Consolidation of banking industry strategy

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A PROJECT REPOT

ON

“Consolidation of Indian Banking Sector”

Submitted By :

Nipun Trikha (58/2008)

Submitted To:

(Dr.Harish Handa)

LAL BAHADUR SHASTRI INSTITUTE OF MANAGEMENT, NEW DELHI

JANUARY 2010

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LAL BAHADUR SHASTRI INSTITUTE OF MANAGEMENT, DELHI

Sector-3, R. K. Puram, Delhi

Dated……………

CERTIFICATE

Certified that NIPUN TRIKHA has successfully completed Project Study entitled

“Consolidation of Indian Banking Sector” under my guidance. It is his original

work, and is fit for evaluation in partial fulfillment for the requirement of the TwoYear (Full-Time) Post Graduate Diploma in Management.

Nipun Trikha Dr. HarishHanda

(Signature)(Signature)

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ACKNOWLEDGEMENT

The satisfaction and joy that accompany the completion of this task is incomplete

without mentioning the people who made it possible. And so, I would like to thank

all those who have supported and guided me to successfully complete this

project.

I would like to acknowledge the support, co-operation, and guidance of all those

who have helped me to complete this project successfully.

I would like to extend my sincere gratitude towards Dr. Harish Handa for helping

me to undertake this project study and providing me the guidance, advice, and

direction that is required to carry out a project, and for helping me with the

intricate details of the project at every step of the way.

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T able of content

SerialNo.

Content PageNo.

Executive Summary 4

1. Introduction6

1. Banking Industry at A Glance 9

2. Literature review2.1 Methods of Consolidation

2.2 Forces encouraging consolidation Introduction

2.3 Forces discouraging consolidation Introduction

222425

3. Objective 26

4. Methodology 27

5. How do we calculate EVA 28

6. Discussion & Analysis

10.1 Centurion Bank and Bank of Punjab Deal 10.2 Centurion Bank and Lord Krishna Bank 10.3 ICICI Bank and Bank of Madura Limited

10.4 ICICI Bank and Sangli Bank

10.5 HDFC and Times Bank 10.6 Oriental Bank of Commerce and Global Trust Bank

10.7 Federal Bank and Ganesh Bank of Kurundwad Ltd 10.8 Bank of Baroda and Benares State Bank Ltd

2930303031323333

7. Conclusion 34

8. AnnexureBibliography3638

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CHAPTER 1

Indian Banking Sector

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STRUCTURE OF THE BANKING INDUSTRY

According to the RBI definition, commercial banks which conduct the business of bankingin India and which (a) have paid up capital and reserves of an aggregate real and

exchangeable value of not less than Rs 0.5 mn and (b) satisfy the RBI that their affairsare not being conducted in a manner detrimental to the interest of their depositors, areeligible for inclusion in the Second Schedule to the Reserve Bank of India Act, 1934, andwhen included are known as ‘Scheduled Commercial Banks’. Scheduled CommercialBanks in India are categorized in five different groups according to their ownershipand/or nature of operation. These bank groups are (i) State Bank of India and itsassociates, (ii) Nationalised Banks, (iii) Regional Rural Banks, (iv) Foreign Banks and (v)Other Indian Scheduled Commercial Banks (in the private sector). All Scheduled Bankscomprise Schedule Commercial and Scheduled Co-operative Banks. ScheduledCooperative banks consist of Scheduled State Co-operative Banks and Scheduled UrbanCooperative Banks

.

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Banking Industry at a Glance

In the reference period of this publication (FY06), the number of scheduled commercial

banks functioning in India was 222, of which 133 were regional rural banks. There are

71,177 bank XIV offices spread across the country, of which 43 % are located in rural

areas, 22% in semi-urban areas, 18% in urban areas and the rest (17 %) in the

metropolitan areas. The major bank groups (as defined by RBI) functioning during the

reference period of the report are State Bank of India and its seven associate banks, 19

nationalised banks and the IDBI Ltd, 19 Old Private Sector Banks, 8 New Private Sector

Banks and 29 Foreign Banks.

