of growth.
The strategic priority in the banking industry has changed over the last two decades.
Presently, more emphasis has been put on efficiency, soundness, value creation, and
productivity rather than on growth. To achieve all these goals, the government and regulatory
authorities have adopted various policies and measures, out of which consolidation of the
banks emerged as one of the most preferable strategy. There are several ways to consolidate
the banking sector; the most commonly adopted by the banks is mergers. Merger and
acquisition of the banking sector was one of the outcomes of the deregulation, liberalization,
and technological progress. Merger of two weaker banks or merger of one healthy bank with
one weak bank can be treated as the faster and less costly way to improve profitability than
spurring internal growth (Franz, H. Khan).
One of the main motives behind the mergers and acquisitions in the banking industry is to
achieve economies of scale. Scale economies arise when banks increase their scale of
production and size by merging with other banks.
With this consideration in mind, the present paper attempted to study the effect of mergers on
efficiency of Indian banks that have participated in the merger activity during 1990-200. The
remainder of this paper is organized as follows: section 2 provides brief overview of the
Indian banking sector. Next section deals with the review of empirical studies related with the
impact of mergers on efficiency. Database and methodology are discussed in Section 4 while
Section 5 relates to the empirical analysis and Section 6 concludes.
In India, the Reserve Bank of India is acts as a central bank of the country. RBI regulating the
operations of other banks and managing the money supply of the economy. The Indian
banking system consists of commercial banks and Co-operative banks. Commercial banks
play dominant role in the growth of Indian economy and accounts for more than 90 percent of
the total assets of the banking sector. Commercial banks are classified into two categories
namely Scheduled Commercial Banks and nonscheduled commercial banks. Banks that listed
in Scheduled II of the Reserve Bank of India Act, 1934 are considered as Scheduled
Commercial Banks. Based on the pattern of ownership, scheduled commercial banks can also
be classified into three broad categories.
(1) Public Sector Banks which include (a) State Bank of India and its associates (b)
Nationalized banks.
(2) Private Sector Banks comprise Indian private banks and foreign banks. Private sector
banks further bifurcated into old private banks, which come into existence prior to 1992 and
new private banks, which established after 1992.
(3) Regional Rural Banks During last few decades, the environment under which Indian
banking sector have operated witnessed a remarkable changes. India embarked on a strategy
of economic reforms in the wake of a serious balance of payment crisis in 1991 (Mohan,
Rakesh 2005). In Indian banking sector, the policy makers adopted a cautious approach for
introducing reform measures on the recommendation of Narishmam Committee I (1991),
Narishmam Committee II (1997) and Verma Committee (1999). The main objective of the
banking sector reforms was to improve the efficiency of banks and to promote a
diversified and competitive financial system. One of the outcomes of such reforms was the
consolidation of the banking industry through mergers and acquisitions. Technological
progress and financial deregulation have played an important role in accelerating the process
of merger and acquisition in Indian banking industry. Due to technological progress, the scale
at which financial services and products are produced has been expanded which provide an
opportunity for the banks to increase their size and scale of production. At that, time mergers
of banking institutions emerged as an important strategy for growing the size of banks. Size
of the bank plays a significant role to enter the global financial market.
Mergers and acquisitions in Indian banking sector have initiated through the
recommendations of Narasimham committee. The committee recommended that merger
between banks and Development Financial Institutions (DFI's) and Non Banking Financial
Corporation's (NBFCs) no to seen as a mean of bailing out weak banks. The committees also
stressed, that the combined value of new bank will be greater, than the combined value of
merged banks, and have a "forced multiplier effect."
The pace of bank mergers and acquisitions is increasing all over the world and it has given
rise to an extensive economic research. Today, there is quite an abundance literature available
on the subject of bank mergers. Berger et. al (1999) provided a comprehensive review of
studies evaluating mergers and acquisitions in banking industry.
