CONSOLIDATION THROUGH M&A

The volatility of the business environment has altered the ways and means by which transactions
are carried out. The objective of the business firms in the new environment is to take measures
which would result in high levels of sustained profitability. The growth process can be facilitated
through various forms of corporate combinations such as absorptions, acquisitions,
amalgamations, de-mergers, divestures, joint ventures, leveraged buyouts, mergers, selloffs,
spinoffs, strategic alliances, takeovers, and so on.

The banking industry in India has been in the process of transformation and consolidation ever
since 1961. The Banking Regulation Act, 1949 empowers the regulator with the approval of the
government to amalgamate weak banks with stronger ones. Majority of the mergers in India have
been crafted to bail out weak banks to safeguard depositors’ interest and to protect the financial
system.1
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

The Indian Banks too did not stay aloof from this wave of mergers and acquisitions (M&A).
Initially banks were merged to save non-performing banks or non-efficient banks but as time
evolved the system too evolved. In the recent times mergers and acquisitions have also been
made on grounds of business growth, profitability and organizational restructure.

1
The report of the Committee on Banking Sector Reforms (the Second Narasimham Committee - 1998), however,
discouraged this practice. It recommended a multi-tier banking system with existing banks to merge into 3-4
international banks at the topmost level, 8-10 national banks engaged in universal banking at the next level and local
and rural banks confined to specific regions. 37 http://www.deccanherald.com/content/39299/banking-sector-needs-
consolidation.html.

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  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. In the global market, the Indian banks will gain greater
recognition and higher rating
 Increase Penetration: There is an uneven distribution of banking services in the country.
It is limited to few customer segments and geographies only. Of the total 611 districts in
the country, 375 districts are under-banked. There is a need for banks to open branches at
these locations and establish connectivity with the help of a core banking solution. The
objectives of financial inclusion and broadening the geographical reach of banking can be
achieved better with the merger of large public sector banks and leveraging on their
expertise. The merger will also help the geographically concentrated regionally present
banks to expand their coverage.
 Progress: One of them is that large banks will be able to lend more money and help
revive the slowing economy. The government also believes that increased credit growth
is essential in order to achieve its target of growing India into a $5-trillion economy in the
next few years. It is also of the view that the merger will lead to increased operational
efficiency that will help these banks lower their costs, thus enabling them to lower their
lending rates. Merger will compensate for the deterioration in the financials of the
stronger banks.
 Proper Growth Environment: For a bank that has the capacity to grow in terms of its
intrinsic comparative advantage but is constrained due to the problems of inter-regional
penetration, merger with a similar bank (in terms of comparative advantage and portfolio)
will provide an avenue to grow optimally. Similarly, a bank of the size and experience of
SBI can aspire to become a universal bank by acquiring smaller banks with lucrative
retail and wholesale portfolio and through strategic alliances with investment banks,
insurance companies and asset management firms.2
 Reduction of Responsibility: Indian PSBs have long been burdened with the
responsibility of development banking through mobilizing deposits at the countryside and

2
Indrajit Mullick, Does the Future of Indian Banking Lie in M&A?, Centre for Studies in Social sciences,
Electronic copy available at: http://ssrn.com/abstract=1403103 (Oct 12, 2017)

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 providing finance to agriculture and small scale industries at subsidized rates. It is time to
marry the social responsibility of these banks with proper commercial orientation so that
they can survive and prosper in an environment of high growth, competition and risks.
For some PSBs today, this implies the need for mergers.

 Liquidity: A larger bank can manage its short and long term liquidity better. There will
not be any need for overnight borrowings in call money market and from RBI under
Liquidity Adjustment Facility (LAF) and Marginal Standing Facility (MSF)
 Identity Upgradation: for the bank, retaining and enhancing its identity as a larger bank
becomes easier. After the merger, benefits of merger are enormous and the biggest is
generation of a brand new customer base, empowering of business, increased hold in the
market share, opportunity of technology upgrade. Thus overall it proves to be beneficial
to the overall Economy.

Mergers are important for the consolidation and expansion purposes that is why in today’s
scenario many private sector banks are genuinely interested in mergers and acquisition. They are
also crucial for Economy as they are most of the times successful in saving weak banks which
fail in meeting expectations. As per studies conducted until now most of the mergers done in the
past, have proved to be an overall success for the weaker banks although there are no concrete
parameters to verify this observation. Hence going by the track record merger and acquisition in
Indian banking have been fruitful for the Indian Economy.3

ISSUES AND CHALLENGES

One of the prime factors behind the extensive regulatory framework for consolidation in banking
sector was the financial inclusion through ‘social control’, which was aimed to benefit the
consumers to increased extents.4 Today, various serious questions have been raised regarding
consolidation of banking companies being expressly regulated by RBI and probable answers are
being sought to the question.5 While such observations dominate, some argue that consolidation
of banking system is inevitable in order to establish some world size banks, on the lines of

