ProjecCHALLENGES AND CONSOLIDATION OF BANKS IN INDIAt

8/13/2019 ProjecCHALLENGES AND CONSOLIDATION OF BANKS IN INDIAt

1/72

CHALLENGES AND CONSOLIDATION OF BANKS IN

INDIA.

Bachelor of Commerce

Banking & Insurance

Semester V

[2013-2014]

Guided by

Mrs. Celsa

Submitted by- Minal.v.Dalvi

Roll No. 06

ST. GONSALO GARCIA COLLEGE

Vasai, Dist. Thane


2/72


3/72

ST. GONSALO GARCIA COLLEGE

Vasai, Dist. Thane

CERTIFICATE

This is to certify that Shri. Minal.v.Dalvi

Roll No. 06 student of ST. Gonsalo Garcia College has completed the Project on

CHALLENGES AND CONSOLIDATION OF BANKS IN INDIA in the

year 2013-2014 in fulfillment of B.Com. Banking & Insurance. He has

successfully completed the project under the guidance of Mrs. Celsa

COURSE CO-ORDINATOR PRINCIPAL

INTERNAL EXAMINER EXTERNAL EXAMINER


4/72

DECLARATION

I hereby declare that the Project report titled CHALLENGES AND

CONSOLIDATION OF BANKS IN INDIA is my original work to the best of

my knowledge and has not been published or submitted for any degree, diploma or

other similar titles elsewhere. This has been undertaken for the purpose of partial

fulfillment of B.Com. Banking & Insurance at St. Gonsalo Garcia College.

Date: Signature of Student:-

Name of the Student: - Minal.v.Dalvi

Roll No. : - 06


5/72

ACKNOWLEDGMENT

It is really a matter of pleasure for me to get an opportunity to thank all the persons

who contributed directly or indirectly for the successful completion of the project

report, Employee Turnover and Retention in Banks.

First of all I am extremely thankful to my college St. Gonsalo Garcia collegefor providing me with this opportunity and for all its cooperation and

contribution. I also express my gratitude to my Project mentor and guide

Mrs. Celsa

I am highly thankful to our respected project guide for giving me the

encouragement and freedom to conduct my project.

I am also grateful to all my faculty members for their valuable guidance and

suggestions for my entire study.

Minal.v.Dalvi

Roll No.: 06


6/72

CHALLENGES AND CONSOLIDATION OF

BANKS IN INDIA


7/72

INDEX

Sr. No TITLE Page No.

Remark

01.

02.

03.

04.

05.

06.

07.

08.

09.

10.

11.

12.

13.

14.

15.

16.17.

18.

19.


8/72

20.

21.22.

23.

24.

25.

26.

27.28.

29.

30.


9/72

Executive Summary

Consolidation is the present banking industry scenario; banking sector isheading towards a more compact and consolidated shape. This project has beentaken to understand the need of consolidation from Indian banks perspective.Consolidation activity in India both domestic and cross-border has explosive

growth in recent years. Along with it there are certain organizational &strategic issues tha t has to be taken care of before this sort of consolidatemove.

"Consolidation alone will give banks the muscle, size and scale to act like world-class banks. We have to think global and act local and seek new markets,new classes of borrowers. It is heartening to note that the Indian Banks'Association is working out a strategy for consolidation among banks."

The consolidation on the profitability, efficiency and synergistic effect in bankingindustry. It includes conceptual definition by different scholars and reviews ofinternational, national empirical research papers, where-by a lot of conclusions ofstudies on the impact of consolidation in different areas of the banking industryhave been reviewed.


10/72

Objectives Of Consolidation

As seen above, each business unit in the same bank has multiple applications

and in addition, these applications overlap among other business units as well.

There is a strong business case for a consolidation exercise to rationalize them

within each business units. The objectives could be rationalization of

overlapping applications among Business Units, rationalization of applications

within each Business Unit, decommissioning applications which are rarely used

or obsolete and retaining or replacing with more efficient applications which

are specific to the Business Unit and has no overlap either with the Business or

other Business Units

improve the underlying strength of the economy, attempt to ensure against future crises and further the fundamental

developmental;

Objectives of growth with equity and self reliance.


11/72

Overview Of Banking

Evolution of banking in India

Modern banking in India could be traced back to the establishment of Bank ofBengal (Jan 2, 1809), the first joint-stock bank sponsored by Government ofBengal and governed by the royal charter of the British India Government. It wasfollowed by establishment of Bank of Bombay (Apr 15, 1840) and Bank ofMadras (Jul 1, 1843). These three banks, known as the presidency banks, markedthe beginning of the limited liability and joint stock banking in India and werealso vested with the right of note issue.

In 1921, the three presidency banks were merged to form the Imperial Bank of

India, which had multiple roles and responsibilities and that functioned as acommercial bank, a banker to the government and a bankers bank. Following theestablishment of the Reserve Bank of India (RBI) in 1935, the central bankingresponsibilities that the Imperial Bank of India was carrying out came to an end,leading it to become more of a commercial bank. At the time of independence ofIndia, the capital and reserves of the Imperial Bank stood at Rs 118 mn, depositsat Rs 2751 mn and advances at Rs 723 mn and a network of 172 branches and 200sub offices spread all over the country.

In 1951, in the backdrop of central planning and the need to extend bank credit tothe rural areas, the Government constituted All India Rural Credit SurveyCommittee, which recommended the creation of a state sponsored institution thatwill extend banking services to the rural areas. Following this, by an act of

parliament passed in May 1955, State Bank of India was established in Jul, 1955.In 1959, State Bank of India took over the eight former state-associated banks asits subsidiaries. To further accelerate the credit to fl ow to the rural areas and thevital sections of the economy such as agriculture, small scale industry etc., that areof national importance, Social Control over banks was announced in 1967 and a

National Credit Council was set up in 1968 to assess the demand for credit by

these sectors and determine resource allocations. The decade of 1960s alsowitnessed significant consolidation in the Indian banking industry with more than500 banks functioning in the 1950s reduced to 89 by 1969.

For the Indian banking industry, Jul 19, 1969, was a landmark day, on whichnationalization of 14 major banks was announced that each had a minimum of Rs500 mn and above of aggregate deposits. In 1980, eight more banks were


12/72


13/72

The reforms led to significant changes in the strength and sustainability of Indian banking. In addition to significant growth in business, Indian banks experiencedsharp growth in profitability, greater emphasis on prudential norms with higher

provisioning levels, reduction in the non performing assets and surge in capitaladequacy. All bank groups witnessed sharp growth in performance and

profitability. Indian banking industry is preparing for smooth transition towardsmore intense competition arising from further liberalization of banking sector thatwas envisaged in the year 2009 as a part of the adherence to liberalization of thefinancial services industry.


