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In the recent times, there have been numerous reports in the

media on the Indian Banking Industr y Repor ts have been on a


variety of topics. The topics have been ranging from issues such
as user friendliness of Indian banks, preparedness of banks to
meet the fast approaching Basel II deadline, increasing foray of
Indian banks in the overseas markets targeting inorganic growth.
Repor ts from the western markets of increased M&A activity have
also aroused a deep sense of keenness in the authors to compare
the various aspects of M&A in the Banking sector in India and the
international arena.

M e r g e r is defined as the combination of two relatively


comparable organizations into one.

T YPES OF MERGER

 ‘H o r i z o n t a l ’ : between enterprises in the same product


market and at the same level of the production or
distribution cycle.

 ‘V e r t i c a l ’: between enterprises that operate at dif ferent


levels of the production or distribution cycle.

 ‘C o n g l o m e r a t e ’: between enterprises operating in


dif ferent markets.
 F o r w a r d – Merger of target into the acquirer
 R e v e r s e – Merger of acquirer into the target
 Tr i a n g u l a r – U s e o f a n S P V f o r u n d e r t a k i n g F o r w a r d o r
Reverse merger
 D e m e r g e r – Hive-of f of an undertaking into a separate
company

A c q u i s i t i o n is the take-over of a smaller company by a larger


one. Whilst in both cases the two companies merge voluntarily on
the basis of a contract, there are also cases of so-called hostile
t a k e o v e r, i n w h i c h t h e m e r g e r t a k e s p l a c e s o t h a t t h e l a r g e r
company acquires a controlling interest in a weaker bank or
other wise wins over the bank’s majority shareholders against the
will of the management. While the legal personality of the
o r i g i n a l e n t i t i e s u s u a l l y e n d s i n a m e r g e r, i t i s u s u a l l y
maintained in the case of an acquisition.

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Multiple reasons force us to believe that M&A in the Indian
Banking Sector is an imperative. We list them down below:

Stability:

Fr a g m e n t a t i o n p o s e s i n c r e a s i n g r i s k i n t h e I n d i a n B a n k i n g
S e c t o r. D u r i n g t h e f i n a n c i a l p e r i o d 2 0 01 - 2 0 0 5 , o n l y f o u r b a n k s
have been able to cross the market capitalization of Rs. 50
billion included Bank of Baroda, HDFC Bank, ICICI Bank, and
State Bank of India. Considerable fragmentation exists in the
Banking sector for banks with market capitalization of less than
Rs. 50 billion. Moreover the created value is moving away from
the top 5 banks thus indicating fragmentation indeed has
increased over the period of last five years. Shown below are the
deposit shares of the Banks operating in India over the period
2000-2004. Data was drawn from around 45 banks which
included state-controlled public sector banks, private sector
banks and even foreign banks operating in India. It is obser ved
that the share of the top 5 players has eroded and been
consumed by the next fif teen players. Considering that the base
of total deposits has been consistently increasing, consequently
the value in deposits gained by the next 15 banks has been
tremendous (see table below).

Ye a r 2 0 0 0 2 0 0 4
Similar trends are obser ved in profit af ter tax, borrowings and
interest and non interest incomes of the banks, thereby hinting
at increased levels of fragmentation in the top 20 banks. Though
this could be the sign of a competitive bank market with healthy
banks remaining in the market the goal of globally competent
banks would be missed. In other words, while a fragmented
Indian banking structure may ver y well be beneficial to the
customers (given increased competition due to lower market
power of existing players), at the same time this also creates the
problem of no player having the critical mass to play the game at
the global banking industr y level. This has to be looked at
significantly from the state’s long- term strategic per spective.

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Fu r t h e r m o r e , i t i s o b s e r v e d t h a t i n a n i n c r e a s i n g c o m p e t i t i v e
arena the smaller fragmented banks with no economies of scale,
low capabilities to manage risks and poor market power at times
end up taking excessive risks resulting in irreparable loss to their
depositors. This also results in af fecting the state and its
r e g u l a t o r ’ s i . e . , c e n t r a l b a n k n e g a t i v e l y. Ta k e t h e f o l l o w i n g c a s e s
of trouble in the recent past:

a . G l o b a l Tr u s t B a n k : S i g n i f i c a n t e x p o s u r e t o h i g h r i s k m i d s i z e
corporates and an excessive exposure to capital market
operations.

b. Madhavpura Mercantile Co-operative Bank: Nineteen customers


had unsecured loans of
more than Rs. 10 billion
.
c . S o u t h I n d i a n C o - o p e r a t i v e B a n k : N o n P e r f o r m i n g A s s e t s ( N PA s )
from excessive lending to
small group of clients

d. Nedungadi Bank: This bank based in Southern part of India


had significant exposure to
plantation industr y and had weak credit risk management
systems and processes.

