By Prof. B. Radhakrishnan, Swati Pradhan
Article
Preamble :
The period since the early 90s has witnessed a flurry of
activities in the Indian economy not experienced earlier. This is truly the era
of liberalisation, economic reforms, globalisation, etc. The trend of events in
the Indian economy during this period can be summed up only as positive. While
there is always the downside in any scenario, the balance is certainly
encouraging. The fast growth in the GDP, the strong foreign exchange reserves
position, and a host of other parameters all point in this direction with the
result that India is being seen as a very attractive destination for several
countries for investments in different fields.
One of the sectors that has been eyed for sometime now is the
banking and financial sector. India is already home for different categories of
banks viz. public sector banks, old generation private sector banks, new
generation private sector banks, foreign banks, co-operative banks. The list
does not include non-banking finance companies, investment banks, etc. While the
canvas is quite wide, the immediate focus of this article is the public sector
banks and private sector banks. Much interest has been evinced by several
foreign banks, which do not have a presence in India at present, for setting
base here or widening the existing base, and establishing a large presence
because of the opportunities that have been identified for banking activities in
the country. The Government of India has however been holding back permission
for these banks, essentially with a view to provide the Indian banks an
opportunity to strengthen their position adequately enough to be able to
withstand foreign competition — a necessary fallout of the globalisation that
has been taking place across the world. (The existing guidelines1 prescribe a
74% limit for all types of foreign investment, which effectively means a minimum
stake of 26% for resident Indian capital. Foreign banks have been allowed to
open branches or establish wholly-owned subsidiary or subsidiaries, which have
investment up to 74% in private banks.) Since however such protective policies
cannot remain without any time limit, the Government of India has decided that
from April 2009 onwards, the banking sector would be thrown open to foreign
entrants as well. This date incidentally coincides with the date by which banks
in India are expected to be Basel II–compliant, which to mention in simple
terms, would ensure that the financials are strong enough by international
standards. Thus, the post-April 2009 scenario is expected to witness hectic
activities in this sector with the expected increased presence of foreign
players. The strategies and course of action that would need to be adopted by
Indian banks to equip themselves to face the situation that is likely to emerge
make interesting study. This process of consolidation, which has been suggested
very often by the Government of India, would inter alia witness
mergers and acquisitions in the industry. This paper seeks to look at a few
issues that would have a bear-ing on the decisions of banks to acquire/be
acquired/get merged with other banks, some of the factors that could induce such
decisions, and a few matters having a bearing on the success or otherwise of the
process. The focus would essentially be on the issues involved rather than a
simple statistical tell-tale rhetoric, figures being mentioned purely
incidentally.
History of mergers & acquisitions in Indian banking industry :
Since the onset of reforms in 1990, there have been quite a
few bank amalgamations. Prior to 1999, the amalgamations of banks were 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. The earlier mergers were more often
distress mergers and hence not entirely for business considerations. Mergers
were driven by the Government to address the financial crisis or distressed
financial position of a bank. Some of the examples are those of SBI taking over
Bank of Cochin and Kashinath Seth Bank, New Bank of India merging with Punjab
National Bank, Global Trust Bank with Oriental Bank of Commerce, Ganesh Bank of
Kurundwad with Federal Bank, etc. . . . But in the recent years a new wave of
consolidation has entered the Indian banking industry. The mergers of Times Bank
with HDFC Bank, Bank of Madura and ICICI with ICICI Bank, Bank of Punjab with
Centurion Bank and now Centurion Bank of Punjab with HDFC Bank fall under this
category of mergers not arising out of distressed financial position.
The few paragraphs that follow have been devoted to a few
topics that are incidental to the main theme, essentially relating to the
causative factors, both external and internal. This has been done consciously
since the capacity of the Indian banking sector to be prepared for coping with
the emerging scenario would not depend on the picture as may be presented, but
on the harsh ground level realities, and any attempt to turn a “Nelson’s eye” to
these warning signals would only be counter-productive and, in certain
circumstances, could even prove suicidal. As such, this diversion is considered
a necessity.