3
https://www.mbauniverse.com/group-discussion/topic/business-economy/banks-merger-in-india
4
Rana Kapoor, MD & CEO, Yes Bank, http://articles.economictimes.indiatimes.com/2011-08-
5
Pradeep S Mehta, CUTS International, Should Banking M&As come under CCI?,
http://www.business-standard.com/india/news/should-banking-mas-come-undercci/489040/

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China.6 This is a paradox. Some authors establish that consolidation of a weak bank with another
strong bank was a way to rescue the dying banks that may lead to economic crises and as such
banks were prohibited to carry out ancillary activities besides core-banking activities. 7 In such a
scenario, unregulated or over-regulated consolidation among the banking companies may lead to
market control by few thereby behaving in an anti-competitive manner. 8 There are however,
many other internal and external factors besides such inevitable needs; social control etc. that
regulate or govern the mergers of banks in India.9

If we cross-check the propelling reasons behind the consolidation of banks in India, we see that it
is a government set mood. Though such consolidations were suggested earlier by Narsimhan
Committee Report-I, RBI is against exposing the Indian Banking Sector to compete in the
international forum. ‘Merger’ as envisaged, for banking companies was essentially a rescue
clause and for that prime reason, amalgamations were put in the strict control of RBI. However,
much complex issues such as competition, stake-holder interests etc. require a deep insight as
RBI is concerned with depositors’ interests only. It is in that ‘likely default’ situation that RBI
triggers compulsory merger to protect the interests of the depositors in a bank. In a complex
scheme devised by either the parties themselves or the regulator, some crucial issues that suffer
an impact on the implementation of M&A deal are reflected herewith:

 COMPLEX AND STATIC PROCEDURE: The growing complexities of the banking

business coupled with significant cross border and cross-sector expansion has rendered
the system increasingly vulnerable to the threat of ‘contagion’. The paradigm shifts in the
banks’ business processes, products and systems with an ever-growing reliance on ICT,
as delivery channels pose immense challenges before the banking supervisor. While on
the one hand, the banking landscape has witnessed considerable changes, the supervisory
processes within the Reserve Bank have remained more or less static. This has
necessitated a review of the supervisory processes and rationalization of the
6
P.Chidambaram, Finance Minister of India, Consolidation of Banks is Inevitable: FM,
<http://www.thehindu.com/business/Industry/consolidation-of-banks-inevitable-
fm/article4130642.ece> (Oct. 11, 2017)
7
Glass-Steagall Act, 1933 in USA
8
T.T. Ram Mohan, (Indian Institute of Management, Ahmedabad), Bank Consolidation- Issues and
Challenges, Economic & Political Weekly, Vol. 40, No. 12, Money, Banking and Finance (Mar. 19-25,
2005), pp. 1151-1152, 1155-1161
9
Prof. B. Radhakrishnan & Swati Pradhan, Consolidation in Indian Banking Industry, Sep 2008,
http://www.bcasonline.org/articles/artin.asp?800 (Last accessed on Oct. 11, 2017)

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 organizational structure for bank supervision. Additionally, lessons from the financial
crisis which have manifested in form of new regulatory and supervisory benchmarks like
Basel III, revisions to the Core Principles for Effective Bank Supervision, increased focus
on systemically important banks also have to be factored in for making the supervisory
processes and mechanism at the Reserve Bank more robust and capable of addressing
emerging issues.10 In such a perspective, mergers should not be forced, for that would
lead to overregulation and not supervision.11

 SHAREHOLDER RESPONSES TO M&A DEALS: In one of the studies, it was

revealed that shareholders were not supportive to such M&A deals in public sector banks
initially, but post-merger status of banks has brought in additional wealth to them. 12
However, some commentators argue that it need not necessarily be profitable to the
shareholder in all situations, while the combine effect is positive for the target banks and
negative for the bidder banks.13 However, some studies show that in cases of forced
merger by RBI, shareholders of the target banks have gained abnormal returns and the
shareholders of bidder banks lose their value of equity in the stock-market. 32 In such an
arrangement, shareholders of acquired bank get much benefited than those of the acquirer
bank. It seems as if equality amongst shareholders loses its significance or remains un-
noticed. It would not be proper to depict any of the above situations as fruitful and it
could not be thus said that a proposal of acquisition is always welcomed by the
shareholders of the target bank.

 UNCERTAINITY: The considerable mix between banks doesn’t clear the fate of
business. This becomes a perpetual question, when the deal is carried amongst two banks

10
Indian Banking Sector: Towards the Next Orbit, Inaugural address delivered by Dr K. C. Chakrabarty,
Deputy Governor, Reserve Bank of India at 9th Advanced Management Programme at IMI, Delhi on Feb
13, 2012
11
Excerpts from speech of Dr C. Rangarajan, Chairman of the Economic Advisory Council and former
Governor, RBI at Global Banking Conference, 12th Sept 2007
12
S. Venkatasan, K. Govindarajan, Acquisition Activities of Public Sector Banks in India and its
Impact on Shareholders’ Wealth, International Research Journal of Finance & Economics, ISSN 14502887,
Issue 67, 2011, pp. 64-71
13
Dr. Suresh Chandra, Are Mergers & Acquisitions Beneficial for Banks?, South Asian Journal of
Marketing & Management Research, Vol. 2 , Issue 1, January 2012 32 M Jayadev, Mergers in Indian
Banking: An Analysis, IIM Bangalore.