Fu r t h e r r e c e n t c a s e s ( i n 2 0 0 5 - 0 6 ) o f t w o b a n k s i n I n d i a n a m e l y
United Western Bank and Sangli Bank became attractive targets
for acquisition by private sector banks because of their risk
profile. The merger with these larger banks is expected to
i m p r o v e t h e a s s e t p r o f i l e , N PA m a n a g e m e n t a n d p r o t e c t t h e
depositors at the same time of fer the acquiring private sector
banks further reach in terms of branches and customer base.

How Would Consolidation Help Indian Banks?

A bigger player can af ford to invest in requisite technology


and play globally to take advantage of global oppor tunities

Because for going global a bank needs to upgrade its


t e c h n o l o g y, M I S , “ s y s t e m s & p r o c e s s e s ” a n d s t r a t e g i e s , .
t o c o m p e t e e f f e c t i v e l y a n d “ M & A” c o u l d f a c i l i t a t e t h i s .

The confidence of international investors in Indian banks


has increased manifold in recent times and this offers our
banking sector a good opportunity to restructure itself

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A small analysis of per formance of the bank sector and the
equity market benchmark index in India and USA showed the
following results:

India United States of America (USA)


The above table clearly indicates that the banking portfolio in US
is as risky as the composite portfolio which is not the case in
India. Though the returns are more in India the risk is also higher
as shown by the standard deviation. A report as early as August
1 9 91 r e c o g n i z e d t h e t r e n d i n s h a r e h o l d e r r e t u r n s i n t h e U S a n d
hence was one of the reasons for the bank M&A wave in the USA
Benefits to the customers:

Benefits to customers can be seen in a number of ways. One such


way being lowering in the intermediation costs. A 10 year trend
i n t h e i n t e r m e d i a t i o n c o s t s a s a p e r c e n t a g e o f To t a l a s s e t s i n
Indian Banks shows that the Indian private sector banks have the
least intermediation costs as a percentage of total assets (see
graph below). During this time frame, a significant decreasing
trend can also be obser ved in the Private Sector banks of India in
the decade. Being non fragmented they could claim greater
ef ficiency and hence lower intermediation costs.

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Adhering to the International CAR norms and Supporting
Regulator y Framework:

Supporting institutional and regulator y framework in India is


vital for domestic banks aspiring for global operations. The
Central Bank i.e., the Reser ve Bank of India (RBI) has suitably
c hanged the countr y’s regulator y framework from time to time to
support Indian financial institutions to withstand the competitive
pressures placed on them by increasing globalization. Proper
steps have been taken to guide the banking sector to see that the
banks pass through this transition phase by and large
s u c c e s s f u l l y. W i t h t h e R B I r e g u l a t i n g t h e C a p i t a l t o R i s k -
Weighted Asset Ratio (CRAR) at 9%, a percent above the Basel II
CRAR, going for ward many banks would not be able to meet these
requirements and may have to go through restructuring in order
t o m e e t t h e r e g u l a t o r y r e q u i r e m e n t s . Fu r t h e r m o r e t h e r e a r e a
number of banks in India whose growth is restricted due to
unavailability of capital. These banks have a significant
depositor base but the market perception does not enable them
to raise further funds. Hence such banks also become potential
targets of acquisition.