14/72


15/72


16/72

number of players in the banking industry. Thereby reduced corporate credit off

which has resulted in large number of competitors battling for the same pie.

2. Modified New rules:

As a result, the market place has been redefined with new rules of the game. Banks

are transforming to universal banking, adding new channels with lucrative pricing

and freebees to offer. New channels squeezed spreads, demanding customers better

service, marketing skills heightened competition, defined new rules of the game

pressure on efficiency. Need for new orientation diffused customer loyalty. Bank

has led to a series of innovative product offerings catering to various customer

segments, specifically retail credit.

3. Efficiency:

Excellent efficiencies are required at banker's end to establish a balance between

the commercial and social considerations Bank need to access low cost funds and

simultaneously improve the efficiency and efficacy. Owing to cut-throat

competition in the industry, banks are facing pricing pressure, have to give thrust

on retail assets.

4. Diffused customer loyalty:

Attractive offers by MNC and other nationalized banks, customers have become

more demanding and the loyalties are diffused. Value added offerings bound

customers to change their preferences and perspective. These are multiple choices;

the wallet share is reduced per bank with demand on flexibility and customization.

Given the relatively low switching costs; customer retention calls for customized

service and hassle free, flawless service delivery.


17/72


18/72

8.Global Banking:

It is practically and fundamentally impossible for any nation to exclude itself from

world economy. Therefore, for sustainable development, one has to adopt

integration process in the form of liberalization and globalization as India spread

the red carpet for foreign firms in 1991. The impact of globalization becomes

challenges for the domestic enterprises as they are bound to compete with global

players.

If we look at the Indian Banking Industry, then we find that there are 36 foreign

banks operating in India, which becomes a major challenge for Nationalized and

private sector banks. These foreign banks are large in size, technically advanced

and having presence in global market, which gives more and better options and

services to Indian traders.

9.Employees Retention :

The banking industry has transformed rapidly in the last ten years, shifting from

transactional and customer service-oriented to an increasingly aggressiveenvironment, where competition for revenue is on top priority. Long-time banking

employees are becoming disenchanted with the industry and are often resistant to

perform up to new expectations. The diminishing employee morale results in

decreased revenue. Due to the intrinsically close ties between staff and clients,

losing those employees completely can mean the loss of valuable customer

relationships. The retail banking industry is concerned about employee retention

from all levels: from tellers to executives to customer service representatives

because competition is always moving in to hire them away. The competition to

retain key employees is intense.


19/72

Top-level executives and HR departments spend large amounts of time, effort, and

money trying to figure out how to keep their people from leaving.

10.Customer Retention:

The major determinants of customer satisfaction and future intentions in the retail

bank sector. They identified the determinants which include service quality

dimensions (e.g. getting it right the first time), service features (e.g. competitive

interest rates), service problems, service recovery and products used. It was found,

in particular, that service problems and the banks service recovery ability have a

major impact on customer satisfaction and intentions to switch.


20/72

Conclusion

Over the years, it has been observed that clouds of trepidation and drops of growth

are two important phenomena of market, which frequently changes in different setsof conditions. The pre and post liberalization era has witnessed various

environmental changes which directly affects the aforesaid phenomena. It is

evident that post liberalization era has spread new colors of growth in India, but

simultaneously it has also posed some challenges.

This article discusses the various challenges and opportunities like rural market,

transparency, customer expectations, management of risks, growth in bankingsector, human factor, global banking, environmental concern, social, ethical issues,

employee and customer retentions. Banks are striving to combat the competition.

The competition from global banks and technological innovation has compelled

the banks to rethink their policies and strategies.

we can say that the biggest challenge for banking industry is to serve the mass

market of India. The better we understand our customers, the more successful wewill be in meeting their needs. In order to mitigate above mentioned challenges

Indian banks must cut their cost of their services. Apart from traditional banking

services, Indian banks must adopt some product innovation so that they can

compete in gamut of competition. The level of consumer awareness is significantly

higher as compared to previous years. Now a days they need internet banking,

mobile banking and ATM services. Expansion of branch size in order to increase

market share is another tool to combat competitors. Therefore, Indian nationalized

and private sector banks must spread their wings towards global markets as some

of them have already done it.


21/72


22/72

the small and medium segment or the mass-market retail segment or even the

agricultural segment all are under-served. We have sub-scale banks that cannot

invest and serve their customers. Finance minister P Chidambaram recently

reiterated that India's mantra for banking reforms would be consolidation,competition &convergence to enable Public sector Banks to become stronger,

bigger and globally competitive. The logic behind is to create a few solid banks

capable of operating and competing internationally.

The Indian banking sector is crowded with nearly 100 public, private and foreign

banks and 200 regional rural banks. Consolidation in PSU banking sector will

ensure the existence of 5 to 6 public sector banks. Countries like Argentina andBrazil too have gone for consolidation and reduced the number of their banks from

118 to 80 and 253 to 180 respectively.

In India so far there has been merger and acquisition activity between private and

public sector banks with strong PSU banks. Since the advent of the era of new

generation private banks, Times bank merged with HDFC bank in February 2000,

ICICI bank acquired Chennai based Bank of Madura in December 2000 andBenares State bank merged with BOB in June 2002.

Continuing the above trend RBI merged Kozhikode-based Nedungadi bank, an old

generation private bank with Delhi based PNB in Feb. 2003.Lately, Global trust

bank, a private sector bank merged with OBC.


23/72


24/72

3) Upon consolidation, the consolidated bank shall designate and

operate one of the prior main banking houses of consolidating banks as its main

banking house and the bank may maintain and continue to operate the main

banking houses of each of other consolidating banks as a branch bank.

4) Upon consolidation, the resulting bank, including all depository institutions that

are affiliates of the resulting bank, may directly or indirectly control more than

22% of the total amount of deposits of insured depository institutions and credit

unions located in this state.


25/72

The Agreement of Consolidation

National banks proposing to consolidate should advise with the Comptroller of the

Currency and apply for his approval. If the consolidation seems advisable and theterms of it are not objectionable, the Comptroller issues instructions for procedure.

