Mergers and Acquisitions: Indian Banking Consolidation

Mergers and Acquisitions Indian commiting integrationGlob exclusively(a)(a)y it has been found that the conjugations and learnedness bring on start out one of the major ways to corporate restructuring which has too touch the monetary go constancy which has experienced conjugation waves leading to the breakgrowth of huge wedges and financial institutions. The primary(prenominal) reason for nuclear fusions is intense competition among the companies in the same industry which put focus on economies of scale, aptitude in re bring in and profitability. Some early(a) divisors leading to the nuclear fusion reactions is the too big to stag principle followed by the authorities. In few countries like Germ whatsoever, weak brims were forcefully merged to avoid the problem financial distress arising out of pestilential imparts and erosion of keen funds. some(prenominal) academic studies read analyzed conjugation related shed light ons in cashboxing and these st udies have adopted both onrushes. The first salute deals with evaluating the long term per peeance of the jointure by analyzing the noniceing development such as return on assets, run costs and faculty ratios. A mergers is considered to have led to remedyd performance if the the change in the accounting based performance is superior to the changes in the performance of the standardized send awayts that were not involved in the merger activity during that period. Another approach is to analyze the gains in stock legal injury of the bidder and the pit company almost the announcement of the merger. In this approach the merger is assumed to create cherish if the combined c be for of the bidder and stooge brinks ontogenesis on the announcement of the merger and the consequent and the stock prices reflect the latent value of the acquiring banks.The object of this paper is to present a panoramic view of merger trends in India and to ascertain two important perception s of empale-holders, sh arholders and managers and to discuss dilemmas and other appears of this topic of Indian banking.Review of Literature for impact of mergersThe two important issues which argon examined by various academic studies relating to bank mergers arimpact of mergers on the operating performance and efficacy of the banksImpact of mergers on the merchandise value of the integrity of both bidder and the fair game banks.Cornett and Tehranian (1992) and Spindit and Tarhan (1992) provided certainty for increase in slur-merger operating performance. only the studies of Berger and Humphrey (1992), Piloff (1996) and Berger (1997) did not stripping any evidence in increase in post-merger operating performance. Berger and Humphrey (1994) also reported that most of the studies that examined pre-merger and post-merger financial ratios found no impact on operating cost and profit ratios. The reasons for mixed evidence argon lag between completion of merger work at and the identification of bring ins of mergers, sample selection and the methods adopted in the financing of mergers. Further, the financial ratios whitethorn be misleading indicators of performance because they do not take into account for product mix or input prices. On the other travel by researches whitethorn also could have confuse scale and scope efficiency gains with what is known as X-efficiency gains. Recent studies have explicitly employed bourne X-efficiency methods to identify the X-efficiency benefits of bank mergers. Few studies have also analyzed the potential benefits and scale economies of mergers. Landerman (2000) explored diversification benefits to be had from banks merging with non banking financial service firms. phony mergers of US banks and non-bank financial service firms demonstrated that diversification of banks into insurance vexation and securities brokerage is optimal for reducing the probability of bankruptcy for bank keeping companies. Wheelock an d Wilson (2004) found that expected merger activity in US banking industry is positively related to forethought rating, surface of the bank, competitive part and geographical location of banks and is minusly related to market concentration.The second issue intractable was the digest of merger gains in terms of the gains in stock price performance of the bidder and the target banks on announcement of merger. In this reference a merger is expected to create value only if the combined value of the bidder and target companies increases after the promulgation of the merger. hitherto a clump of studies have failed to find any direct relationship between the merger and the gains in performance or in sh beholder wealth. But in that respect ar reasons for mixed evidence as a merger announcement also takes in to account the way the deal is financed .If legality offerings ar used it may be interpreted as oervaluation by the issuer. thus the negative announcements returns to th e firms that be bidding atomic number 50 be attri yeted to the negative sign each(prenominal)ing which is exclusively unrelated to the value which is created by the merger. Returns to the bidders companies sh areholders is greater when the merger is totally financed with interchange than in mergers in which financing is done through rightfulness offering. on that point is one more problem with this event register analysis as if there is a desegregation wave going on mergers are anticipated by stockholders and analyst. Potential candidates for the mergers are gamylighted and made popular by the financial press and the stock market analysts. In these cases the event study analysis may fail.Therefore an analysis of mergers across the world and a literature review does not provide strong evidence on the benefits gained by banks in the mergers in the banking industry. Also the findings of the literature also dividing line with the findings of the consultants who find a consider able cost savings and practicable efficiency achieved through mergers. The reasons why academic study do not find cost benefits and the consultants highlight this fact areConsulates may study a potential cost savings which may