Causative factors :
The situations influencing M&A in the banking industry (as
indeed in any industry) could broadly be classified as external and internal,
though the discussions could see a bit of overlapping of these two factors.
External factors refer to the intent of a bank to grow inorganically by takeover
of another bank or to join hands with another bank in order to reap the benefits
of size and reach. These can also relate to a necessity-based situation driven
by the inherent weakness of a bank as a component of the sector as a whole and
its inability to cope with the dynamic situation. Internal factors on the other
hand refer to the position of the concerned bank itself in terms of its overall
internal financial strength as reflected by various parameters. The following
paragraphs seek to look into these factors and related aspects.
External factors :
The globalisation process has brought ‘in its wake quite a few challenges, not the least being one of intense competition which would ultimately result in the survival of the fittest, the others being forced out of the race for one reason or the other. The focus thus shifts entirely to one characteristic – being fit enough to withstand the competition and being the fittest in order to outperform others. This is where quite a lot of discussions have taken place and will continue to take place – as to what constitutes fitness? Suffice it to understand that the concerned bank needs to be financially strong not only in isolation, but more importantly, as one among, and in comparison with, the other players in the field. In the context of the players in the banking industry, this should encompass largeness of size (where this provides the advantages of volumes in transactions and balance sheet size), a wider reach than at present (where this provides not only the reach into newer areas geographically, but also facilitates newer approaches and products not hitherto possible), a stronger balance sheet (with the inherent advantages of faster growth), etc. It must be mentioned that largeness of size and having a wide reach could turn into disadvantages if not handled in a proper and planned fashion. While it is not the intention of this paper to enter into a debate on the advantages and disadvantages of largeness of size and reach – these have been discussed and chronicled fairly adequately – a few connected points need mention in order to have a clearer understanding:
1. Largeness of size without a proper integration of various activities and co-ordination among them could create total chaos. While this is true of any organisation, it is all the more relevant in the case of banks which deal with public funds and where ongoing changes in the market affecting one activity could have a direct or indirect bearing on another activity of the bank. It is necessary to take full advantage of the synergies of the various activities and utilise the benefits of networking among them, if largeness of size is not to become a ‘drag’.
2. The above observations equally apply to the wide reach that is expected to be one of the advantages of consolidation. The planning process plays a very important role since the reach of a bank in different locations would provide different strengths, depending on the location. For example, location in a rural area would provide the advantage of funding of small business, agriculture and micro-credit as against an urban location which would facilitate corporate business, etc.
3. Viewed from a different angle, smallness of size is also a disadvantage in certain circumstances. With the deadline for reporting compliance with Basel II norms just round the comer, there could be issues connected with need for a strong database and MIS. Inadequacies in these areas would be serious. At the same time, getting these in place would necessitate a strong technology base and connectivity, with the obvious issue of costs. Equally important is the need to build up sophisticated systems which would continuously assess the capital requirements for the different risks and ensure optimal allocation of capital towards these risks; this would again have a cost implication that could prove too high for smaller banks.
4. A large number of small banks have the effect of splitting the consumer base of existing players in the market, similar trends being observed in profit after tax, borrowings and interest and non-interest incomes of the banks, thereby hinting at increased levels of fragmentation in banks. Though this could be an opportunity for healthy competition, the goal of becoming a globally competent bank, for which size of the bank does play an important role, would be missed out. (It may be significant to state at this stage that State Bank of India (SBI)the country’s largest bank, is ranked 60th in the world according to Fortune it is gathered that the next biggest i.e. ICICI Bank, is ranked around 200.) 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 losses overall. (This aspect is covered in slightly greater detail later in this note.) Under these circumstances, merging or getting taken over by a bank with a ready infrastructure has a lot to commend itself.
As mentioned earlier, the inorganic growth through the process of mergers and acquisitions could be the voluntary route where two banks decide to merge or one bank decides to acquire another bank, essentially by mutual consent, in order to secure the advantages of size and/or reach. Alternatively, it could arise because of inherent weaknesses observed in the bank being acquired. While the former would essentially be caused by external factors, the latter could see a combination of external and internal factors.