Table 1: Indian Banking at a Glance

Source: Reserve Bank of India

Table 2: Number of Banks, Group Wise

Source: Indian Banks’ Association/ Reserve Bank of India.

* Includes Industrial Development Bank of India Ltd.

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Table 3: Group Wise: Comparative Average

Source: Reserve Bank of India.

Deposits and Credit

II.1 Credit Deposit RatioThe credit-deposit ratio (C-D ratio) provides an indication of the extent of credit

deployment for every unit of resource raised in the form of deposits. The C-D ratios of all

scheduled commercial banks decreased gradually from 63.3 per cent in 1980 to 49.3

percent in 2000. This declining trend has been reversed in the recent years, with the

ratio increasing to 62.7 per cent in 2005. The foreign bank group recorded the highest C-

D ratio (87.1 per cent) and State Bank Group the lowest (56.3 per cent) in 2005. The C-

D ratios of all the bank groups had fallen drastically in 2000, except for foreign banks.

With respect to domestic private sector banks group, this ratio was high at 70.5 per cent

in 2005. With respect to State Bank Group and nationalised bank group, the C-D ratios

were lower at 56.3 per cent and 61.3 per cent, respectively, which were less than the C-

D ratio of all scheduled commercial banks at 62.7 per cent in 2005.

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Capital To Risk-weighted Assets Ratio (CRAR)

The capital to risk weighted assets ratio (CRAR) is an indicator for assessing soundness

and solvency of banks. Out of 92 scheduled commercial banks, 75 banks could maintain

the CRAR of more than 8 per cent during the year 1995-96, when the prescribed CRAR

was8 per cent. During 1999-2000, 96 banks maintained CRAR of 9 to 10 per cent and

above when the prescribed rate was 9 per cent. In 2004-05,

out of 88 scheduled commercial banks, 78 banks could maintain CRAR of above 10 per

cent and 8 banks between 9 and 10 per cent.

Distribution of scheduled commercial banks by CRAR

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CHAPTER 2

LITERATURE REVIEW :

CONSOLIDATION OF BANKS

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Methods of consolidation

In general terms, consolidation of the financial services sector involves the resources of

the industry becoming more tightly controlled, either because the number of key firms

are smaller or the rivalry between firms is reduced. Consolidation may result from

combinations of existing firms, growth among leading firms, or industry exit of weaker

institutions. This chapter focuses primarily on the first of these causes. There are several

alternatives for firms combining with each other. Each has its strengths and weaknesses

and may be particularly appropriate in certain situations.

two classes of methods: (1) mergers and acquisitions and (2) joint ventures and strategic

alliances.

The primary methods of consolidation employed by firms are mergers and acquisitions.

With both of these methods, two formerly independent firms become commonly

controlled.

the terms merger and acquisition are used interchangeably to refer to transactions

involving the combination of two independent firms to form one or more commonly

controlled entities. The distinction between a merger and an acquisition i somewhat

vague. A merger is often defined as a transaction where one entity is combined with

another so that at least one initial entity loses its distinct identity. Thus, full integration of

the two firms takes place and control over a single entity can easily be exercised. An

acquisition is often classified as a transaction where one firm purchases a controlling

stake of another firm without combining the assets of the firms involved. Relative to

acquisitions, mergers provide a greater level of control, because there is only one

corporate entity to manage. Acquisitions are most appropriate when there are

operational, geographic or legal reasons to maintain separate corporate structures.

Mergers and acquisitions are also sometimes distinguished by defining mergers as

transactions involving two firms that are of essentially equal size, while acquisitions are

transactions where one party clearly obtains control of another. A partial, or non-

controlling, acquisition is similar to an acquisition of a controlling interest, except that, as

the name implies, the acquiring firm does not establish control. Such deals encourage

cooperation between potential rivals, because they establish a common interest among

the firms. Partial acquisitions may also serve as a first step for firms before engaging in

more complete consolidations of control.

Joint ventures and strategic alliances enable firms to work together without either firm

relinquishing control of its own operations and activities. Strategic alliances are

partnerships between independent firms that involve the creation of tangible or intangible

assets. The level of collaboration is often fairly low and focused on a well-defined set of

activities, services or products. Strategic alliances may be most appropriate for the

exchange of technical information and sophisticated knowledge or when there are legal,

regulatory or cultural constraints making a more thorough collaboration difficult or illegal.