The directors of the two banks enter into an agreement covering the terms of the

consolidation, that is, with respect to the charter to be used by the consolidated

bank, the title, the capitalization, the distribution of shares to the present

stockholders of the two banks, the assets to be contributed by each and at what

valuation, the disposition of such assets as are not desired for the consolidated

bank, the continuance of the present boards of directors for the remainder of the

year, and the provision for votes of approval by the stockholders. This agreement

may provide for an increase of capitalization in excess of the aggregate

capitalization of the two banks, or for payment of cash to equalize the

contributions of assets of the two banks - the payment of these sums in cash to be

certified to the Comptroller by the officers. If by the terms of consolidation the

capitalization is reduced, it is necessary to secure the consent of the FederalReserve Board.

The agreement having been approved by the Comptroller, signed by the directors,

and acknowledged before a notary public, it is submitted to a special meeting of

the shareholders of each bank, four weeks' notice having been given in the public

press and a registered mail notice sent to each registered shareholder at least ten

days prior to the meeting. To ratify the consolidation, the vote of shareholders

owning two-thirds of the shares of each bank is required. A certificate of the

ratification is sent to the Comptroller, and he then issues his certificate approving

the consolidation.
http://chestofbooks.com/finance/banking/Banking-Principles-And-Practice-2/The-Comptroller-Of-The-Currency-Powers-And-Duties.htmlhttp://chestofbooks.com/finance/banking/Banking-Principles-And-Practice-2/The-Comptroller-Of-The-Currency-Powers-And-Duties.htmlhttp://chestofbooks.com/finance/banking/Banking-Principles-And-Practice-2/Chapter-XXVI-Charter-Changes-Consolidation-And-Liquidat.htmlhttp://chestofbooks.com/finance/banking/Banking-Principles-And-Practice-2/Election-Of-Directors-And-Officers.htmlhttp://chestofbooks.com/finance/banking/Banking-Principles-And-Practice-2/Chapter-XV-The-Federal-Reserve-Board-Membership-Of-The-Boa.htmlhttp://chestofbooks.com/finance/banking/Banking-Principles-And-Practice-2/Chapter-XV-The-Federal-Reserve-Board-Membership-Of-The-Boa.htmlhttp://chestofbooks.com/finance/banking/Banking-Principles-And-Practice-2/Chapter-XV-The-Federal-Reserve-Board-Membership-Of-The-Boa.htmlhttp://chestofbooks.com/finance/banking/Banking-Principles-And-Practice-2/Chapter-XV-The-Federal-Reserve-Board-Membership-Of-The-Boa.htmlhttp://chestofbooks.com/finance/banking/Banking-Principles-And-Practice-2/Election-Of-Directors-And-Officers.htmlhttp://chestofbooks.com/finance/banking/Banking-Principles-And-Practice-2/Chapter-XXVI-Charter-Changes-Consolidation-And-Liquidat.htmlhttp://chestofbooks.com/finance/banking/Banking-Principles-And-Practice-2/The-Comptroller-Of-The-Currency-Powers-And-Duties.htmlhttp://chestofbooks.com/finance/banking/Banking-Principles-And-Practice-2/The-Comptroller-Of-The-Currency-Powers-And-Duties.html


26/72


27/72

Methods Of Consolidation

Consolidation may be effected by placing one or both of the banks in

liquidation, to which end three methods are in use:

1. Without an increase of the capital the directors of the absorbing bank

may contract with the directors of the liquidating bank to purchase its

assets, assume its liabilities, and pay the value of assets purchased in

excess of liabilities, less any expenses incident to liquidation.

2. By increasing the capitalization of the absorbing bank by an amount

equal to that of the liquidated bank the additional shares may be sold to

stockholders of the latter. This requires the previous consent of the

stockholders of the absorbing bank. The directors of the absorbing bank

then proceed to contract for the purchase of the assets and the

assumption of the liabilities of the liquidated bank.

3. Having first placed both the interested banks in voluntary liquidation,

the interested officers may proceed to organize a new bank under a

different corporate title and acquire the business of the liquidating banks.

In any of these three methods there should be a contract covering the

transfer of assets and assumption of liabilities, and an examination of the

assets to be taken over will be made by a national bank examiner the

expense of the bank acquiring the assets.
http://chestofbooks.com/finance/banking/Banking-Principles-And-Practice-2/Chapter-XXVI-Charter-Changes-Consolidation-And-Liquidat.htmlhttp://chestofbooks.com/finance/banking/Banking-Principles-And-Practice-2/Capital.htmlhttp://chestofbooks.com/finance/banking/Banking-Principles-And-Practice-2/Amounts-And-Distribution-Of-Reserves.htmlhttp://chestofbooks.com/finance/banking/Banking-Principles-And-Practice-2/Election-Of-Directors-And-Officers.htmlhttp://chestofbooks.com/finance/banking/Banking-Principles-And-Practice-2/Election-Of-Directors-And-Officers.htmlhttp://chestofbooks.com/finance/banking/Banking-Principles-And-Practice-2/Amounts-And-Distribution-Of-Reserves.htmlhttp://chestofbooks.com/finance/banking/Banking-Principles-And-Practice-2/Capital.htmlhttp://chestofbooks.com/finance/banking/Banking-Principles-And-Practice-2/Chapter-XXVI-Charter-Changes-Consolidation-And-Liquidat.html


28/72


29/72


30/72

Reasons for Bank Consolidation

One reason for banks to consolidate is to alleviate competing institutions.

Consolidation may also occur when a banking house wants to gain domestic or

international capital power. The larger a company is, the more potential it has to

compete with other mega banks. Another motivation for banks to consolidate is the

ability for firms to expand their providing services while decreasing the cost of

operating two institutions.

Example of Bank Consolidation

On September 26, 2008, Washington Mutual, once the sixth largest bank in

America, declared Chapter 11 bankruptcy. JPMorgan Chase promptly purchased

the banking subsidiaries from the Federal Deposit Insurance Corporation. Since

then, Washington Mutual has been managed as a part of JPMorgan Chase.