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Average Capital Adequacy Ratio of Banks in India

The reforms initiated in the banking sector have now reached a


crucial stage. Government’s stake in many Public Sector Banks
(PSBs) has gone down and as a consequence other shareholders
equity ownership in these PSBs has gone up. This leads to
greater responsibility on the bank managements since the level
of accountability has increased. Pressures of performance and
profitability will keep the PSBs on their toes all the time as the
public shareholders expect good financial performance along
w i t h g o o d r e t u r n s o n t h e i r e q u i t y. M a n y P S B s h a v e a l r e a d y
star ted the exercise of cleaning up of their balance sheets by
s h e d d i n g t h e e x c e s s b a g g a g e . T h e Vo l u n t a r y R e t i r e m e n t S c h e m e
(VRS) in the recent past in some of the banks was aimed not only
at downsizing the manpower but also at cutting down the future
staf f costs and increasing the per formance levels of the staf f in
the long run. Some of these PSB banks are able to run the show
to a cer tain extent by low cost funds that are available thanks to
the branch network spread over the length and breadth of the
c o u n t r y. M & A a c t i v i t y w i l l f u r t h e r b o o s t t h i s p r o c e s s f o r m a n y
other banks that cannot go through this exercise individually and
need larger par tners to execute them in terms of processes and
resources.

Managing Bankruptcy Risks

Recent studies have established that if merger and acquisitions


in banks if allowed in a controlled manner would significantly
r e d u c e t h e b a n k r u p t c y r i s k o f t h e m e r g e d e n t i t y. O b v i o u s l y,
mergers would also provide these benefits to banks in India
reducing their bankruptcy concerns.

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Bottom Line Growth:

Mergers and Acquisitions or Restructuring may also help banks


improve in three other areas as listed below:

1. E c o n o m i e s of Scale: An acquirer would have the


capabilities to improve the collections, ser vice processes,
distribution, infrastructure and IT of the target bank

2. E c o n o m i e s o f S c o p e : An ability to grow products and


segments and an opportunity to cross sell would enhance
revenue. This could also result in more geographic growth could
also be
obtained.

3 . S y n e r g y B e n e f i t s : Tr e a s u r y p e r f o r m a n c e w o u l d b e i m p r o v e d
as the cost of funds would reduce (hence, improve spread) as it
would have a better credit rating. A bank would also be able to
leverage scale and improve its trading income.

Tw o p r i m e r e a s o n s f o r c e u s t o b e l i e v e t h a t M & A i n t h e I n d i a n
B a n k i n g S e c t o r i s a n o p p o r t u n i t y.

Creation of a Financial Super Market or a Universal


Bank:

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A recent trend is to promote the concept of a financial super
market chain, making available all types of credit and non-fund
facilities under one roof under one umbrella organization (or
through specialized subsidiaries).
An example of such a financial supermarket would be the reverse
merger of ICICI and ICICI Bank . ICICI Bank today stands as
India’s second largest bank of fering its clients both in India and
overseas a product range as varied us retail banking products to
e x o t i c i n v e s t m e n t b a n k i n g a n d t r e a s u r y s o l u t i o n s . S i m i l a r l y, I D B I
and IDBI Bank treaded the same route. Though one has to state
that consolidated accounting and super visor y techniques would
have to evolve and appropriate fire walls built to address the
risks underlying such large organizations and banking
conglomerates.

Tec h n ol og ic a l Ex p e r t is e:

New entrants in the banking sector are armed with technological


exper tise while older players are well equipped with experience
in practices. Mergers would thus help both parties gain an
exper tise in areas in which they lack . In India, the retail banking
market biased towards the urban markets is growing at a
C o m p o u n d e d A n n u a l G r o w t h R a t e ( C AG R ) o f a l m o s t 1 8 - 2 0 % w h i l e
the rural market is yet to be fully tapped. Keeping in focus the
population profile, technology would be a major enabler for
banking in the future. A number of state owned banks in India
are adopting sophisticated core banking solutions and these are
just the larger ones. For smaller banks to adopt technology
platforms the expenditure may not be sustainable and hence this
may be one more reason for M&A . Growing integration of
economies and the markets around the world is making global
b a n k i n g a r e a l i t y. T h e s u r g e i n g l o b a l i z a t i o n o f f i n a n c e h a s a l s o
gained momentum with the technological advancements which
have ef fectively overcome the national borders in the financial
ser vices business. Widespread use of internet banking, mobile
banking, and other modern technologies (such as SWIFT) has
widened frontiers of global banking, and it is now possible to
market financial products and services on a global basis.
In the coming years globalization would spread fur ther on
account of the likely opening up of financial ser vices under W TO.
India is one of the signatories of Financial Ser vices A greement
( F S A ) o f 1 9 97. T h i s g i v e s I n d i a ’ s f i n a n c i a l s e c t o r i n c l u d i n g b a n k s
an opportunity to expand their business on a quid pro quo basis.
An easy way for this is thus to go through adequate
reconstruction to acquire the necessar y technology and get an
early mover advantage in globalizing the Indian Banks.