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Moreover, relative to mergers and acquisitions, strategic alliances generally involve

lower formation and dissolution costs. Like partial acquisitions, strategic alliances may

enhance cooperation among firms or serve as a first step towards a merger or

acquisition. A joint venture, which may be viewed as a type of strategic alliance, occurs

when two or more independent firms form and jointly control a different entity, which is

created to pursue a specific objective. This new entity typically draws on the strengths of each partner. Joint ventures facilitate consolidation, because they enable firms to develop

strong ties. Joint ventures may also serve as a precursor to more comprehensive

consolidation such as mergers.

Mergers and acquisitions in the financial sector are undertaken for a wide variety of

reasons. In any given case, more than one motive may underlie the decision to merge.

Motives may vary with firm characteristics such as size or organisational structure, over

time, across countries, across industry segments, or even across lines of business within

a segment. In the framework used in this chapter, the motives for mergers and

acquisitions are broken down into two basic categories: value-maximising motives and

non-value-maximising motives. In a world characterised by perfect capital markets, all

activities of financial institutions would be motivated by a desire to maximise shareholder

value. In the “real” world, while value maximisation is an important factor underlying

most decisions, other considerations can, and often do, come into play.

Value-maximising motives

The value of a financial institution, like any other firm, is determined by the present

discounted value of expected future profits. Mergers can increase expected future profits

either by reducing expected costs or by increasing expected revenues.

Mergers can lead to reductions in costs for several reasons, including:

• economies of scale (reductions in per-unit cost due to increased scale of operations);

• economies of scope (reductions in per-unit cost due to synergies involved in producing

multiple products within the same firm);

• replacement of inefficient managers with more efficient managers or management

techniques;

• reduction of risk due to geographic or product diversification;

• reduction of tax obligations;

• increased monopsony power allowing firms to purchase inputs at lower prices;

• allowing a firm to become large enough to gain access to capital markets or to receive

a credit rating;

• providing a way for financial firms to enter new geographic or product markets at a

lower cost than that associated with de novo entry.

Mergers can lead to increased revenues for a variety of reasons, including:

• increased size allowing firms to better serve large customers;

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increased product diversification allowing firms to offer customers “one-stop shopping”

for a variety of different products;

• increased product or geographic diversification expanding the pool of potential

customers;

• increased size or market share making it easier to attract customers (visibility or

reputation effects);• increased monopoly power allowing firms to raise prices;

• increased size allowing firms to increase the riskiness of their portfolios.

Non-value-maximising motives

Managers’ actions and decisions are not always consistent with the maximisation of firm

value. In particular, when the identities of owners and managers differ and capital

markets are less than perfect, managers may take actions that further their own personal

goals and are not in the interests of the firm’s owners. For example, managers may

derive satisfaction from controlling a larger organisation or from increasing their own jobsecurity. Thus, they might engage in mergers designed to increase the size of the firm or

reduce firm risk, even if such mergers do not enhance firm value. Managers may acquire

other firms in order to avoid being acquired themselves (defensive acquisitions), even if

being acquired would benefit the firm’s owners. In some cases, managers may care

about the size of their firm relative to competitors, leading them to engage in

consolidation simply because other firms in the industry are doing so.

Forces encouraging consolidation

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This section is concerned with the external forces that have encouraged consolidation in

the financial services industry. More generally, much of the ongoing restructuring in

financial services has been a strategic response on the part of market participants to

changes in the competitive environment. Among the major forces creating pressure for

change are:

• Technological advances;

• Deregulation; and• Globalisation of the marketplace.

1. Technological changes

Technology has both direct and indirect effects on the restructuring of financial services.