31/72

Consolidation In Global Banking Sector

In the global arena the deregulation of the banking sector had a wide impact on the

banking sector .This process started in from 1980s in United States .The

deregulation resulted in price competition in the banking sector and also dis-

intermediation .As a result of this profit of the banks suffered heavy brunt. They

started to look at the avenues to increase their returns and one of the ways was

consolidation. In the global banking scenario the consolidation has been used for

cutting costs and increasing the revenue This trend took pace from 1998 onwards

when more than fourth of the merger deals involved banks .(The Economist

,1999).Even thought this trend started in US but now it has spread to othereconomics of the world. The reasons for the consolidation in US banking sector

were mainly the regulatory changes which allowed interstate ownership of the

banks, this gave the banks an avenue to scale up their branches and reap the

benefits of the economies of scale and geographical diversification. As the

legislature allowed the banks to have other investment services as well, this

resulted in increased competition and this was also a prime reason of mergers and

acquisition in the US banking sector. In Japan the reasons of consolidation were

driven by technology .The banks wanted to scale up their technology and it did not

make sense to buy a very costly technology for only a single small operation bank.

This drove the banks to consolidation and which rationalized their purchase of the

costly technology .Also this was kind of the safe wall creation to safe guard

themselves from the competition which the foreign banks would create when they

enter into the Japanese markets. In the European markets the banking sector is

highly concentrated and as the result the European banks are doing a lot of cross

border consolidation. Consolidation is a key word in the banking sector in al

economies with somewhat varying reasons or motives of consolidation.


32/72

Bank Consolidation Through Merger And Acquisition

Consolidation is achieved through merger and acquisition. A merger is thecombination of two or more separate firms into a single firm. The firm that results

from the process could take any of the following identities: Acquirer target or newidentity.

Acquisition on the other hand, takes place where a company takes over thecontrolling shareholding interest of another company. Usually, at the end of the

process, there exist two separate entities or companies. The target company becomes either a division or a subsidiary of the acquiring company .Whileconsolidation involves merger and acquisition of banks, convergence involves theconsolidation of banking and other types of financial services like securities andinsurance.

Anecdotal evidence indicates that the commonest form of mergers and acquisitionsfound in the financial services industry involves domestic firms competing in thesame segment (for instance, bank to bank). The second most common type ofmerger and acquisition transactions involves domestic firms in different segments(e.g. bank-insurance firms). Cross-border merger and acquisition are less frequents

particularly those involving firms in different industry segments.


33/72

SWOT analysis of consolidation of banks in Indian

Liquidity:

Liquidity has been a traditional strength of the Indian banking system. Banks are

required to keep a stipulated proportion of their total demand and time liabilities in

the form of liquid assets which affect their liquidity position. RBI has been

easing the requirements with several rounds of reduction in the Statutory Liquidity

Ratio (SLR) and Cash Reserve Ratio (CRR).Sound banking systems: The banking

system in India has generally been stable and sound in terms of growth, asset

quality and profitability. It is because of healthy, prudent and well capitalized

policies and practices implemented by the RBI from time to time. The same is

evident from the remarkable resilience of the Indian financial sector to the global

financial turmoil which erupted during 2008-09.

Weaknesses

Competition from foreign banks: Foreign banks will be soon allowed to spread

their business in India which will create intense competition for Indian banks. The

RBI Report on Currency and Finance presents the view that mergers are the onlyway to face competition from foreign banks. High cost of intermediation:

Intermediation cost (operating expenses as a proportion of total assets), an

indicator of competitiveness, is higher in India as compared to international levels.

High level of fragmentation: There is a high level of fragmentation, especially

among cooperative banks, as compared to some of the advanced economies of the

world, which poses a serious threat to their profitability and viability in conducting business. About 1, 00,000 entities in the cooperative sector share just 4 percent of

the total banking assets in the economy. Lack of product differentiation: The

financial products offered by banks in India are similar across the industry with no

distinctive features, thereby leading to unhealthy competition. Low penetration:


34/72

There is an uneven distribution of banking services in the country. It is limited to

few customer segments and geographies only. Of the total 611 districts in the

country, 375 districts are under-banked. There is a need for banks to open branches

at these locations and establish connectivity with the help of a core bankingsolution. According to a report on banking sector consolidation by Ernst & Young,

the country would require 11,600branches by 2013 and an additional 20,300

branches by 2018 in order to achieve the desired penetration levels of 74 per cent

and 81.5 per cent in 2013 and 2018 respectively. No competition at international

level: Indian banks are not able to compete globally in terms of fund mobilization ,

credit disbursal, investment and rendering of financial services. The main reason

behind it is the size of the industry. State Bank of India (SBI), is the worlds 57th

largest bank in the list of the top1,000 banks in the world carried in the July

2009 issue of The Banker based on its tier-I capital, or equity and reserves, for the

fiscal year ended March 2008. Similarly, in terms of assets, SBI is now the

worlds70th largest bank. On the other hand, ICICI Bank Ltd, the largest private

sector lender has attained the150th position. Based on assets, ICICI Banks world

ranking is 148th. None of the other Indian banks featured among the top 200 banks

in the world-in terms of tier-I capital. In 2008, there was only one Indian lender -

SBI, at eighth place among the top 25 Asian banks. Industrial and Commercial

Bank of China, the biggest Asian bank and the worlds eighth biggest bank, is four

times bigger than SBI, both in terms of tier-I capital as well as assets. Another

recent study Report on Currency and Finance released by the RBI reveals that the

combined assets of the five largest Indian banks - SBI, ICICI Bank, Punjab National Bank, Canara Bank and Bank of Baroda are just about half the asset size

of the largest Chinese bank, Bank of China. The bank is 3.6 times larger than SBI

in terms of assets, branches and profits.


35/72

Opportunities

Advanced technology: New generation private sector banks and foreign banks

are technologically more advanced in terms of management information systems,

delivery mechanisms, etc. These systems and processes require substantial

investments which may be possible after consolidation. Cutting-edge technology

may lead to acceleration of service delivery and broadening of customer

relationships. Basel norms: Basel II requires banks to meet tougher and higher

capital adequacy norms such as capital allocation towards operational risk, in

addition to credit and market risks. Many Indian banks, especially public sector

banks, cooperative banks and regional rural banks are unprepared for thisimplementation due to capital inadequacy. According to the report, every category

of bank has to arrange additional capital from its own internal sources. To maintain

the 51 per cent minimum government share, PSBs cannot collect additional capital

directly from the public and with this view it promotes bank mergers.

Consolidation may be a route for smaller banks to infuse funds to strengthen their

capital base .Cost cutting: Many branches and ATMs of various banks are

congregated in the same areas leading to pointless outlay on premises, manpower

and maintenance facilities. Consolidation may lead to redeployment and

rationalization of such infrastructure, human resources and other administrative

facilities thereby undercutting the cost factor. Consolidation will lead to

cost efficiency which will enhance profitability. Enhancement in risk absorption

ability: The risk management capabilities of the banks may improve. Larger size

improves the risk bearing capacity of a bank and strengthens its balance sheet.