The history of mergers and recent discussions held to discuss possible mergers would indicate both categories. The mergers of ICICI with ICICI Bank, IDBI Bank with IDBI, etc. and the discussions held between Bank of India and Union Bank of India are examples of mergers by mutual consent aimed at tapping the inherent synergies between the two organisations. More recently, the discussions between State Bank of India and State Bank of Saurashtra, and also the indications of talks aimed at merger of its other associate banks with State Bank of India, are further examples of this category. On the other hand, the takeover of banks like Global Trust Bank by Oriental Bank of Commerce, Lord Krishna Bank by Centurion Bank and Nedungadi Bank by Punjab National Bank fall in the latter category viz. banks that have had problems and are required to be taken over in the interests of the stakeholders. Also, since there has been quite a bit of analysis on the former category of consolidation, only a brief mention has been made above of the former category. It is however considered necessary to discuss the latter category in slightly greater detail. This would essentially focus on the internal causative factors, though as mentioned earlier, a slight degree of overlapping of the external factors cannot be totally avoided.
Internal factors:
Situations where a bank is confronted with problems to the extent that external help is required to resurrect it are invariably built up over a period – these do not happen overnight or in a totally unexpected manner. On occasions, the approach of a bank to remain content with its level of operations, whether in terms of size or area of operations, could turn out to be the negative factor. Instances exist of banks having been in existence for quite a long period (sometimes even extending to decades) without the type of growth that is seen in other banks placed in a similar category in terms of period of existence, etc. By the time there is an ‘awakening’, it is perhaps too late – the concerned bank remains small in comparison to other players, thereby having to face the negative effects of smallness of size and reach. While this by itself could induce corrective action through the process of consolidation (which would perhaps be the right course of action when viewed from the stakeholders’ angle), the temptation of attempting to remain afloat and in the race’ at any cost’ very often leads to its undoing and pushes the concerned bank into an enforced consolidation by way of takeover by another bank. The next part of this study looks at some of the ways in which this misguided attempt takes place, as also some of the implications of such attempts:
1. Efforts are made to make up for lost time by adopting inappropriate shortcuts. A typical instance would be of a bank trying to go beyond its capacity and rushing in an unplanned manner into activities which it may not be able to handle. For example, taking into account the size and other related factors of a bank. it may not be equipped to handle the larger, and more sophisticated, business offered by corporates. This type of business is however a strong temptation for achieving quantum jump in figures on the business front. This situation can be avoided only with a strong and well-informed Board of Directors which should be very particular on a properly drawn out business plan covering a reasonable period into the future, based purely on the inherent strengths of the bank, sector-wise growth prospects and the opportunities available. In this context, the importance of an independent director on the Board who is truly independent cannot be overstated. This aspect of the Board’s composition is an area that requires serious attention.
2. A variation of the above possibility is the anxiety of the top management, particularly at the CEO’s level, to show good progress in terms of figures during his/her tenure, which could be quite short. During this process, the interests of the stakeholders are lost sight of, since the time available at the disposal of the CEO is less, in view of the short tenure of appointment. The solution to this matter partly lies in the CEO being appointed ab initio for longer durations (say, 4-5 years) with very clear mandates from the Board of Directors (as a sequel to the point mentioned above), so that the long-term interests of the bank and its stakeholders are not sacrificed in the process of achieving short-term results which may not be sustainable.
3. A slightly narrower version of the above observations arises out of the fixation on figures (targets ?), whether year end or at end of specific periods viz. quarter-end or half year-end. This fixation takes the form of ‘ballooning’ towards end of such specific periods, whether in terms of deposits or advances (credit). Often, there is a spurt in the figures of business at such period-ends which revert to the earlier levels when the fresh period commences. While this by itself may not always impact the financial health of the bank, the figures per se are misleading. Where such action also impacts the bank’s financial health, the matter is more serious. This aspect is discussed briefly.in the following paragraphs :
a) It is evident that growth of the type envisaged above cannot be achieved through retail or other small business avenues in the very short period of (say) a fortnight or a month. The temptation is therefore to go in for bulk business, whether deposits or advances. Deposits, when raised in bulk, are invariably from corporates/institutions where the rates offered have to be high enough to be attractive. These do not conform to the normal rates otherwise offered by the bank – they are quite higher. Looking to the volumes generated through this route, the impact on the profitability can easily be visualised, though the deposits may have been raised only for short periods. The logical sequel to the above is the deployment of the funds thus raised. Here again, the situation is similar to deposits except that the competitive rates have to be low enough to be attractive, with the obvious impact on the bottom line of the bank.
