New study. Banking mergers in India have been beneficial to the banking sector: RBI paper

Banking mergers in India have been, on an average, beneficial to the banking sector as the financial performance and efficiency of acquirers improved post-merger, according to a Reserve Bank of India occasional paper.

These findings also hold true for the recent bank mergers during 2019-2020, for which limited data is available so far.

The study covered all registered M&As in the Indian commercial banking industry, between 1997 and 2020. The sample reduced to includes 17 merger cases during 1997- 2017 and five merger cases during 2019-2020 .

Efficiency trends

“Presumably, most of the mergers amongst PVBs (private sector banks) were market-driven and those between PSBs (public sector banks) were government-led mergers. Our analysis suggests that the efficiency trends between acquirers and their acquirees were consistent across ownership patterns,” the authors said.

Therefore, singling out the government-led mergers alone as being aimed at accommodating weak banks with stronger ones may not be correct, they added.

The study’s findings suggest that the mean technical efficiency of acquirers increased from 90.88 in the pre-merger period to 93.80 three years post-merger, and 94.24 five years post-merger.

“Relatively lower managerial and organisational competencies in acquired banks were not a hindrance for preserving efficiency of the merged entity and the benefits to acquirers from mergers on account of increased scale of productive capacity were statistically significant”, the authors said.

A deep dive into factors that may have led to efficiency gains identifies post-merger geographical diversification and improvement in the share of interest income as the significant factors, per the authors led by Snehal S Herwadkar, Director, Department of Economic and Policy Research, RBI.

An analysis of cumulative abnormal returns one day prior and one day after the ‘news leak day’ in the event study framework for banks that merged during 2019-2020 suggested wealth gains for the shareholders of the acquiree banks. 

“This is not surprising in light of our earlier results that generally weak banks were acquired by stronger banks. Thus, the markets viewed the news of merger positively for the acquiree banks, in anticipation that their financials would strengthen after merger,” the authors said.

The evidence so far, thus, suggests that mergers have been an effective tool of efficiency improvement in the Indian banking sector.

Business strategies

Mergers have provided avenues for increasing the scale of operations, geographical diversification, and adoption of more efficient business strategies.

Financial ratio analysis suggests that while mergers led to improvement in acquirers’ efficiency across most of the metrics, it was most prominent for liquidity, capital adequacy, profitability and NPA provisions measures. 

Moreover, the impact was sharper in the medium term (-3 to +5 years period) as compared to the short-term (-1 to +1 years or -3 to +3 years period) .

Gains in liquidity indicators suggest that post-merger, the inter-mediation function of the combined entity improved—banks were able to channelise higher share of deposits/assets into loans, per the paper.

Financial risks

The improvement in capital adequacy and NPA provisions measures indicate that post-merger, the combined entity has become relatively more resilient to financial risks.

The authors noted that improvement in profitability ratios may be indicative of economies of scale—post-merger, banks may have been able to cut some operating costs by consolidating bank branches/ATMs operating in the same area, etc.

These gains were also complemented by improvement in operating efficiency as well as asset quality indicators.

The acquirers’ financial performance improved post-merger compared to pre-merger, even after adjusting for industry-wide influences, both in the short-term and medium-term period.

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