Biger organizations have inherent advantages and they are too big to fail. Enlarged

customer base: The combined customer base may increase the volume of business.

The enhanced rural branch network may lead to increase in microfinance activities

and lending to the agriculture sector. Geographical spread: Banks can diversify


36/72

the risk of concentrated lending through mergers. They can also have a greater

market access thereby widening the deposit base. The RBI has imposed strict

licensing norms for opening of new branches and hence via consolidation, the

acquirer will have access to ready physical infrastructure. Pan-India presence ofthe combined entity may enhance convenience for the customers. Improvement in

operational efficiency: The operational efficiency of banks may improve owing to

bigger size. There may be increase in financial capability greater resource/deposit

mobilization, output and better pricing of products. Product diversification: Merger

creates the opportunity to cross-sell products and leverage alternative delivery

channels. Old generation banks can merge with the new generation private sector

banks and foreign banks to diversify their credit profile. They can sell technology-

based innovative products. Tax shields: In case of bailout mergers, the

accumulated losses and unabsorbed depreciation of the amalgamating bank can be

carried forward and set off against the future profits of the amalgamated bank.

Threats

Alignment of technology: The technology infrastructure, system platforms(Finance, Flex cube, etc), network architecture, database vendors and IT-enabled

synergies (customer service, payroll, back office operations, risk management, etc)

should be compatible in banks desiring to merge. Most of the public sector banks

are at different stages of technology implementation. It would pose a stiff

challenge to such merging entities to integrate their technology and working

platforms. Assimilation of systems and processes: The cost of integrating diverse

systems and processes should be paid due attention. Bancassurance is one of the

areas where merging entities may face problems. Customer dissatisfaction: The

change in the nature and quality of financial products may dissatisfy the customers,

even if the products are better. In some cases customers may be deterred by the


37/72

acquiring company for various reasons which may affect brand loyalty of the

combined entity. Integration of people: The acquirer bank may have to absorb the

entire workforce of the target bank which may push up the wage cost. It

also requires the integration of the heterogeneous work cultures. The views of theemployees towards various aspects of the new organization, management styles,

training, leadership, etc are to be considered in a critical manner. The varied

aspects of the work environment, if

not handled properly, may lead to resentment and shrinkage in productivity.

Marginalization of small customers: Larger entities may neglect small customers

and concentrate on affluent customers or High Net worth Individuals

(HNIs).Regulatory hurdles: Some of the legal barriers need to be removed to make

PSBs, which still control about 68 per cent of the Indian banking sector, active

participants in the consolidation process. It will help realize the true benefits

of consolidation. These hurdles include bringing down the government ownership

from the statutory 51 per cent and amending certain clauses in acts governing

these banks to facilitate either merger. On the cooperative banking side too, issuesof dual control should be resolved to facilitate a smoother consolidation exercise.

They may give rise to monopolistic structures and lower competition. Monopolistic

entities may charge higher fees for services rendered in case there is no effective

competition. The motive should be to increase the size but not in isolation. Size

should be measured in terms of efficiency with which interests of

various stakeholders are adequately met. In order to leverage the benefits of bigger

size, geographic expansion, huge loan portfolios, improved technology, product

diversification and reduced transaction costs, Indian banks are gradually but surely

moving from a cluster of large number of small banks to small number of large

banks. Cons olidation will positively amplify the business prospects of the industry


38/72

in the domestic as well as international market place. References: 1. RBI Annual

Report, 2007-08, 2. RBI deputy governor, V Leeladhars speech on Consolidation

in the Indian Financia l Sector, 3. RBI Report on Currency and Finance, 2006-

08(Source: The Indian Banker, a publicati on of Indian Banks Association)


39/72

Mission & Vision Of Consolidated Banks

Our Vision

To be the Bank of choice offering pleasant and convenient services.Our Mission

To provide flexible financial solutions that support our customers achieve

success.

Our Core Values

We are guided by the following core values in our day to day activities:

Customer focus - The customer is at the centre of our service delivery.

Integrity - We undertake to operate with the highest degree of honesty and

integrity

Professionalism - We adheres to high professional and personal standards in

the conduct of our business. Team work - We work as a team and nurture a performance driven culture.

Innovation- We continuously make product improvements to serve the

evolving needs of our customers.

Flexibility

We are dynamic and progressive bank. We offer flexible financial solutions that

are innovative and in to uch with our customers needs.


40/72

Customer First

We are driven by our customers needs. We serve them with a personal, friendly

and human touch while always being responsive and build close working

relationship with them.

Partnership

We have the same goals as our customers to grow. We view our customers as

partners and always strive to facilitate and support them as we mutually grow and

achieve success.


41/72

Caught In A Tug-Of-War: Bank Consolidation In India

Considering the growth prospects of India, it can easily be said that banking and

financial services will be of key importance to fuel the growth in the future.

Currently there are around 34 listed banks catering to the needs of the nation and

about 70% of the market share rests with government-owned banks.

However, in a world where size is equated to financial soundness, Indian banks are

mere pygmies. Indias largest commercial bank, the State Bank of India stands in

the 57th place in the list of top 1,000 commercial bank s ranking by Fortune. Its

assets are a tenth of the worlds biggest bank, Citigroup.

Even Chinese banks are far larger than banks in India. The Industrial and

Commercial Bank of Chinas (ICBCs) deposit base is eight times that of SBI.

According to a recent study by Associated Chambers of Commerce and Industry

(Assoc ham), consolidation in the Indian banking sector is necessary to enhance

global competitiveness. Presently, banks are not able to compete in the globalarena in terms of fund mobilization, loan disbursal, investment and rendering of

financial services due to the fragmented nature of the industry.

Given that international competition is rising, the government has time and again

brought up the issue of consolidation among public sector banks without much

success. The issue of consolidation thus is high on the agenda of the UPA-led

government.

This is not the first time that the Centre has expressed the need for consolidation.

In fact, consolidation has been on the policy agenda ever since the Narasimham


42/72

Committee-II recommended the creation of four or five large banks to take on

international competition in 1997.

Although there were occasions when the government tried to force the agenda, notmuch progress has been made so far. Any merger dictated by the government met

with opposition from trade unions and independent banking experts, who opined

that the costs far outweighed the likely benefits.