Direct effects of technology may include:

• Increases in the feasible scale of production of certain products and services (eg. credit

cards and asset management);

• Scale advantages in the production of risk management instruments such as derivative

contracts and other off-balance sheet guarantees; and

• Economies of scale in the provision of services such as custody, cash management,

back office operations and research

2. Deregulation

Governments influence the restructuring process in a number of ways:

• Through effects on market competition and entry conditions (eg placing limits on or

prohibiting cross-border mergers or mergers between banks and other types of service

providers);

• through approval/disapproval decisions for individual merger transactions;

• through limits on the range of permissible activities for service providers;

• through public ownership of institutions; and

• through efforts to minimise the social costs of failures

3. Globalisation

Globalisation is in many respects a by-product of technology and deregulation.

Technological advances have lowered computing costs and telecommunications, while at

the same time greatly expanding capacity, making a global reach economically more

feasible. Deregulation, meanwhile, has opened up many new markets, both in developed

and in transition economies. As a factor encouraging consolidation, globalisation largely

affects institutions providing wholesale services

Forces discouraging consolidation

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• When two banks merge into one then there is an inevitable increase in the size of

the organization. Big size may not always be better. The size may get too widely

and go beyond the control of the management. The increased size may become a

drug rather than an asset.

• Consolidation does not lead to instant results and there is an incubation period

before the results arrive. Mergers and acquisitions are sometimes followed by

losses and tough intervening periods before the eventual profits pour in. Patience,

forbearance and resilience are required in ample measure to make any merger a

success story. All may not be up to the plan, which explains why there are high

rate of failures in mergers.

• Consolidation mainly comes due to the decision taken at the top. It is a top-heavy

decision and willingness of the rank and file of both entities may not be

forthcoming. This leads to problems of industrial relations, deprivation, depression

and de-motivation among the employees. Such a work force can never churn out

good results. Therefore, personal management at the highest order with humane

touch alone can pave the way.

• The structure, systems and the procedures followed in two banks may be vastly

different, for example, a PSU bank or an old generation bank and that of a

technologically superior foreign bank. The erstwhile structures, systems and

procedures may not be conducive in the new milieu. A thorough overhauling and

systems analysis has to be done to assimilate both the organizations. This is a

time consuming process and requires lot of cautions approaches to reduce the

frictions.

• There is a problem of valuation associated with all mergers. The shareholder of

existing entities has to be given new shares. Till now a foolproof valuation system

for transfer and compensation is yet to emerge.

• Further, there is also a problem of brand projection. This becomes more

complicated when existing brands themselves have a good appeal. Question arises

whether the earlier brands should continue to be projected or should they be

submerged in favour of a new comprehensive identity. Goodwill is often towards a

brand and its sub-merger is usually not taken kindly

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CHAPTER 3

OBJECTIVE

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Problem:-

Now with the end of the financial crisis, there shall be resurrection of banks and

financial institutions all over the world. Indian banking industry was the least

affected from this crises because of strong fundamentals and prudent policymakers

and thus it shall be the fastest growing banking sector. This scenario along with

the increased FDI limits in the private banks shall intensify the level of competition

in the banking industry. Though there are 290 banks operating in our country but

still none of them is among the top 50 banks at global level, SBI the largest Indian

bank is ranked 52nd globally with other 5 banks among top 1000 banks. Out of

these 290 banks, 80 banks are catering to only 2% of the industry. As per the

chairman of SBI, “India needs atlest 3 globally reputed banks and 5 banks

equivalent to the size of SBI. This shows the need of consolidation of Indian

banking industry.

objectives

The main objective of the project is:

“To study process and consequences of consolidation of banking sector of

India”

However, the specific objectives can be stated as:

• To understand the present scenario & upcoming trends in Indian banking system.

• To analyze the basic needs for reforms in banking system, and of consolidation particularly.

• To find out & analyze management’s perception about the consolidation throughMerger & Acquisitions.

• To evaluate some of the recent cases of consolidatory activities in the bankingsector and to analyze them from the customers and investors perspectives.

• To evaluate the pros and cons of consolidation in the banking industry .