not materializeThey escape to highlight potential cost saving activities and the economist study all the activities.They ladder to be biased towards successful cases and ignore the unsuccessful ones.They tend blow up the benefits achieved while the benefits may be miniscule if accounted on a relative terms.The academic studies provide motivation for the examination and valuation of two important issues pertaining to the mergers and learnedness to the Indian banking.Do mergers help in improving the movemental performance and result in cost savingsHowever in India most of the mergers are hale by the rudimentary bank in rig to protect the engage of the depositors and avoid financial distress therefore the above mentioned reason is rarely found in the me rgers activities.Do merger provide abnormal gains and returns to the merchant bank and the target banks upon the declarationConsolidation Trends Observed in IndiaImproving the operational performance and cost efficiency has always been a priority in Indian banking empyrean and has been a major issue of discussions in the policy formulation by the authorities of India in the consultation and with the central bank (Reserve Bank of India). Several committees have also been organize in order to suggest geomorphologic changes to achieve this objective. Some of the major committees formed areBanking Commission, 1972 Chairman R.G Saraiya, 1976 chairman Manubhai ShahCommittee for the functioning of public sphere banks, 1978 chairman James S RajThese committees have suggested the restructuring of the Indian banking system with an objective to improve the process of cite delivery and also suggested the idea of having around 3 to 4 sizeable banks which have a pan India presence and the rest of the bank should be present at the regional level. The major thrust on integrating started with the Narasimham committee in 1991. It emphasised and embarked upon consolidation and merger in order to make the Indian banks huge in size and also corresponding to the global banks. A second Narasimham committe was also formed in 1998 which suggested mergers and consolidation among the strong banks in public as well as individual(a) sector and also with other financial institutions, NBFC (Non Banking Financial Companies). Now we leave alone have a look at some of the recent trends in consolidation in Indian banking.Restructuring of weak Indian BanksAmongst other routes government of India has adopted mergers as a means to achieve restructuring of the Indian banking system. umpteen banks which are small in size and are weak are merged with other banks which are stronger and are expectantr to protect the fill of the depositors and also to avoid financial distress. These types of mergers can be termed as forced mergers. Hence when a banks shows symptoms of sickness like increasing size of NPAs, diminution in the net worth and substantial decline in capital adequateness ratio, rbi forces moratorium under the section 45(1) of the Banking Regulation act 1949 for a specified period on the activities and the operations of the working of the sick bank. In this period a strong bank is identified and asked to prepare and present a scheme of merger with the weak bank. In this case the merchant bank banks takes hold of all the assets of the weak bank and ensures the depositors of their money in case they want to withdraw. The mergers which took place in the pre-reform period fall into this category. In the post reform period 21 mergers have taken place out of which 13 are forced mergers where run batted in has intervened. The main reason for these mergers was the apology of the depositors interest and avoids the financial distress.Mergers which took place volun tarilyApart from forced mergers there have been few mergers in which expansion, diversification and growth were the major motives and in which rbi did not intervene or force. The first merger of this charitable took place in 1993 when the clock Bank was acquired by HDFC bank which was followed by acquisition of Bank of Madura by the ICICI Bank. The latest of these is merger of Lord Krishnan Bank with Centurion Bank of Punjab. Although in all these deals the target bank suffered with low profitability, outgrowth in NPA and lack of alternate revenues in order to provide daze for capital adequacy but these mergers were not forced. There was no regulatory intervention in these mergers barely the motives female genitals these mergers may not ineluctably be scale of economies and achieving market power. For slip ICICI bank acquired bank of Russia with a motive of compliance in to Russia although it just had one branch. SBI acquired 51% stake in Mauritian Bank through Indian Ocea n global Bank which impart be integrated with the State Bank of Indias world(prenominal) business as a subsidiary.Integration of Financial Services and Achieving universal joint Banking ModelSeveral developmental financial institutions have been formed over a period of time in India in order to improve the efficiency of allocation of resources to diametric segments of the economy. However because of the flexibility given by the RBI to the banks in the credit delivery process the banks have increase and diversified their loan portfolio to various areas such as project finance, long loans, and other specialised sector lending. This is the reason why DFIs have become redundant. A working capital group (1998) was appointed by RBI which has recommended the universal model of banking by exploring the possibility of mergers between various sets of financial entities based on economical considerations. Similarly in the private sector ICICI merger with its subsidiary bank and IDBI (ind ustrial Development Bank of India) was incorporates as a public sector bank which acquired private sector bank IDBI bank in 2004. In order to provide integrated financial services and achieve operation efficiencies many public sector banks have acquired their subsidiaries, for instance Andhra Bank acquired its housing finance subsidiary Andhra Bank Housing pay LTD, Bank of India acquired BOI finance Ltd and BOI Asset Management Company Ltd. Acquisition