Of late, the government has taken the position that the initiative for consolidation

should come from the boards of the banks concerned and its own role, as the

majority shareholder, would be a supportive one.

In this context, Finance Minister Pranab Mukherjee has said: If someone decides

to merge, if we see it is in conformity with our policy and if we find that

parameters are being followed as per SEBI and RBI guidelines, then the

government would play a supportive role. He has, however, maintained that the

government itself has not taken any initiative to ask public sector banks to go for a

merger and maintained that it did not intend to interfere in their routine activities.

The Reserve Bank of India is, however, not in favour of consolidation of banks just

as yet, citing reasons such as need for greater financial inclusion and the need to

strengthen capital base to carry out better risk management, as more pressing

requirements of the day.

Despite the adverse stance on consolidation, the finance ministry continues its

push and has asked the top five public sector banks to come up with ideas on

banking consolidation by the end of the current fiscal.


43/72

All these banks have been asked to submit a detailed road map and also do due

diligence of the smaller banks they could acquire. The government may appoint

consultants and chalk out a road map if the banks fail to come up with their views

by the deadline, a finance ministry official has indicated.

The banks that are likely to be merged with larger banks include Dena Bank,

Corporation Bank, Andhra Bank, Bank of Maharashtra, Central Bank of India,

Punjab & Sind Bank, UCO Bank, Allahabad Bank and United Bank of India,

which is unlisted.

The finance ministry officials are expected to meet the heads of these banks by

next month. The government will take into account the preference of the board and

shareholders of the small banks which would come up for acquisition.

Though the governments urgent push for consolidation is on the grounds of

improving financial stability and increase its global competitiveness, global experts

remain unsure whether the likely benefits stated will actually accrue, state banking

industry experts.

For instance, the argument that a merged entity will be in a better position to raise

capital than individual banks may not be correct. Government-owned banks will

have to always reckon with the condition that their majority shareholder will not let

its shareholding fall below 51%. Some of the public sector banks (PSBs), including

SBI, are near that floor.

Other banks may have some leeway, but they too will soon be constrained. A

merger between two such entities will not help.


44/72

Other routes to raise capital such as divestment in India or sale to overseas

investors are ruled out for now, as denationalization has not found favour with any

government. And for a good reason. In India, government ownership has stood the

banks in good stead during the financial sector crisis.

Further, the merging of PSBs is a highly complex task. Many legal hurdles will

have to be crossed and parliamentary approvals obtained. The government will

have to do a lot of preparatory work.

Even if practicable, the time horizon is likely to be long. Most importantly, the

merger advocates ignore the fact that beyond a point, size does not increase

efficiency.

Creating behemoths from two already large banks will not help in either facing

competition or raising capital. On the other hand, several more layers will be added

to the existing bureaucratic structures in government owned banks.

Also there are crucial issues such as rationalizing manpower and branch network

after bank mergers. In the reform era, the strengths of public sector banking, the

branch network and superbly trained manpower have been initially discounted.

Yet todays urgent tasks of the financial sector social banking and financial

inclusion require these strengths to be harnessed to an even greater degree than

before. Bank consolidation will create redundancy, demotivate staff and make the

financial sector less inclusive. says a banking industry expert.

Further, cultural issues and regional strengths are not discussed when mergers

among banks are discussed. Almost all banks in India have grown from specific


45/72

regions and have retained certain unique strengths despite some of them coming

under the government fold.

The consolidation of such institutions with another bank would whittle down thestrength. Why, then, this emphasis on consolidation? The reason is simple.

Privatization is a political impossibility, so consolidation is a politically feasible,

albeit second-best option.

However it is good to remember that bank consolidation in India is very different

from moves to consolidate companies in specific industries or segments. For all the

excitement it evokes, consolidation is a slow process and is best not dictated by the

government.


46/72

How Would Consolidation Help Indian Banks?

As of today, Indian banks are not able to compete internationally in terms of

funds mobilization, credit disbursal, investments & rendering of financial services

due to their relatively small size.

Indian banking industry is highly skewed and almost 80 banks have a less than

2.0% market share in India

Though the top five occupy more than 50% market share in India, they are much

smaller by global standards.

Many Indian banks are unprepared for Basel II implementation due to capital

inadequacy.

Banks also need to consolidate to improve their risk management capabilities.

Indian corporate are fast globalizing and our banks need to keep pace to service

them.

A bigger player can afford to invest in requisite technology and play globally totake advantage of global opportunities.

Because for going global a bank needs to upgrade its technology, MIS, syste ms

& processes and strategies, to compete effectively and consolidation could

facilitate this.

The confidence of international investors in Indian banks has increased manifold in

recent times and this offers our banking sector a good opportunity to restructure

itself.


47/72

Consolidation Processes

Consolidation processes consist of the assembly of smaller objects into a single

product in order to achieve a desired geometry, structure, or property. These

processes rely on the application of mechanical, chemical, or thermal energy to

effect consolidation and achieve bonding between objects. Interaction between the

material and the energy that produces the consolidation is a key feature of the

process. This interaction can be either beneficial or detrimental to the final product.

In some cases, the consolidation energy enhances the structure or properties of the

material and is an integral part of the process. For example, in the forging of

powder performs, the mechanical energy not only consolidates the powder but also

imparts macroscopic geometry to the part while improving the microstructure of

the material.

In other cases, the energy used to effect consolidation is detrimental to the

structure or properties of the product. For example, in fusion welding, the heat of

melting achieves bonding between the objects but also can create an undesired

microstructure in the heat-affected zone of the joint, causing distortion anddetrimental residual stresses.