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CHAPTER 4

MethodologyAnd

Data Analysis

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Methodology

After doing the literature review and understanding the motives of the merger of banks inIndia and benefits achieved there by. It is tried to validate with help of the data if the

benefits of the merger are there in the Indian banking sector .For this study I have

chosen the time period from 1999 to 2006 .The data for 8 significant deals which have

happened during this period has been collected as the time series data. In all the deals

which have been selected between the banks a caution has been taken so that only those

deal are selected for which only 2 banks are involved in the merger. After collection of

data various empirical methods have been applied on the data to validate or refute the

arguments stated in the literature review section and then giving the conclusion on the

basis of the observed results .The data required for the analysis is:

1. Returns of the stock of the banks

2. Expected Rate of return for the stock

3. Cumulative abnormal return

Returns of the stock have been calculated by comparing the closing stock price on the t

day (Day zero) to the closing stock price of the stock on t-1 day. The expected rate of

the return is calculated using the using the capital asset pricing model.

The expected return is calculated as follows:

Expected return = _ + _ * RM

α + β: these are aspects which are related to a individual stock,

RM return of market

α alpha is an intercept of minimum rate of return.

β is a beta which implies the systematic risk of a stock.

α & β are calculated by running a linear regression and then Abnormal returns are

calculated

Abnormal Return = Actual stock – Expected Return on Stock

After a T-TEST is run at confidence level of 95% to verify if there is any significant

change in the CAR calculated. It is this which will indicate the effect of the merger. Also

another test which has been applied to check the financial performance of the banks is

the EVA method .Economic Value Added is a measure of the financial performance of the

banks .EVA method is the invention of the Stern Steward and Co which was launched in

1989.

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DataThis report till now talks about the merger and its benefits in Indian context .To check

how many mergers have been profitable to the banks in India the paper has short listed

8 deals which have happened in the Indian banking sector from the period 1999 to 2006.

The deals which have happened in 2007 have not been included because it would not be

possible to study the effect of merger due to the less number of time periods available

after 2006 .that is post merger years. Also only deals where only two banks have been

involved have been selected.

After selecting the deals we applied two empirical methods on it. To study the short term

impact we applied the t-test and for long term impact we applied EVA (Economic value

added method). T-Test To study the T-Test on the data we selected a time series data of

the closing prices of the stock from 1999 to 2007 and then found the return of these

stocks. We found the intercept and the slope of these stocks and by applying the CAPM

formula we found the expected return on the stocks. Then this expected return was

subtracted from the actual return to arrive at the abnormal return .Over the period of 30

days pre and post merger the abnormal returns where found and t-test was applied on

these abnormal returns .If the value given by the t-test is less than .05 then thehypothesis which is that the data sets are similar over the period of study is rejected and

we conclude that the significant effect of merger is prevalent.

To study the long term effect of merger another indicator is the EVA. We calculated the

EVA pre merger, in the year of merger and post merger which gives us the idea of the

efficiency of the merger. All the data has been analysed from the acquiring banks

perspective.

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EVA gives us a clear understanding of the values which the banks create over a period of

time .It connects the theories of Finance with the strategy of competitive markets given

by Michael Porter. For the operations of the banks the EVA is used as a common measure

by many banks like Citi Bank, Barclays etc .Many Indian banks also use EVA to calculatetheir profits by EVA method like ICICI Bank, HDFC etc which in itself justifies the reason

of using EVA for our methodology for calculating the profits of the banks .Whenever the

benefits of the decisions taken by the banks are more than the cost involved in its

structure, it creates the value for the Bank. Most of the strategies of the banks create

value for the bank over a period of some -time which may be in distant future and thus

when ever profitability of the bank’s merger is to be calculated it should be done through

EVA method. There are two sensitive drives of the value creation in the banks .Firstly

how fast the funds are moved and how much of these funds create further value which is

more than the cost factor of generating these funds which clearly given by the EVA of the

banks Another important thing to be understood in terms of the mergers of the banks is

difference between the projects and strategies. For projects it is best to calculate the NPV

or IRR to check for the feasibility of the projects .For strategies one should check the EVA

and the decision of the merger should be based on the EVA calculated from estimation of

the strategies of the merger.