of similar types took place in the private sector as well.Alignment of operations of Foreign Banks with Global TrendsAs the Parent banks went under reconstruction process their parts operating in India also started restructuring. For example, Standard Charted Grindlay bank was formed due to acquisition of ANZ Grindlay by the Standard Charted Bank. Similarly due to acquisition of two Japanese banks like Sakura Bank and Sumitomo Bank Ltd the Indian operations of Sakura Bank were merged with Sumitomo Bank in 2001.Forign banks were permi tted to enter into merger and acquisition transaction with any of the private sector bank in India with a condition that the overall investment limit limit will be 74 per cent after the second phase of WTO commitments which commenced in April 2009. This may lead to gain consolidation in the Indian banking sector.Merger and Consolidation of Cooperatives, RRBs and UCBsSmall banks present in India apart from other banks are co-operative banks, regional Rural Banks (RRBs) and Urban Co-operative Banks (UCBs). These are formed for fulfilling the credit requirements of agriculture, small traders and SSI and other rural economic activities. All of these institutions are suffering from bad loans, operational inefficiencies, and Poor recovery of loans. This proved to be a barrier for further lending and financial intermediation. A committee formed under Jugdish Capoor suggested self-imposed amalgamations or merger of these co-operatives based on various criterias like economies of scale, peculiarly in areas where the operations of these banks have become unviable and there are no more in a position to supply credit to agriculture sector. 28 RRBs were consolidated into 9 new RRBs in September 2005.A high powered committee on Urban Co-operative Banks (1999) recommended that UCBs which are sick should be liquidated in a time bound manner as the operation of large number of financially sick banks is devastating for UCBs and also for the interest of depositors. Due to this more mergers are expected in the future and RBI also has taken a lot of new initiatives for restructuring of banks including the issuance of guidelines in May 2005.Shareholders Perception of MergerAs stated above the Indian banking sector has experienced two types of mergers focussed and voluntary mergers. Forced mergers were initiated by RBI and their main objective was to protect the interest of the depositors and prevent financial distress of the banks. Whenever a bank showed symptoms of sickness l ike huge NPA levels, erosion of net worth etc, RBI intervened and merged the weak bank with a stronger one by force. Thus we can form a opening that in case of forced mergers the target banks shareholders will gain abnormally with the declaration. The second type of merger is voluntary type where the motivation behind the merger is to achieve cost reduction, increase in size, diversification, strategic entry into a market. In these cases the acquired banks reaped the benefit of branch network and customer trade of the banks acquired. In these cases both the acquirer bank and the target bank mustiness have had benefit out of the merger. In this paper the mergers between 1993 to 2006 are considered. There were 21 mergers out of which only five were voluntary. These are in the first place mergers of private sector banks with other private sector banks. Two cases are conversion of financial institution to commercial bank where the objective was to form a universal bank model which o ffers a wide post of financial services. Ina study conducted which is presented in this paper six cases of forced mergers were selected for the propose of analysis as in other cases the target banks were not listed and the size of the banks were much lower than the acquirer banks therefore these cases are of less deserve for further analysis.In this study the wealth effects of almost all the banking mergers during the period 1999-2006 is analyzed. The event study analysis used in this analysis is very straight forward and conventional. The merger period consist of tetrad days prior and four days after the event. The reason for victorious such window is to analyze the change in wealth of the shareholder around the day of the declaration on the merger. Daily adjusted goal prices of stocks and the market tycoon is taken for the analysis. The abnormal returns are cipher as follows.ARit= Rit a + BRmHereRit daily return on firm i on day tRmt is the return on the bench mark indexa and B are the regression parameters.The abnormal return is calculated for both the acquirer and the target firm and the significance of these values are tested by finding standard error and the t-value Analysis of seek ResultsIn forced mergers case the stockholders of target banks have not achieved any operative returns on the declaration of the merger. However in the case of Nedungadi Bank, the stockholder did gain significant on the 2nd day of the announcement but after that no abnormal returns were found. In the case of GTB the stockholders had deeply discounted the merger. As it was a case of serious case of bank failure the merger did give a confidence to the depositors but the merger declaration did not provide any abnormal returns. United bank did gain marginally on the announcement but it was not significant statistically. Thus the opening that target banks shareholders welcome merger announcement as a golosh net can be rejected. The shareholders of the acquirer bank lo st their market value of equity. In case of ICICI bank, it was signalled as an emergence of a large private sector bank and hence due to which the banks shareholders expectations go up with significant increase in the returns. In other cases of acquisition the acquirer bank lost on merging with the weak banks. Hence in all the forced mergers neither the acquirer bank nor the target bank gained on declaration of the merger and the stockholders of the acquirer bank lost wealth as the announcement of the merger was taken as a negative signal. It is argued that merger of weak banks with strong ones is essential for restructuring of banking system and also