Consolidation processes are employed throughout the manufacturing sequence,

from the initial production of the raw material to modification of the final

assembly. One group of consolidation processes involves the production of parts

from particulate or powders of metals, ceramics, or composite mixtures. These

consolidated products are typically semi finished and require final thermal or

machining processes. In some material systems, consolidation of powders produces

feedstock billets for extensive processing into continuous mill products of bar, rod,

wire, plate, or sheet. Other consolidation processes produce composites, with either

polymer, graphite, metal, or ceramic matrices. Welding and joining processes, a


48/72

unique group of consolidation processes, are used to combine subcomponents,

often of dissimilar materials, into permanent assemblies. The performance of the

final component is often governed by the quality of the joining process. This

chapter presents an overview of the research needs


49/72

Consolidation Trends Observed in India

Improving the operational performance and cost efficiency has always been a

priority in Indian banking sector and has been a major issue of discussions in the

policy formulation by the government of India in the consultation and with the

central bank (Reserve Bank of India). Several committees have also been formed

in order to suggest structural changes to achieve this objective. Some of the major

committees formed are

Banking Commission, 1972 Chairman R.G Saraiya, 1976 chairman: Manubhai

Shah Committee for the functioning of public sector banks, 1978 chairman: James

S Raj These committees have suggested the restructuring of the Indian bankingsystem with an objective to improve the process of credit delivery and also

suggested the idea of having around 3 to 4 large banks which have a pan India

presence and the rest of the bank should be present at the regional level. The major

thrust on consolidation started with the Narasimham committee in 1991. It

emphasized and embarked upon consolidation and merger in order to make the

Indian banks huge in size and also comparable to the global banks. A second

Narasimham committee was also formed in 1998 which suggested mergers and

consolidation among the strong banks in public as well as private sector and also

with other financial institutions, NBFC (Non Banking Financial Companies). Now

we will have a look at some of the recent trends in consolidation in Indian banking.

Cross country experience :

The banking systems of many emerging economies are fragmented in terms of

the number and size of institutions, ownership patterns, competitiveness, use of

modern technology, and other structural features. Most of the Asian banks are

family owned whereas in Latin America and Central Europe, banks were

historically owned by the government. Some commercial banks in emerging


50/72

economies are at the cutting edge of technology and financial innovation, but many

are struggling with management of credit and liquidity risks. Banking crises in

many countries have weakened the financial systems. In this context, the natural

alternative emerged was to improve the structure and efficiency of the bankingindustry through consolidation and mergers among other financial sector reforms.

The motive for consolidation in Central Europe is market driven whereas in many

Latin American countries the government has taken up several initiatives to

restructure inefficient banking systems. Consolidation has become a vital exercise

in Korea and Southeast Asian countries due to serious banking crises. In all these

countries different models have been adopted for consolidation. Several research

studies have critically analyzed various issues in each consolidation case which

serves as a useful lesson for the banks and policymakers who are pursuing the

agenda of consolidation. Some of the important studies in this context are: The

European Savings Bank Group Report on 9European Banking Consolidation

(2004), impact of mergers on bank lending relationship in Belgium (Degryse et.

al., 2004) and Italy (Sapienza, 2002), Polish banking sector (Havrylchyk, 2004),

emerging market economies (Bank of International Settlements, 2001), Hungarys

experience with privatization and consolidation (Abel and Sikeos 2004), emerging

markets (Gelos and Roldos, 2004), Japan (Brook et. al., 2000, and Tadesse, 2006),

and European countries (Boot, 1999). An ILO study reports that as a consequence

of the recent merger wave in the US, the number of banking organizations

decreased from 12333 to 7122 during the period 1980 to 1997 (ILO, 2001). In

Europe, between 1980 and 1995, the number of banking establishments fell, particularly significantly in Denmark (by 57 per cent) and France (by 43 per cent).

The European mergers have so far been mostly domestic, directed at creating

domestic behemoths. However, subsequent to the formation of a single financial

market under the European Union (EU), consolidation across the EU area has


51/72


52/72

TYPES OF CONSOLIDATION

1. Horizontal Consolidation

Consolidation is designed to increase overall efficiencies and profits. Horizontal

consolidation signals that a particular industry has reached a new stage within its

life cycle. Of course, consolidation is not to be confused for monopoly power.

Identification

Horizontal consolidation occurs when firms offering similar products combine

through mergers and acquisition. Horizontal consolidation may also represent an

extension of product lines. Clothiers can consolidate horizontally to combine

casual menswear, suits and cologne beneath one institution.

Benefits

Horizontal consolidation enables firms to pool resources into one entity.

Consolidation strengthens the financial position of the new company, so

management may negotiate better terms with creditors and suppliers. Savings are

passed down to consumers in the form of lower prices.

Considerations

Growing industries consolidate prior to reaching a mature stage of development.

This consolidation occurs when emerging companies purchase start-ups to expand

market share. Conversely, older industries consolidate to survive. Struggling

companies are often forced to sell out---or go bankrupt.


53/72

Misconceptions

Horizontal consolidation differs from vertical integration. Vertical integration

happens when companies expand across their supply chain. Vertically integrated

oil companies purchase oil drillers, refineries and gas stations.

Risks

Horizontal consolidation that leads toward monopoly draws criticism from

consumers and the government. The Federal Trade Commission enforces

monopoly law and blocks anti-competitive mergers.

2. Vertical Consolidation

Vertical consolidation is a term that is frequently discussed in the business world.

There is much debate over whether vertical consolidation is a wise change for a

company to make. However, before these decisions can be made, it is important to

know exactly what vertical consolidation is and what advantages and

disadvantages can occur with this system.

History

Vertical consolidation has been around for many years. The 1800s were the first

century to heavily employ the use of vertical consolidation. The industrial

revolution brought the need for companies to control many aspects of the same

production and distribution process. Economics of scale was the primary reason for

vertical consolidation in the 1800s. The 1900s saw a shift in the reason companies

chose vertical consolidation. The consolidation was used to ensure companies

received a steady supply of inputs that were vital to operations. Late in the 20th

century vertical consolidation was employed as a cost-saving measure. However,

at the end of the 20th century and into the early part of the 21st century, companies


54/72

were forced to eliminate much of their vertical consolidated structure due to

competition.

Features

Vertical consolidation is the process by which a company absorbs a distribution

center or supplier into its own value stream. This can occur when a company

purchases a new supplier or when a company begins to offer the same services as a

third-party supplier themselves. This process is also referred to as vertical

integration. An example of vertical consolidation is when an oil company

purchases gas stations to sell their oil products or when the same oil company

conducts exploration for new oil sources.

Function

The purpose for vertical consolidation is so that a company can eliminate as many

different parties as possible to streamline a business process. Another reason to use

vertical consolidation is to save money by having processes completed all under

one company name. If processes are completed by the same company that sells the

products, then third-party convenience payments do not have to be made. There are

two types of vertical consolidation: forward consolidation and backward

consolidation. Backward consolidation is when a company purchases the suppliers

and manufacturers of a product. Forward consolidation is when a company

purchases the distributors of a product.


55/72

Benefits

There are many benefits to vertical consolidation. Vertical consolidation can

reduce transportation costs if local suppliers and distributors are in the same area.