Limitation of ratios

Many accounting fundaments such as Price Earnings, Return of Equity, Return of Net,

Book Value do not give a clear understanding of the major variables which are the value

drives .These all ratios are prone to window dressing by the mischievous management

.Also these measures use the historical data to arrive at the conclusions .EVA also very

beautifully raises the point of how the shareholders of the bank expect a certain rate of

return for taking the risk of investing in the bank

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Chapter 5

RESULT

Discussion and analysis

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Discussion and Analysis

Centurion Bank and Bank of Punjab Deal Bank of Punjab in order to meet the credit requirements sold 15 % of its shares and this

led to a sharp decrease in the stock price of Bank of Punjab .This happened in Feb. 2005.

As the basic concept of the merger whenever the company’s stock prices drop down

drastically then it becomes the target for a acquisition .In this case finally the Centurion

bank which wanted to expands its arms in northern part of India and more so in the

agricultural belts of Punjab acquired the Bank of Punjab in June, 2005. The combined

entity was known as Centurion bank of Punjab and it had 235 outlets with a customer

base of 2.2 million .This deal was perceived by the market as the good deal because of

the cost factor and the synergies of merger in terms of geographical expansion .Tomeasure the benefits of this deal we ran the t –test on this deal with the time period of

t+30 ,t-30 ,t .This was to check the effect of the merger before and after using the CAPM

and t-test and to establish that has merger shown any effect over a short period of

time .As per t-test which was done on a sample from time period 1999 – 2007 .The value

of t-test for this deal for t+30 ,t-30 is coming out be .96 which is quite high and accepts

our hypothesis that the merger has not had a significant effect on the abnormal returns

of the bank pre merger and post merger . Cumulative abnormal returns have also not

changed over a period of time interval t + 30 and t-30.This shows that over a short

period of time merger did not effect the returns .Then we studied effect of merger over a

long period of time that is one year .This was done through the method of EVA .The dealtook place in 2005 so we calculate the economic value added by the merger in the year

2004 ( the year before the merger ) ,2005 the year of the merger and 2006( the post

merger year ) .As per the data observed in Table -1 for the Centurion bank which is

acquirer bank had an EVA value of negative 50.49. .In the year of the merger its value

increase to 154.61 which is a clear indication that the even the news of the merger of the

two banks did create an upsurge it its profitability. To see the long term effect of the

merger we observed that the 1 year post merger the value of EVA was 421.31. This was

a tremendous increase in the Economic value of the bank which had an intermingled

effect of merger news with Lord Krishna Bank which the bank was going to go through.

The positive effects of this merger was validated even by the stock market with increasein its stock price by 2.1 percent when the news of merger broke out .This is an indication

that merger was successful.

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Centurion Bank and Lord Krishna Bank The merger between the lord Krishna bank and Centurion bank was more of a RBI driven

merger to safe guard the interests of the depositors .This deal took place finally on 04-

09-2006. As has been talked about in this paper above that many mergers in Indian

banking scenario also happen due to the managed M & A activity by legislature or more

clearly RBI .In this case as well we studies the effect of the merger on returns by t-test

for time period t, t+ 30 and t-30 days where in t stand for the date of the merger. The

value which we get from the t-test is .305 .As the t-test has been done on 95 %

confidence level this accepts the hypothesis that the merger did not show any significant

effect on the bank’s returns. For the significant returns to be shown and to reject the null

hypothesis of t-test we should get the value of .05 or below for the t-test. Also the

cumulative abnormal returns 30 days prior to and post merger did not show any

change .This shows that the within a short period of 30 days the merger did not show

any signs .Also the news of the merger did not create any significant ripples in the

market .To understand the effect of the synergy derived over a long period of time we

applied the EVA test on this merger as well .The EVA for the year before the merger that

is 2005 is 154.61 for the year of the merger it is 421.31 which is a very high value .Even

though the banks spend the money for the merger and the economic value should have

ideally either remained same or marginally increased .But in this case we see a very high

value of EVA .This is contributed due to dual effect .The market had very well accepted

the merger with Lord Krishna bank and this increased the credit worthiness of the

merged entity .But the main factor for such an increase in the EVA was the post merger

gain with the Bank of Punjab which had started to show the effect .This compound effect

really pulled the EVA value high for Centurion bank .The Centurion Bank become the 4th

largest bank after the deals and in the post merger year 2007 its EVA continued to be

good and upwards which is an indication that the merger was successful.