In literature, there has been number of studies conducted on the impact of mergers on the
efficiency of banks. The studies that have been conducted to analyze the impact of mergers
and acquisitions on bank performance can be classified as ex-ante studies and ex-post studies.
Ex-ante studies assess the effect of merger on bank performance by analyzing the stock
market reaction to merger announcement. Ex-ante studies are also called the event studies as
the announcement of merger is considered as an event in the stock price history of the
merging entity. Ex-post studies, on the other hand asses the effect of merger on banks'
performance by comparing, pre and post merger performance of banks. This comparison can
be made by using either traditional financial ratio analysis or by econometric and frontier
analysis. There is voluminous literature on mergers and acquisitions in developed economies
like US but there is dearth of literature in developing economies like India and other Asian
countries. The literature suggests that there is mixed empirical evidence regarding the impact
of mergers and acquisitions on the efficiency and performance of banks.
Cost efficiency gains from merger may be arise from the fact that merged banks gain access
to cost saving technologies or spread their fixed cost over a larger base, thus reducing average
cost.
Frei et al. (1996) suggest that the cost efficiency effects of merger and acquisition may
depend on the type of merger and acquisition, the motivation behind it and the manner in
which the management implemented its plans.
Vennet (1996) studied the impact of mergers on the efficiency of European Union banking
industry by using some key financial ratios and stochastic frontier analysis for the period
1988-93 and found that merger improve the efficiency of participating banks. Akhavein et al.
(1997) examined the price and efficiency effect of mega mergers on US banking industry and
found that after merger banks have experienced higher level of profit efficiency than before
merger. Berger (1998) found very little improvement in efficiency for M & A of either large
or small banks. Gourlay et al. (2006) analyzed the efficiency gains from mergers among
Indian banks over the period 1991-92 to 2004-05 and observed that the merger led to
improvement of efficiency for the merging banks. R. B. I. (2008) also drives the same
conclusions and found that public sector banks have been able to get higher level of
efficiency than private sector banks during post merger period.
Mergers and acquisitions are strategic decisions taken for maximisation of a company's
growth by enhancing its production and marketing operations. They are being used in a wide
array of fields such as information technology, telecommunications, and business process
outsourcing as well as in traditional businesses in order to gain strength, expand the customer
base, cut competition or enter into a new market or product segment.
Mergers or Amalgamations
A merger is a combination of two or more businesses into one business. Laws in India use the
term 'amalgamation' for merger. The Income Tax Act,1961 [Section 2(1A)] defines
amalgamation as the merger of one or more companies with another or the merger of two or
more companies to form a new company, in such a way that all assets and liabilities of the
amalgamating companies become assets and liabilities of the amalgamated company and
shareholders not less than nine-tenths in value of the shares in the amalgamating company or
companies become shareholders of the amalgamated company.
An acquisition may be defined as an act of acquiring effective control by one company over
assets or management of another company without any combination of companies. Thus, in
an acquisition two or more companies may remain independent, separate legal entities, but
there may be a change in control of the companies. When an acquisition is 'forced' or
'unwilling', it is called a takeover. In an unwilling acquisition, the management of 'target'
company would oppose a move of being taken over. But, when managements of acquiring
and target companies mutually and willingly agree for the takeover, it is called acquisition or
friendly takeover.
Under the Monopolies and Restrictive Practices Act, takeover meant acquisition of not less
than 25 percent of the voting power in a company. While in the Companies Act (Section
372), a company's investment in the shares of another company in excess of 10 percent of the
subscribed capital can result in takeovers. An acquisition or takeover does not necessarily
entail full legal control. A company can also have effective control over another company by
holding a minority ownership.
The most common motives and advantages of mergers and acquisitions are:-
Diversifying the risks of the company, particularly when it acquires those businesses
whose income streams are not correlated. Diversification implies growth through the
combination of firms in unrelated businesses. It results in reduction of total risks
through substantial reduction of cyclicality of operations. The combination of
management and other systems strengthen the capacity of the combined firm to
withstand the severity of the unforeseen economic factors which could otherwise
endanger the survival of the individual companies.