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 that differ in their characteristics viz. a public sector bank and a private sector or a
cooperative bank.
The recent move to merge Union Bank of India & Bank of India 14 depict that
societal/organizations/other co-operative societies also play a significant role in merger of
banks. The management teams of Union Bank of India & Corporation Bank also refuted
the government’s proposal to merge the two banks.15
 IMPROPER MANAGEMENT: The merging of healthy banks with weak banks may
not really improve the health of the banking system as a whole. In fact, by diluting the
management of strong banks, forced mergers may lead to a significant deterioration in the
overall health of the banking system. This can further negatively affect the long-term
performance of state-owned banks.16
 STRUCTURAL PROBLEMS: The merger of banks per se will not lead to a decrease in
the absolute size of bad loans in their books. The size of bad loans in bank books can
drop only if banks manage to improve the recovery of these loans, or if these loans are
written off their balance sheets. The bad loan recovery process remains slow due to the
inefficient judicial system in the country and banks have been unwilling to aggressively
write off bad loans since that would require recognizing greater losses. Mergers do not
address these serious structural problems.
 The merger also does not address the issue of political interference in the management of
state-owned banks that is at the root of the bad loan crisis.
 NON-COMPLIANCE: Compliance needed in every decision which might not be
favorable as thinking perspectives and risk taking abilities of different organizations are
different. It leads to friction and rift which, if not managed well may lead to the downfall
of the organization as a whole.

14
See, Officers of UBI and BOI refute Merger Scheme,
http://www.businessstandard.com/india/news/boi-ubi-merger-buzz-rankles-unions/196364/
(Accessed on Oct 12, 2017)
15
See, http://www.contify.com/stories/6233 (UBI & Corporation Bank Merger)
16
https://www.thehindu.com/business/Industry/how-will-mergers-affect-public-
banks/article29363041.ece

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 INCONSISTENSY: Banks are merged only on papers without taking their people or
culture into account. Their people and culture are difficult to change. It is a recipe for
disaster as it leads to poor culture fit not ideal for the organization or the economy.

 RISK FAILURE: Risk of failure increases if the executives are not committed enough in
bringing the merger platforms together for the merging and taking over bank. Such
failure may prove brutal for the Economy.

 INTEREST OF CONSUMERS: While undergoing an M&A event at bank, it’s critical

that one pay attention to the impact it has on your customers. Customers often respond
very emotionally to a bank acquisition, so it’s essential to manage customer perception
with regular, careful communication and once the merger or acquisition is fully
underway, remember to consider the impact on the customers at every stage. Anything
from changing technology platforms to financial products could impact your customers
negatively if attention is not given.

 OPERATIONAL ISSUE: The individual balance sheet position of the banks is yet
another crucial matter. This assumes greater seriousness when one of the banks is being
taken over due to its weak financial position. Differences in the quality of loan portfolios,
mix that is one bank having a greater percentage of corporate accounts and the other a
high level of retail portfolio, the levels of non-performing assets and stressed accounts,
the composition of deposits (time and demand), the Credit-Deposit ratios, the investment
strategies adopted and the types of investments on the balance sheet either statutory or
otherwise, the Capital Adequacy ratios, matters relating to Asset Liability Management
(area of maturities and interest rates mismatches) ,all these demand a high degree of
attention and analysis.
 COMPETITION LAW ISSUES: Competition Act covers all sectors including banking
and other financial sector activities. CCI is competent to inquire into agreement such as
horizontal agreements and vertical agreements among banks, abuse of dominant position
and combination and regulations of combinations between banks above the prescribed
threshold limits set by the central government. Being the regulator RBI may make
reference to CCI for opinion in any issue suspected to have competition angle, including

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 agreements. CCI has a suo moto power to inquire into such anti-competitive practices.
Issues involved are Multi-market contacts that is banks that compete in many markets
recognize the need to co-exist rather than compete. Barriers to entry means contestable
markets are highly competitive. However, entry restrictions exist in the form of
Regulatory barriers that is minimum capital requirements, restraints on lines of business,
licensing of branches or subsidiaries, restrictions on entry of foreign banks etc. Exit
barriers are in the form of preventive measures for bank insolvencies. Scope and branch
networks is limited as banks market access depends on the network of branches it has and
its nation or worldwide presence.

Merger creates variety of problems which can cause great damage if the process of merging is
not executed properly. If merging is needed it must be executed in a manner which leads to an
environment of trust and agreement among the people of both the organizations. If people, work
culture and vision are blended together nicely, merging will definitely have synergic effects and
create a win-win situation.