b) The cause-effect could also be reversed in the sense that with availability of large quantum of surplus funds, the deployment could take place first, followed by raising of deposits, the latter with an eye on the need for a satisfactory Credit-Deposit (CD) ratio. In either case, the impact would be the same. Such developments would in the normal course get reflected in the Asset Liability Management (ALM) exercise, as would the possible situation of such bulk advances being extended for longer periods as compared to the tenure of the bulk deposits. There do arise circumstances where these indicators are given a ‘go-by’ in a variety of ways, but dilating on these would shift the focus away from the main theme, and is therefore being left open for individual interpretations.
c) An incidental fallout of the above is the frightening possibility of one or more of such bulk advances turning bad, a situation that could seriously impact the financial position of the bank whose size may not permit such an impact. The implications are obvious.
4. Another area where the focus on figures could easily take the visibility away from realities relates to the identification and declaration of non-performing assets (NPAs). While the matter of handling of NPAs is by itself a complex one permitting a full-fledged discussion paper, acts of omission and commission in this area could also present the financial position of a bank at an unreal level. One of the routes followed is what is commonly referred to as the process of ‘ever-greening’. Quite simply put, this is the process where, just before an account slips into the category of an NPA, fresh assistance is provided on an ad hoc basis to clear the amounts that are about to slip into the overdue category. This is an area that has been attracting a lot of flak from the regulators who have been giving several guidelines to overcome this ‘illness’. The ultimate effectiveness would however depend on the will to face the real picture which alone would facilitate taking of corrective steps, all in the interests of the health of the banking sector aimed at making it strong enough to face up to the emerging challenges.
Some important issues :
With April 2009 just round the corner, when the sector would be more fully opened up to the foreign banks, and with the prospect of these banks landing with their huge resources and infrastructure, size would become a matter that cannot be wished away. It is therefore apparent that consolidation in the banking industry is inevitable sooner than later. Against this backdrop, it would be appropriate to take a brief look at some of the areas where the consolidation process would make an impact, and some of the issues that may be required to be addressed:
Invariably, the shareholders of the bank being taken over benefit as compared to the shareholders of the acquiring bank.
A few issues could be posed by differences in the customer mix if the banks entering into an arrangement are of different categories e.g., old generation bank and new generation one, public sector bank and private sector bank, Indian bank and foreign bank, etc. The differences could relate to the manner in which transactions are put through in each bank even in such simple matters like withdrawal or deposit of cash.
Objections raised by unions/associations may playa role. The recent case in view is the plan for merger of Union Bank of India and Bank of India, which did not move beyond the initial stages.
Related alliances of either bank have to be taken into account. In today’s scenario, most of the banks have some tie-up or the other. For instance, a bank may have linkages with an insurance company for marketing of the latter’s products. If two such banks with linkages with two different insurance companies come together in the consolidation process, appropriate methodologies may have to be worked out in this area as well.
The next issue which should be thoroughly analysed is the HR factor. Looking to its importance, it would only be appropriate to look at this area in slightly greater detail under a couple of sub-heads:
The culture and behavioral patterns of the concerned banks could be quite different, and their mutual compatibility and adapt-ability is an important pre-condition for the success of the consolidation process. While problems could arise even between two banks of similar character (e.g., two new private sector banks or two nationalised banks), the matter gets more complex when such similarity does not exist. The complexities could relate to different types of hierarchies and reporting practices in the organisation structure, procedures (whether in internal personnel matters or seeking decisions on credit and other business-related matters, and a host of such matters), differences in staff regulations, etc.