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ICICI Bank and Bank of Madura Limited This deal too place in the month of December 2000 .At that time ICICI bank did not have

very strong holdings in southern part of India .This deal was done to increase the

presence of ICICI in southern India. ICICI bank paid $70 mn min in share swap to buy

Bank of Madura limited .This deal made ICICI bank 33 percent bigger than HDFC ,its rival

.This deal provided ICICI bank with the synergies that enhanced its brand image

,branches and gave it additional 2.6 million customer and 263 branches in southern

India. The author of this paper checks the short term gains and to gauge the market

reaction using the t-test over short period .The t –test give us a value of .27 which again

accepts our hypothesis that the merger did not show gains over a short period of 30 days

pre and post merger and that the abnormal returns where almost similar .Even though

the value of the t-test is coming out to be .27 which is low and some variation is

abnormal returns can be seen but it is not significant enough in term of merger point of

view. Also the cumulative returns given in the table -3 below shows that the values have

not changed much which is an indication that within short period of 30 days there was no

abnormality of returns pre and post merger. But the gains from the merger were high

over the long period of time.

ICICI Bank and Sangli Bank The deal between ICICI Bank and Sangli Bank took place in Dec 2006 which is exactly 6

years after the deal of ICICI bank with Bank of Madura Limited .Sangli Bank was a non

listed bank .The deal structure was in the ratio of 1 share of ICICI for 9.25 shares of

Sangli Bank .By the market value the deal size was 302 crores .Sangli bank was held 30% by Bhate family of Sangli . On the analysis of the returns of 8 years and applying t –

test we get a value of .772 which accepts our hypothesis that the merger has did not

created any change in the returns over a short period of 30 days .The cumulative returns

over a short period of 30 days turned negative from positive value which was pre merger.

Details of which can be seen in table -3 To study the effort over the long period of time

through the calculation of the EVA for the given deal pre merger , on the year of the

merger ,post merger and which is shown in table -1 which is 3191.919 for the pre

merger year ,2688.00 for the merger year and 5293.31 for the post merger year .This

EVA gives us a clear understanding how the value has been created for the ICICI by this

merger over a long period of time .Synergies from this deal have realised over a periodof 1 year .During the year of merger the EVA had gone down due the extra shares which

the company had to release and money spend over the deal which had effected the

bottom-line of the bank and over the period of the one year the economics of scale

benefits where realised and the EVA jumped up to 5293.31.This was due the inroads

which the ICICI could get into the interior of Maharastra state in India through the

branches of Sangli bank where had a major customer base in these places. This merger

of the Indian bank was also a success. and the benefits talked about in the beginning

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EVA increased to 850.27.This is also a clear indication that banks do benefit over a long

period of time from merger

Federal Bank and Ganesh Bank of Kurundwad Ltd This was a small merger in the Indian banking context .The Ganesh Bank of Kurundwad

was a bank of Maharashtra which was under moratorium to safeguard the investors

money.So at that time Federal Bank which was a private bank asked the RBI to permit

them to merge Ganesh Bank of Kurundwad with it .Even though Ganesh Bank of

Kurundwad had only 32 branches but this was a strategic decision for Federal bank as it

gave federal bank in roads into the agricultural belt of Maharastra. In the short run the

Federal Bank did not have any change or gain from the merger as could be seen by the t-

test done over t-30 and t + 30 days whose value is coming out to .735 .This suggests

that the hypothesis is accepted that the bank has not benefited over a short period of

time .To see the effect of the merger over a long period of time we could see that the

merger was really very effective .The Federal bank could capitalise on the inroads which

it got from the Ganesh Bank of Kurundwad in the agricultural sector of Maharastra and its

Economic value one year prior to merger ,in the year of the merger and post merger was

185.18 ,259.30 and 406.52. Merger is beneficial if it is sustained and in this case it was

sustained as well .The data shows clearly the benefit of the merger and the value added.

