Mergers ; Acquisitions: Indian Banking Scenario Essay

The Indian financial system would be open to intense international competition with complete implementation of the provisions of WTO agreement on services (GATS) during the year 2005-06 when banks will be required to compete across the globe with multinational banks having greater financial strengths. The banks will also be required to strengthen their capital position to meet stringent prudential capital adequacy norms under Basel-II (beginning 2006-07). In the backdrop of growing openness of Indian financial system, there is growing interest in mergers and acquisition with focus on size of the banking organisation.

It is inevitable that banks in India, particularly the public sector banks, could no longer afford to operate as a monolith and the Central govt. has already indicated that the banks have to consolidate, not just to create behemoths, but to create synergies. In the past, the mergers were initiated by regulator (RBI) to protect the interest of depositors of weak banks but the market led mergers have been gaining momentum in the present day context and these cannot be seen as a means of bailing out weak banks any more. Mergers between strong banks/FIs make greater economic and commercial sense and have a “ force multiplier effect”.

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Focus of mergers: The growing tendency towards mergers in banks world-wide, has been driven by intensifying competition, need to reduce costs, need for global size, take benefit of economies of scale, investment in technology for technology gains, desire to expand business into new areas and need for improvement in shareholder value. The underlying strategy for mergers, as it is presently being thought to be, is, ‘larger the bank, higher its competitiveness and better prospects of survival’. Due to smaller size, the Indian banks may find it very difficult to compete with international banks in various facets of banking and financial services.

Hence, one of the strategies to face the intense competition could be, to consolidate through the process of mergers. Recent scenario of mergers in India : In India, the mergers in 60s had taken place under the direction of RBI and as a result from 566 banks during 1951, the no. came down to 85 (14 non-scheduled) by 1969. During 90s, the merger of eNBI with PNB created personnel integration problems and as a result, PSB mergers were not contemplated, subsequently. However private bank mergers continued with merger of Bank of Madura with

ICICI, that of Times Bank with HDFC, Benares State Bank with BoB in 2002, Nedungadi Bank with PNB in 2003 and more recently that of the Global Trust Bank with OBC in 2004. Reverse merger of ICICI Ltd also took place with ICICI Bank, during the year 2001. These mergers did help in strengthening financially, helped to avoid the complex processes of restructuring the weaker of the units and foster financial stability and opened the possibility of actively promoting universal banking. It is encouraging that these mergers were facilitated to a large extent by banking sector reforms.

However, there is little published empirical literature on the impact of mergers in banking in India. Case for mergers : The mergers and acquisitions can be thought of in India on merit, due to following factors also: a: Top 5-6 Indian banks have solid management and they can improve the functioning of some of the smaller banks, through changes in their management. b: Indian banks are scattered regionally and can consolidate to improve their client and industry positions. There is an opportunity for smaller banks to become large and larger banks to consolidate and become even larger. : There are other cost cutting opportunities in IT implementation, branch rationalisation and staff rationalisation. d: M & A provides a fast and easy method for many banks to enter areas where they lack a presence. Structured framework of merger process : The 1st report of the Narasimham Committee (Nov 1991) had recommended a broad pattern of the structure of the banking system with 3 or 4 large banks (to become international in character), 8 to 10 national banks (to have a network throughout the country & engaged in ‘universal’ banking) besides local banks and rural banks.

In its 2nd report, the Committee had recommended that the “mergers between banks, DFIs and NBFCs, should be based on synergies and must make sound commercial sense. Role of Govt. , RBI and IBA : The govt. wants Indian banks to look and behave like global banks. The Finance Ministry has indicated in the recent times that it will encourage mergers of public sector banks to create strong entities which can compete with the world class banks. The Govt. will not force the banks to go in for merger but will create a conducive environment for facilitating mergers to help banks to consolidate. The Govt. s also of the view that while initiating the process of mergers, the banks should take into account the regional and ethnic considerations and maximize synergies in regional balances, address HR issues and ensure asset synergies. RBI has indicated that consolidation must take place to tackle challenges before the system. IBA (considering the complexities involved in consolidation on account of requirement of complying with various laws), has suggested the corporatisation of PSBs to simplify the process of consolidation in its report ‘Consolidation in Indian Banking System – legal, regulatory and other issues’.

It has suggested that if this option is not acceptable, certain amendments such as modifying the definition of a banking institution to include RRBs can be carried out, to facilitate mergers of any banking institutions by the Central Govt. Issues in Mergers Human Resources : In the context of consolidation, one of the major issues, which need to be handled, is in regard to the treatment of the employees of the transferor bank consequent upon the merger or acquisition.

Various laws under which the banking institutions are constituted contain provisions about mergers as also continuation of the existing employees of the transferor bank. In the case of New Bank of India Vs. Union of India (1996 (8) SCC 407) the Supreme Court held that the Central Government had the powers to frame such a scheme and the Court would be entitled to interfere with such a scheme only if it comes to the conclusion that either the scheme is arbitrary or irrational or based on extraneous considerations.

In all cases of mergers, the Central Government will have to formulate a suitable scheme for continuation and other service conditions, applicable to the employees of the transferor bank consequent upon merger. Taxation: Under section 72A (1) of the Income Tax Act where there has been an amalgamation of a banking company with a specified bank, the accumulated loss and the unabsorbed depreciation of the amalgamating company shall be deemed to be the loss and the provisions of the Income Tax Act relating to set-off and carry forward of loss and allowance for depreciation shall apply accordingly.

The effect of this provision is that benefit of carry forward loss and unabsorbed depreciation is available only in case where a banking company is merged with SBI or subsidiary of SBI or a corresponding new bank. Accounting : The system of maintaining accounts and accounting practices, are standardized and uniform in banks. Standards in regard to income recognition, classification of accounts and provisioning have also been tandardized by RBI directives. Section 29 of the Banking Regulation Act, 1949 requires every bank to prepare a balance-sheet and profit and loss account in the forms set out in the Third Schedule to the Act. Sub-section (3) of section 29 further provides that provisions of the Companies Act, 1956 relating to balance-sheet and profit and loss account shall apply to banking companies to the extent they are not inconsistent with the Banking Regulation Act.

Hence, in view of such standardization, merger may not pose problems in relation to accounting practices except the need to fine-tune any divergent practices, in respect of specific heads of accounts. IT integration : One critical area that would need careful consideration is integration of different technology platforms and software which not only have process and control implications but may involve substantial costs in terms of money and time and retraining of personnel.

Integration of products and services : In regard to actual banking operations, each bank has different nomenclatures for deposit schemes and loan products. Similarly, in internal working and inter-branch transactions, banks have different nomenclatures for debit and credit vouchers. On any merger, such variations in the schemes and products and other practices need to be integrated. Swap Ratio: As regards the shareholders’ interest, the swap ratio could be decided mutually at the time of merger and normally does not pose much problem.

Mergers abroad : Across the globe, the mergers have taken place in recent months. For instance during August 2004, Japan’s Supreme Court ruling cleared the way for World’s largest bank by way of full take over of UFJ by Mitsubishi Tokyo Financial Group. Similarly during June 2004, the Federal Reserve US approved the merger of JP Morgan Chase and Bank One Corp to form US 2nd largest banks with more than $ 1 trillion in assets.