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Cross Border M&A in Banks

One more reason for M&A which has sprung up in the recent
years is Indian Banks seeking international presence. In the last
two decades, there has been a jump in the Indian diaspora
working abroad. A new recent trend is the increase in the interest
of foreign expats to work in India. Both these communities seek
banking products in remittances and other cross border retail
p r o d u c t s . Fu r t h e r f i r m s a r e l o o k i n g f o r f u n d s o v e r s e a s f o r v a r i o u s
purposes ranging from capital expenditure to leveraged M&A
financing. Hence, Indian banks are setting up branches and
subsidiaries overseas and foreign banks are expanding their
operations in India. These bank branches (set up abroad) further
target the local population to be profitable and hence target
l o c a l a c q u i s i t i o n s . E v i d e n t l y, t h i s r e s u l t s i n a n M & A o p p o r t u n i t y
for Foreign Banks to acquire an Indian Bank and also Indian
Banks to acquire foreign banks. For example, ICICI Bank has
made an acquisition of a bank in Europe in 2006 to establish
itself in a geographical area.

The Indian M&A environment is a strongly regulated by the


following major pieces of legislation/bodies:

− The Companies Act, 1956


− The Ta k e o v e r s C o d e , 1 9 97
− The M o n o p o l i e s a n d R e s t r i c t i v e Tr a d e P r a c t i c e s
Act, 1969

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− The Foreign Exchange Management Act, 1999
− The Foreign Investment Promotion Board (FIPB)
− The Reser ve Bank of India
− The I n c o m e Ta x A c t , 1 9 61

• Mergers, amalgamations, de-mergers, acquisitions of


business units or divisions, are all governed by The
Companies Act for all registered companies

• Acquisition of shares in listed Indian companies is
g o v e r n e d b y T h e Ta k e o v e r C o d e , 1 9 97.

M E R G E R O F S TAT E B A N K O F I N D I A A N D S TAT E B A N K
OF SAURASHTRA
SBS is the smallest of the seven associates. The other associates
a r e S t a t e B a n k o f Tr a v a n c o r e , S t a t e B a n k o f M y s o r e , S t a t e B a n k
o f B i k a n e r a n d J a i p u r, S t a t e B a n k o f H y d e r a b a d , S t a t e B a n k o f
Indore and State Bank of Patiala.

SBS has 460 branches and the merger would help eliminate
duplication of branches in the same area. Its net profit rose 45
p e r c e n t t o R s 8 7. 4 c r o r e i n 2 0 0 6 - 07. T h e b a n k h a s p a i d - u p e q u i t y

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c a p i t a l o f R s 31 4 c r o r e . T h e t o t a l d e p o s i t s s t o o d a t R s 1 5 , 8 0 4
crore while total advances were at Rs 11 ,081 crore.

The merger would help SBI consolidate its position as the


countr y's biggest bank and widen the gap with nearest rival ICICI
B a n k . W i t h 9 , 57 9 b r a n c h e s , S B I h a s t o t a l a s s e t s o f R s 5 , 6 6 , 5 6 5
c r o r e a n d p o s t e d a n e t p r o f i t o f R s 4 , 5 41 c r o r e a s o n M a r c h 31 ,
2 0 07. I C I C I B a n k h a d a s s e t s o f R s 3 , 4 4 , 6 5 8 c r o r e a n d p o s t e d a
net profit of Rs 3,110 crore in 2 0 0 6 - 07.

The merger comes at time when the bank has decided to go in for
big expansion. The bank is also looking at freeing up capital by
setting up a holding company for its life insurance and asset
management businesses. SBI’s move to merge its arms could
p a v e t h e w a y f o r f u r t h e r c o n s o l i d a t i o n i n t h e i n d u s t r y, w h i c h
faces imminent competition from foreign banks from 2009.