Differences in the overall age pattern prevailing within each bank can be another serious matter. One cannot afford to bypass matters such as the typical ‘generation-gap’, with the elder generation strongly believing that all its long years of experience and labour are being slighted – particularly if they are required to report to the younger lot, post-consolidation, and the younger generation equally strongly feeling that their professional qualification linked to the current requirements need to get much greater attention and that the earlier generation is somewhat ‘out-of-tune’ with today’s world. The simple fact is that neither the large experience, for which there can be no substitute, nor the technical expertise gained by the younger generation can be ignored a healthy marriage of the two is essential.
Merging and positioning of the personnel of the two banks in the new organisation structure is another challenge, particularly in certain specialised departments like Credit, Treasury and Resource Management, etc.
Differences in compensation structure is yet another serious component of the HR factor, particularly if the employees in the bank being taken over have been drawing more compensation than the employees of the taking-over bank.
Recent mergers/takeovers of Global Trust Bank by Oriental Bank of Commerce, Bank of Madura by ICICI Bank, IDBI Bank with IDBI, etc. have all had issues falling under one or the other of the above HR-related categories.
Instances of this crucial area (HR) could be multiplied, but suffice it for the purpose of this paper to observe that this is a really crucial, if not critical, issue in any process of consolidation, and any due diligence study that does not give this matter the required level of attention would only be half-cooked. The consequences could be disastrous in the form of staff frustration, depression, disappointment over failure to be given due recognition and, quite often, a high degree of attrition. The net result is not hard to visualise.
The type of technologies used in each bank is another crucial factor. With almost all the banks across the economy going in for Core Banking Solutions a necessity in the context of growing competition, imperative need to focus on providing the best customer service, need for a strong database that would keep updating itself on real-time basis and hence provide a strong MIS – different players have emerged for providing this Solution, with differences existing between one and the other. In the event of different vendors having provided the CBS to the two banks, the scope for successful integration of these two technologies needs to be critically examined.
6. 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 (e.g., 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 (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.
Conclusion:
The current scenario on the banking sector front is indeed dynamic, extremely challenging and, for a true hard core professional, immensely exciting. It is certainly not for the weak-willed. Genuine strong and equipped players will find the future holding out several challenges, thrills and prospects. At the same time, players who have missed out on opportunities, focus and direction, all of which have to be based on a strong foundation of discipline and commitment to the sector and the nation, are bound to find the going very tough for survival in the emerging scenario. The process of consolidation is not just a major one – it is almost inevitable. The process necessarily pre-supposes a meticulous and professional due diligence study, for which some of the important issues to be kept in view have been discussed in this note. It would only be an understatement to mention that such a study needs to be factual, fearless, truly independent and totally unbiased. Given the strong professional talent that is available in the country and the committed leaders in the banking sector (quite a few still remain – they only need to be identified and encouraged/supported and assuming a definite sense of purpose, focus and urgency at various levels with various authorities, one only hopes that the future would witness the emergence of a new-face banking sector – a strong, vibrant one, competing fiercely, but with one clear-cut common objective – to build a much stronger India, both financially and industrially, which would be looked upon as a role model by the rest of the financial world.
References :
1. Book: Bhagaban Das and Alok Kumar Pramanik on ‘Mergers and Acquisitions – Indian Scenario’, Kanishka Publishers,2007.
2. Business Standard, Banking Annual, 2006 Issue.
3. IBA Bulletin, Special Issue 2005,Consolidation in Banking Industry: Mergers & Acquisitions, [an 2005,VolXXVII – No. 1.
4. Special address delivered by Shri V. Leeladhar, Deputy Governor, Reserve Bank of India on April 17, 2008 in Mumbai on the occasion of the International Banking & Finance Conference 2008organised by the Indian Merchants’ Chamber, Mumbai.
5. The Banker, July 2007 Issue, ‘Top 1000World Banks’.
6. WebLink: http://rbidocs.rbLorg.in (Roadmap for Presence of Foreign Banks in India and Guidelines on Ownership and Governance in Private Banks, dated February 28, 2005)
7. Weblink: http://money.cnn.com/magazines/fortune/global500/2007/industries/192/1.html (Fortune, Global 500 Companies)
