The Hindu Business Line : Bank M&A: Stability and synergy

There is little empirical literature on the impact of mergers in banking in India, but what there is supports the view that banks significantly improve their profit and operational efficiencies following consolidation, that has happened both for reasons of financial strength and efficiency. A. Vasudevan surveys the merger scene in the banking sector.

THERE has been in recent months a renewed interest in mergers and acquisitions in the banking sector in view of the growing openness of the Indian financial system. The focal point of interest is about the size of the banking firm.

The undercurrent of thinking is that the larger the bank the higher its competitiveness and better its prospects of survival. This argument implies that Indian banks are not in a position to compete for business internationally — in terms of funds mobilisation, credit disbursal, investments and rendering of financial services — essentially because of their relatively small size. It is said that the only Indian bank that could compete internationally would be the State Bank of India, that too if consolidated with some mergers.

In this background, one needs to know the whysmergers and their impact. But the decisions about mergers would require that a view be taken of the optimal number of banks in the country in the context of the opening up of the financial sector for foreign banks to acquire, and amalgamate with banks in the foreign bank category as well as with Indian banks. Before dealing with these issues, let us have a bit of contemporary history of mergers in India.

Mergers of banks took place in India in the 1960s under the direction of the Reserve Bank of India. From 566 reporting commercial banks (of which non-scheduled banks were 474) at the end of 1951, the number came down to 292 (of which 210 were non-scheduled) at end 1961, to 100 (27 non-scheduled) at the end of 1966; and to 85 (14 non-scheduled) by the end of 1969.

The number of bank offices increased sharply during this period: From 4151 in 1951 to 5012 in 1961, to 6593 in 1966 and to 9005 in 1969. The branch offices of scheduled commercial banks increased over this period while those of non-scheduled commercial banks declined. Unviable banks were weeded out, as recommended by the Travancore-Cochin Banking Inquiry Commission (1956). This meant either closure or amalgamation with other, relatively strong banks. This process was accelerated when two scheduled banks failed in 1960. The 1960 episode was essentially an exercise for preserving banking stability.

Much of the general literature on mergers in banking relates to private banking. The complexities involved in mergers of public sector banking are rarely discussed. In the early 1990s when the then National Bank of India was merged with Punjab National Bank, problems of personnel integration cropped up. After this experiment, public sector bank mergers were not contemplated. On the other hand, there were private banks mergers since about the late 1990s for diverse reasons including building up financial strength, capturing larger portion of the growing retail business and securing better regional presence.

Mergers of ICICI Bank and Bank of Madura, as well as HDFC Bank and Times Bank are important examples. These mergers, mooted by the merging banks in the first instance and approved by the authorities, were not entirely for reasons of banking stability as such.

There were also mergers of private banks with public sector banks, the prominent among them being the mergers of Benares State Bank with Bank of Baroda in 2002; Nedungadi Bank with Punjab National Bank in 2003; and, more recently, Global Trust Bank with Oriental Bank of Commerce. But these mergers were at the initiative of the authorities, undertaken for preserving banking stability.

The merger of ICICI with ICICI Bank and the reverse merger of IDBI Bank with IDBI served multiple objectives. First, the institutions were strengthened financially. Second, they helped to avoid the complex processes of restructuring the weaker of the units and to foster financial stability. Finally, they have opened the possibilities of actively promoting universal banking.

The above examples of mergers have been facilitated to a large extent by banking sector reforms that helped relax some of the restrictions on asset portfolio distribution. Also, to an extent the advances in information technology have given banks the incentive to consolidate to scale up operations.

However, they are not meant, at least in the short term, to cut costs, improve efficiency or raise profits. Implied is the argument that efficiency and profits would be assured once the economies of scale operate.

On the other hand, mergers could lead to charging of higher fees for the services rendered, especially if there is no `effective' competition or if smaller banks exhibit `herd behaviour' in imitating the bigger entities. This negative aspect of mergers may not, however, be as serious as when mergers lead to loss of availability of or access to credit or to lower employment, especially of female labour.

Unfortunately, there is little of published empirical literature on the impact of mergers in banking in India. The general literature on the subject views the impact from two angles: One based on accounting data and the other based on stock price reaction. Till almost the mid-1990s, studies in the US suggested that mergers based on former did not lead to significant gains either in efficiency or cost-saving.

More recently, however, empirical data supported the view that banks significantly improve their profit and operational efficiency following mergers. Studies that use stock market data did not show gains from consolidation. They, in fact, suggested that bidders often suffer negative returns partly because of high offer prices and partly because markets revise downward their expectations from the merger.

In the present context of global financial market integration, Indian banks seeking international presence by exploiting the economies of scale and if possible of scope is an appealing argument.

But this alone cannot be a good ground for consolidation. Banking stability is much more important. What is also important is that it should not lower the number of banks to levels that destroy competition. The proposition that banks would be `too large to fail' is passé as the 1990s financial crises experience shows. The question about the optimal number of banks in the country, and the associated issues of their capital adequacy and their capacity to help universalisation of banking are matters to be yet settled.

There is no official view about the optimal number of banks in a country. The Banking Commission recommended in 1972 that national banks be reorganised into two or three all-India banks and six other entities, each specialising in developing services in a broad region.

This was not pursued. But there is need for intense research on the issue, before one takes a judgmental view about the number of Indian banks that could have international presence and could compete for international banking business. While such a view would obviously be based on their financial strength, that by itself would not be enough.

Good internal governance mechanisms and transparency practices need to be also in place. Besides the authorities should resist the temptation of taking a proactive stance in determining which Indian bank should have international presence. Instead they should allow banks to grow into international entities on their own internal dynamic impulses.

The issue however could become complex if foreign banks are allowed to buy out Indian banks. The RBI has done well to be transparent by going in for public views on ownership and governance. One only hopes that political considerations do not influence the final view on the matter.

(The author, a former Executive Director of the Reserve Bank of India, can be accessed at asurivasudevan@hotmail.com)

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