A merger may result in financial synergy and benefits for the firm in many ways:-
The three important steps involved in the analysis of mergers and acquisitions are:-
A merger is said to be at a premium when the offer price is higher than the target
firm's pre-merger market value. The acquiring firm may have to pay premium as an
incentive to target firm's shareholders to induce them to sell their shares so that it
(acquiring firm) is able to obtain the control of the target firm.
Mergers and acquisitions are regulated under various laws in India. The objective of the laws
is to make these deals transparent and protect the interest of all shareholders. They are
regulated through the provisions of :-
The Act lays down the legal procedures for mergers or acquisitions :-
Permission for merger:- Two or more companies can amalgamate only when
the amalgamation is permitted under their memorandum of association. Also,
the acquiring company should have the permission in its object clause to carry
on the business of the acquired company. In the absence of these provisions in
the memorandum of association, it is necessary to seek the permission of the
shareholders, board of directors and the Company Law Board before affecting
the merger.
Information to the stock exchange:- The acquiring and the acquired
companies should inform the stock exchanges (where they are listed) about the
merger.
Approval of board of directors:- The board of directors of the individual
companies should approve the draft proposal for amalgamation and authorise
the managements of the companies to further pursue the proposal.
Application in the High Court:- An application for approving the draft
amalgamation proposal duly approved by the board of directors of the
individual companies should be made to the High Court.
Shareholders' and creators' meetings:- The individual companies should
hold separate meetings of their shareholders and creditors for approving the
amalgamation scheme. At least, 75 percent of shareholders and creditors in
separate meeting, voting in person or by proxy, must accord their approval to
the scheme.
Sanction by the High Court:- After the approval of the shareholders and
creditors, on the petitions of the companies, the High Court will pass an order,
sanctioning the amalgamation scheme after it is satisfied that the scheme is
fair and reasonable. The date of the court's hearing will be published in two
newspapers, and also, the regional director of the Company Law Board will be
intimated.
Filing of the Court order:- After the Court order, its certified true copies will
be filed with the Registrar of Companies.
Transfer of assets and liabilities:- The assets and liabilities of the acquired
company will be transferred to the acquiring company in accordance with the
approved scheme, with effect from the specified date.
Payment by cash or securities:- As per the proposal, the acquiring company
will exchange shares and debentures and/or cash for the shares and debentures
of the acquired company. These securities will be listed on the stock exchange.
The Act regulates the various forms of business combinations through Competition
Commission of India. Under the Act, no person or enterprise shall enter into a
combination, in the form of an acquisition, merger or amalgamation, which causes or
is likely to cause an appreciable adverse effect on competition in the relevant market
and such a combination shall be void. Enterprises intending to enter into a
combination may give notice to the Commission, but this notification is voluntary.
But, all combinations do not call for scrutiny unless the resulting combination exceeds
the threshold limits in terms of assets or turnover as specified by the Competition
Commission of India. The Commission while regulating a 'combination' shall
consider the following factors :-
The other regulations are provided in the:- The Foreign Exchange Management Act,
1999 and the Income Tax Act,1961. Besides, the Securities and Exchange Board of
India (SEBI) has issued guidelines to regulate mergers and acquisitions. The SEBI
(Substantial Acquisition of Shares and Take-overs) Regulations,1997 and its
subsequent amendments aim at making the take-over process transparent, and also
protect the interests of minority shareholders.
Source:
http://www.deccanherald.com/content/39299/banking-sector-needs-consolidation.html
Prior to 1999, the amalgamation of banks was primarily triggered by the weak
financials of the bank being merged, whereas in the post-1999 period, there have also
been mergers between healthy banks driven by business and commercial
considerations. Thus, the new generation mergers on the lines proposed by the
Narasimham Committee are a recent phenomenon in the country.