Bank of Baroda and Benares State Bank Ltd This deal between the banks took place in 2002. Benares State Bank Ltd was a bank in

Uttar Pradesh in India with the 105 branches and 2.35 billion rupees .As at that point of

time most banks in India where trying to expand their customer base and thereby

increase the consumer banking business. Benares State Bank helped Bank of Baroda in

this aspect. On Analysis of the deal to understand the benefits of merger of these bank, icarried out the t-test which gave a value of .277 which is indication that the hypothesis

has been accepted and the merger has not shown any benefits over a short period of

time .On doing a long term analysis of the merger of the bank by calculating the EVA of

the banks before the year of merger ,during the year of merger and after the year of

merger which can be seen from the table below as 906.92,1181.21,1063.83 respectively

which is the indication that even though some benefits where achieved due to the merger

process but they could not be sustained as the benefit of the merger seen through EVA

value has dropped down .

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Chapter 6

Conclusion

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Conclusion

This paper attempted to provide an analysis of ongoing merger trends in Indian banking

from the view point of two important stakeholders of a banking firm—stock holders and

managers. The trend of consolidation in Indian banking industry bas so far been limited

mainly to restructuring of weak banks and harmonization of banks and financialinstitutions. Voluntary mergers demonstrating market dynamics are very few. We

strongly support the view that the Indian financial system requires very large banks to

absorb various risks emanating from operating in domestic and global environments. We

argue that the challenges of free convertibility, Basel-II environment, widening of

financial services activity, and need for large investment banks are the prime drivers of

future consolidation. More voluntary mergers are possible, provided the benefits of

mergers are derived by all the stakeholders of the banks. Currently the forced mergers

may be protecting the interests of depositors but shareholders of both bidder and target

banks are not, necessarily perceived as beneficiaries of the merger. The event study

analysis results, show that both bidder and target banks' market value of equity bas beenreduced on the immediate announcement of mergers. In the case of voluntary mergers,

the results are mixed. Our survey shows that bank managements are strongly in favour

mergers. However, they opine that there are several critical issues, which are to be

bandied carefully to make a merger successful. These are valuation of target bank loan

portfolio, valuation of equity, integration of IT platforms, and issues of human resource

management. Banks are optimistic about realizing the merger gains such as exploration

of new markets and reduction in operating expenses. Based on these results, on the

policy side, we suggest that RBI should activate the Prompt Corrective Mechanism that

helps in identifying the sick banks and advance the timing of the merger to avoid total

collapse of the bank. This will also help the bidder banks to formulate appropriatestrategies, which may mitigate the dilution in market value of equity consequent upon

merger. To ensure the availability of financial services to all segments of the population,

RBI should approve voluntary mergers, conditional upon the disadvantaged segments

being unaffected by the process, and approval should be linked to specific plans offered

by the acquirers to mitigate the extent of financial exclusion. The ongoing consolidation

trends in Indian banking raise some important questions. Is it fair and desirable on the

part of RBI to merge the weak banks with well performing banks, which destroys the

wealth of bidder banks? Being a majority shareholder, the Government of India appears

to be ignoring the interest of minority shareholders. This is a serious concern of corporate

governance. In the case of two forced mergers, viz., GTB with OBC, and Bharat OverseasBank with Indian Overseas Bank, the share prices of these two acquired banks have not

shown any significant increase even after a substantial time gap from the merger. In the

post-reform period almost all the public sector banks have improved their performance in

terms of profitability, low NPAs and raised fresh equity from the capital markets at a

good premium. Forced mergers may be detrimental to the further growth of these banks.

Dilution of government ownership may be a prerequisite to improve operational freedom

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and to devise performance linked incentives for public sector employees, which are

essential to tackle the post-merger problems arising out of forced

mergers. Another issue, which is completely ignored, is the impact of consolidation on

customers, especially small borrowers who are dependent on the banking channel. The

other consolidation model, which is simultaneously in progress, is operational

consolidation among banks. The largest public sector bank, State Bank of India is being

operationally integrated with its subsidiaries in providing various banking services. Aboveall, we firmly believe that certain corporate governance issues are to be solved on a

priority basis before implementation of merger agenda

35



ANNEXURE

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