a step in the consolidation of the banking sector. But in almost all the mergers it was found that the target banks for the merger were determined at the time when they were at the verge of getting collapse. The acquirer bank which was forced by RBI was left with no option but to accept the proposed merger. It is recommended that RBI s hould tag Prompt corrective action system and should determine the weak banks on the basis of some defined criterias so that the acquirer bank can choose the target banks on the strategic issues which benefit all the parties. anomalous Returns of Target BanksAbnormal returns of Bidder banksIn case of voluntary mergers it can be seen that the target banks have obtained higher returns that the acquirer banks. Both the acquirer and the target banks stockholders benefitted on declaration of the merger. Therefore the stock market welcomed the merger which will lead to growth and efficiency aspects of the merged entity and benefitted the shareholders of both the banks. For instance in the case of acquisition of times banks by HDFC bank it was viewed as a positive signal by the shareholders of both the bank. At the time of the merger the Times Bank was crippled with increasing NPAs and low profitability, the acquisition by the HDFC bank gave relief to the depositors of the Times Bank. On the other hand HDFC bank emerged as the largest private sector bank by gaining from the retail portfolio of the Times Bank. In case of BOM acquisition by the ICIC bank the BOM gained the advantage of beingness able to provide services like Treasury management, cash management services to its customers and ICICI bank increased its size by acquiring BOM and reached the position of large private sector banks in 1999. At the announcement of the merger there was a steep rise in the gains which was reaped by the BOM shareholders however the stockholders of ICIC bank did not get any significant returns.In all the even study analysis revealed that neither the acquirer bank nor the target bank stock holders have perceived any potential gain on the declaration of the mergers. Hence the share holders who are important stakeholders of the banking companies did not consider the mergers as a signal of improving health, economies of scale and the market power of banks.Managers take on the Mergers Managers provide highest priority to the merger of the two public sector banks which provides a signals the banking sectors view on the need for consolidation of public sector banks. Managers do not prefer the merger of bank and NBFCs or financial services entitiesThere are some issues which are needed to be taken care of while proposing a merger of banks according to the managersValuation of the Loan portfolio of the target bankThis is one of the main factor which is needed to be considered at the time of the merger. As in the management of the credit portfolio the accounting and the exposure norms suggested by the RBI are the same which helps in figuring out the book value of loans easily. However Indian banks have adopted divergent practices in rating the borrowers, loan pricing and maintenance of collateral securities therefore a detailed inspect of the loan portfolio, cash flow generation and collaterals is very essential in order to get an opinion on the value of the loan por tfolio of the target bank.Valuation of Intangible assetsThe valuation of the assets of the banks is a very hyper vital factor for the success of any merger or consolidation. The tangible assets of the bank are loans, investment part apart from other fixed assets like buildings, ATMs and the IT bag the bank owns. A commercial bank also holds a lot of intangible assets like clientele based on core deposits, arctic value contracts, computer software products, human resources, brands and goodwill. Determining the inherent strength of the bank based on the valuation of the intangible assets is also very important.decision of the value of equityDetermining the value of the target banks assets, liabilities and valuation of its equity value is the major aspect of a merger process. discordant approaches can be used like dividend discount model, cash flow to equity model and excess return model. However banks have totally different operations than a normal manufacturing firm as they are passing leveraged because they have more than 90% of the resources as borrowed or as debt and banks are highly regulated institutions and regulatory instruction have vast subtraction in asset and income recognition. Interest rates volatility, regulatory capital adequacy ratios and restriction on dividend pay put ratios also have lick on the earnings of the banks.Human Resource IssuesIt is the most complicated issue in the merger process.HR issues like the service condition, strategy for rewarding people, employee relation, benefit plans and compensation, provision of pension, law suits and the trade union actions are very critical for the viability of the merger and the deal to go through.Cultural IssuesThis is also a critical issue in the pre-merger and post merger period. It is central to an organizational surroundings and recognizing cultural friction is very difficult as it results in various problems such as poor productivity, riff in the top management, increase in the turn over rates, delays in the integration process and failures in realizing the intercommunicate synergies.Information Technology platform integrationIn todays banking banks are highly dependent on the information technology. It has become a key strategic issue due to the impact it has on the operation of the bank. A significant portion of the synergy depends on the information technology integration. Divergent IT platforms and software systems have proven to be major constraints in the consolidation.Customer computer storageCustomers also major stakeholders of banks and are needed to be communicated properly more or less the merger and the customers of the target bank should be attended with utmost care. Various studies have shown that firms borrowing from target banks are very likely to drift off their relationship with the bank on its merger.