Following are the existing strengths and weaknesses of the Indian banking system and
potential opportunities and threats if it undertakes consolidation by M&A as an avenue
of inorganic growth.
Strengths
Liquidity: Liquidity has been a traditional strength of the Indian banking system.
Banks are required to keep a stipulated proportion of their total demand and time
liabilities in the form of liquid assets which affect their liquidity position. RBI has been
easing the requirements with several roundsof reduction in the Statutory Liquidity
Ratio (SLR) and Cash Reserve Ratio (CRR).
Sound banking systems: The banking system in India has generally been stable and
sound in terms of growth, asset quality and profitability. It is because of healthy,
prudent and well capitalised policies and practices implemented by the RBI from time
to time. The same is evident from the remarkable resilience of the Indian financial
sector to the global financial turmoil which erupted during 2008-09.
Weaknesses
Competition from foreign banks: Foreign banks will be soon allowed to spread their
business in India which will create intense competition for Indian banks. The RBI
Report on Currency and Finance presents the view that mergers are the only way to
face competition from foreign banks. High cost of intermediation: Intermediation cost
(operating expenses as a proportion of total assets), an indicator of competitiveness, is
higher in India as compared to international levels. High level of fragmentation: There
is a high level of fragmentation, especially among cooperative banks, as compared to
some of the advanced economies of the world, which poses a serious threat to their
profitability and viability in conducting business. About 1,00,000 entities in the
cooperative sector share just 4 percent of the total banking assets in the economy.
Lack of product differentiation: The financial products offered by banks in India are
similar across the industry with no distinctive features, thereby leading to unhealthy
competition.
No competition at international level: Indian banks are not able to compete globally in
terms of fund mobilisation, credit disbursal, investment and rendering of financial
services. The main reason behind it is the size of the industry. State Bank of India (SBI),
is the world’s 57th largest bank in the list of the top 1,000 banks in the world carried in
the July 2009 issue of The Banker based on its tier-I capital, or equity and reserves, for
the fiscal year ended March 2008. Similarly, in terms of assets, SBI is now the world’s
70th largest bank. On the other hand, ICICI Bank Ltd, the largest private sector lender
has attained the 150th position. Based on assets, ICICI Bank’s world ranking is 148th.
None of the other Indian banks featured among the top 200 banks in the world-in terms
of tier-I capital. In 2008, there was only one Indian lender - SBI, at eighth place among
the top 25 Asian banks. Industrial and Commercial Bank of China, the biggest Asian
bank and the world’s eighth biggest bank, is four times bigger than SBI, both in terms
of tier-I capital as well as assets. Another recent study ‘Report on Currency and
Finance’ released by the RBI reveals that the combined assets of the five largest Indian
banks - SBI, ICICI Bank, Punjab National Bank, Canara Bank and Bank of Baroda are
just about half the asset size of the largest Chinese bank, Bank of China. The bank is 3.6
times larger than SBI in terms of assets, branches and profits.
Opportunities
Advanced technology: New generation private sector banks and foreign banks are
technologically more advanced in terms of management information systems, delivery
mechanisms, etc. These systems and processes require substantial investments which
may be possible after consolidation. Cutting-edge technology may lead to acceleration of
service delivery and broadening of customer relationships.
Basel norms: Basel II requires banks to meet tougher and higher capital adequacy
norms such as capital allocation towards operational risk, in addition to credit and
market risks. Many Indian banks, especially public sector banks, cooperative banks and
regional rural banks are unprepared for this implementation due to capital inadequacy.
According to the report, every category of bank has to arrange additional capital from
its own internal sources. To maintain the 51 per cent minimum government share, PSBs
cannot collect additional capital directly from the public and with this view it promotes
bank mergers. Consolidation may be a route for smaller banks to infuse funds to
strengthen their capital base.
Cost cutting: Many branches and ATMs of various banks are congregated in the same
areas leading to pointless outlay on premises, manpower and maintenance facilities.