Merger of State Bank of Saurashtra with SBI would enable it to


up-scale in terms of footprint, manpower and other resources. It
would also enable it to face competition arising from
g l o b a l i z a t i o n o f t h e e c o n o m y, a p a r t f r o m a u g m e n t i n g e f f i c i e n c y
and enabling better management of risk. State Bank of
Saurashtra is the smallest of its associate banks and operates in
regions where SBI does not have a large presence.

Buyer

Wells Fargo & Company is a financial holding company and a


b a n k h o l d i n g c o m p a n y. I t i s a d i v e r s i f i e d f i n a n c i a l s e r v i c e s
c o m p a n y. I t p r o v i d e s r e t a i l , c o m m e r c i a l a n d c o r p o r a t e b a n k i n g
ser vices through banking stores located in 23 states: Alaska,
Arizona, California, Colorado, Idaho, Illinois, Indiana, Iowa,
Michigan, Minnesota, Montana, Nebraska, Nevada, New Mexico,
N o r t h D a k o t a , O h i o , O r e g o n , S o u t h D a k o t a , Te x a s , U t a h ,
Washington, Wisconsin and Wyoming. It provides other financial
ser vices through subsidiaries engaged in various businesses,
principally wholesale banking, mortgage banking, consumer
finance, equipment leasing, agricultural finance, commercial

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finance, securities brokerage and investment banking, insurance
agency and brokerage ser vices, computer and data processing
ser vices, trust ser vices, investment advisor y ser vices and venture
capital investment. It operates in three segments: Community
Banking, Wholesale Banking and Wells Fargo Financial.

Ta r g e t

Wac hovia Corporation (Wac hovia) is a financial holding company


a n d a b a n k h o l d i n g c o m p a n y. I t p r o v i d e s c o m m e r c i a l a n d r e t a i l
banking, and trust services through fullservice banking offices in
Alabama, Arizona, California, Colorado, Connecticut, Delaware,
Florida, Georgia, Illinois, Kansas, Mar yland, Mississippi, Nevada,
N e w J e r s e y, N e w Yo r k , N o r t h C a r o l i n a , P e n n s y l v a n i a , S o u t h
C a r o l i n a , Te n n e s s e e , Te x a s , V i r g i n i a a n d Wa s h i n g t o n , D . C . I t a l s o
provides various other financial ser vices, including mor tgage
b a n k i n g , i n v e s t m e n t b a n k i n g , i n v e s t m e n t a d v i s o r y, h o m e e q u i t y
lending, asset-based lending, leasing, insurance, international
and securities brokerage ser vices, through other subsidiaries.
The Company?s retail securities brokerage business is conducted
through Wac hovia Securities, LLC, and operates in 49 states. In
O c t o b e r 2 0 07 , W a c h o v i a c o m p l e t e d t h e a c q u i s i t i o n o f A . G .
E d w a r d s , I n c . I n F e b r u a r y 2 0 07 , t h e C o m p a n y a c q u i r e d a m a j o r i t y
interest in European Credit
Management Ltd.

Wells Fargo to buy Wachovia for $15.1bn

Wells fargo & co the biggest US bank on the west coast, agreed
to buy of Wac hov ia corp for about $1 5.1 bn in stoc k , trumping
C i t i g r o u p ’ s o f f e r f o r e m b a t t l e d N o r t h C a r o l i n a l e n d e r.

T h i s d e a l w o u l d b e e x e c u t e d e n t i r e l y b y We l l s Fa r g o w i t h o u t h e l p
of US unlike citigroup’s of fer which relied on financial backing
from the Federal Deposit Insurance Corp.

R AT E O F R E T U R N

W e l l Fa r g o s a i d i t w i l l a c q u i r e a l l o f Wa c h o v i a ’ s b u s i n e s s e s
preferred equity and banking deposits. Bank claimed that the
acquisition will add to earnings per share by the third year af ter
completion and should produce internal rate of return of at least
15 %.

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Buying Wac hov ia is a detour from the strategy was outlined by
W e l l s F a r g o . A f t e r a c q u i r i n g W a c h o v i a W e l l s Fa r g o w o u l d h a v e
$ 1 . 4 2 t r i l l i o n i n a s s e t s , $ 7 8 7 b i l l i o n i n d e p o s i t s a n d 1 076 1
branches.

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