Consolidation may lead to redeployment and rationalisation of such infrastructure,
human resources and other administrative facilities thereby undercutting the cost
factor. Consolidation will lead to cost efficiency which will enhance profitability.
Enhancement in risk absorption ability: The risk management capabilities of the banks
may improve. Larger size improves the risk bearing capacity of a bank and strengthens
its balance sheet. Biger organisations have inherent advantages and they are too big to
fail.
Enlarged customer base: The combined customer base may increase the volume of
business. The enhanced rural branch network may lead to increase in microfinance
activities and lending to the agriculture sector. M&A may be a far-sighted conclusion to
increase the market share. The time required to expand inorganically may be less than
that of an organic route.
Geographical spread: Banks can diversify the risk of concentrated lending through
mergers. They can also have a greater market access thereby widening the deposit base.
The RBI has imposed strict licensing norms for opening of new branches and hence via
consolidation, the acquirer will have access to ready physical infrastructure. Pan-India
presence of the combined entity may enhance convenience for the customers.
Improvement in operational efficiency: The operational efficiency of banks may
improve owing to bigger size. There may be increase in financial capability greater
resource/deposit mobilisation, output and better pricing of products.
Product diversification: Merger creates the opportunity to cross-sell products and
leverage alternative delivery channels. Old generation banks can merge with the new
generation private sector banks and foreign banks to diversify their credit profile. They
can sell technology-based innovative products.
Tax shields: In case of bailout mergers, the accumulated losses and unabsorbed
depreciation of the amalgamating bank can be carried forward and set off against the
future profits of the amalgamated bank.
Threats
Alignment of technology: The technology infrastructure, system platforms (Finnacle,
Flexcube, etc), network architecture, database vendors and IT-enabled synergies
(customer service, payroll, back office operations, risk management, etc) should be
compatible in banks desiring to merge. Most of the public sector banks are at different
stages of technology implementation. It would pose a stiff challenge to such merging
entities to integrate their technology and working platforms.
Assimilation of systems and processes: The cost of integrating diverse systems and
processes should be paid due attention. Bancassurance is one of the areas where
merging entities may face problems.
Customer dissatisfaction: The change in the nature and quality of financial products
may dissatisfy the customers, even if the products are better. In some cases customers
may be deterred by the acquiring company for various reasons which may affect brand
loyalty of the combined entity.
Integration of people: The acquirer bank may have to absorb the entire workforce of
the target bank which may push up the wage cost. It also requires the integration of the
heterogeneous work cultures. The views of the employees towards various aspects of the
new organisation, management styles, training, leadership, etc are to be considered in a
critical manner. The varied aspects of the work environment, if not handled properly,
may lead to resentment and shrinkage in productivity.
Marginalisation of small customers: Larger entities may neglect small customers and
concentrate on affluent customers or High Networth Individuals (HNIs).
Regulatory hurdles: Some of the legal barriers need to be removed to make PSBs, which
still control about 68 per cent of the Indian banking sector, active participants in the
consolidation process. It will help realise the true benefits of consolidation. These
hurdles include bringing down the government ownership from the statutory 51 per
cent and amending certain clauses in acts governing these banks to facilitate their
merger. On the cooperative banking side too, issues of dual control should be resolved
to facilitate a smoother consolidation exercise.
source: http://www.pravinthorat.com/merger-acquisition-2
Types of acquisition
Share purchases – in a share purchase the buyer buys the shares of the target company from
the shareholders of the target company. The buyer will take on the company with all its assets
and liabilities.
Asset purchases – in an asset purchase the buyer buys the assets of the target company from
the target company. In simplest form this leaves the target company as an empty shell, and
the cash it receives from the acquisition is then paid back to its shareholders by dividend or
through liquidation. However, one of the advantages of an asset purchase for the buyer is that
it can “cherry-pick” the assets that it wants and leave the assets – and liabilities – that it does
not. This leaves the target in a different position after the purchase, but liquidation is
nevertheless usually the end result.