It can greatly improve supply chain coordination. The control over inputs is much

greater. The expansion of core services and competencies is easier to achieve. It is

possible to receive profits from upstream and downstream processes. Greater

amounts of distribution channels are available. It is even possible to block

competitors if rare supplies can be obtained.

Disadvantages

There are also some drawbacks to the vertical consolidation system. The

bureaucratic end of a company becomes much more difficult. There is often an

issue of capacity balance. The upstream suppliers may not be able to match the

demand of the downstream distribution centers. Adding additional services to a

company may cause an overall quality loss. Costs might become higher due to the

lack of competition in the market. Product variety is much reduced. There is also

the chance of reduced company flexibility because of the added processes.


56/72

Challenges of consolidation

People issues : the mergers of bank pose human resourses management

problems.the cross cultural integration are an important post merger issue to be

handled by the management of the two banks.

Technology integration : integration of technology platforms poses a stiff

challenge the merging banks use different working platforms and are at different

stages of technology implementation.

1. Brand Implication : With regards to branch implications, the new entities

that will come from the dust of consolidation will need to deal with brand-

There will be a change of name if two or more banks come together and

decide not to adopt any of the participating bank name.

The logos which were formally used by each of these banks will be dropped

and another one adopted. There will also be the evolution of a new brand culture for the emerging

banks after consolidation.

The brand message of the consolidated banks will also be changed.

The place of information communication technology (ICT) in the bank will

be changed, that is, banks software as the new banks will go for the best tomeet up customers demand.


57/72

2. Structure Implication : The recapitalization of banks will leave in its wake,

a number of structural issues which will have direct impact on staff, customers and

the entire banking sector. They include:

The reduction in the number of banks in the country

The closure of many small banks, especially those in the rural areas with

poor capital deposit.

Increased competition due to better incentives and rendering of banks

services.

Acquisition digestion issues which will include loss of jobs, consolidation of

branch locations and tackling of inefficiencies and bureaucracies.

Reconstitution of management and board of the banks.


58/72

Why Consolidation In Banking Industry

Financial Sector Reforms set in motion in 1991 have greatly changed the face of

Indian Banking. The banking industry has moved gradually from a regulated

environment to a deregulated market economy18. The pace of changes gained

momentum in the last few years. Globalization would gain greater speed in the

coming years particularly on account of expected opening up of financial services

under WTO.

Banks in India are gradually going for-

1) Consolidation of players through mergers and acquisitions,

2) Globalization of operations,

3) Development of new technology and

4) Universalisation of banking.

With the international banking scenario being dominated by larger banks, it is

Important that India too should have a fair number of large banks; this could play a

meaningful role in the emerging economics. Among the top twenty banks in the

emerging economics, India has only one, whereas China has five banks and Brazil

had six banks.

The performance of banks in India indicates that certain performance characteristic

is not restricted to a particular bank. Therefore, consolidation of banking industry

is critical from several aspects. Mainly, the reasons for mergers and acquisitions

can include motives for value maximizations well non-value maximization. The

factors including mergers and acquisitions usually include technological progress,

excess capacity, emerging opportunities, consolidation of international banking

markets and deregulations of geographic, functional and product restrictions.


59/72


60/72

small customers. Evaluation of banks carried out by individual banks reveal that

higher capital adequacy and lower nonperforming assets explain to a greater extent

the growth, Profitability and productivity of banks since increase in capital and

steep reduction in non-performing assets cannot be entirely left to the individual banks in the present scenario. Consolidation in the banking industry is of great

relevance to the economy

A diagnostic performance evolution study would reveal out important aspects of

divergence in the performance of the domestic banking institutions. A high degree

of variations is found in the performance of various groups of banks. Since, public

sector banks account for the large scale of banking assets and the lower performance ratio reflect the entire banking industry, it is considered important that

suitable consolidation process may be initiated at the earliest, so that, the efficiency

gain made by the large number of banks of other groups will be reflected which

could lead to a positive impact on the image of banking.

Consolidation can also be considered critical from the point of view of quantum of

resources required for strengthening the ability of banks in assets creation. Itindicates that restructuring in Indian banking may not be viewed from the point of

particular group rather it can be evolved across the bank groups.

Indians banks have unique character in displaying similar characteristics of

performance despite consisting of different size and ownership. This trend further

substantiates the scope for consolidation across banks group.

As per the Quantitative Impact Study published by Basel Committee in May 2003,

there would be increase in capital requirements by 12% for banks in developing

countries on the implementations of the Basel II Accord. Mergers among the banks


61/72

will be one of the ways to increase market power and thereby increase the revenue

generation of the Banks.

The Reserve Bank of India (central bank) has set up an experts committee to

implement Basel II accord by 2006 to strengthen the financial health of banks by

adopting globally accepted norms for capital adequacy. The RBI also wants all

banks in India to have a capital base of Rs 300 crore (Rs 3 billion) over the next

three years.

This will bring about number of acquisitions in the banking industry. Over the last

two years, the RBI has stopped issuing branch licenses to cooperative Banks, after

the unbridled growth of co-operative banks during the last decade. For Cooperative

banks to expand there is no alternative to go for consolidation.

The Mumbai-based Saraswat Co-operative Bank is now poised to take over

Maharashtra based Maratha Mandir Co-operative Bank which is in trouble. This

could mark the beginning of voluntary mergers of cooperative banks after the

Reserve Bank of India (RBI) unveiled for mergers and amalgamations among

urban co-operative banks. The other suitor for Maratha Mandir was Pune-based

Cosmos Co-operative Bank. Last but most important reason for consolidation in

any industry is tax saving and this thing is true for the banking industry also.


62/72

Case Title:

Consolidation In Indian Banking Industry: A Case On State

Bank Of IndiaAbstract:

The State Bank of India (SBI) is ruling the Indian banking sector with its largest

market share. In order to further consolidate its position, the bank laid down the

proposal of merging all its associate banks. The expansion strategies pursued

earlier by SBI had been jettisoned and the group had to initiate consolidation

strategies for a bigger fit. With the completion of the proposed merger, SBI's asset

base will become more than double that of ICICI Bank, its closest competitor.

But, the strategy of consolidation took a major set-back when the employees of

the Bangalore-headquartered State Bank of Mysore (SBM), one of the oldest

banks of India, resorted to a nationwide agitation. The protest eventually spread to

the rest of the associates with more than 35,000 employees of the associate banks

deciding to observe a day-long strike on 27 September 2007 in protest against the

proposed merger. The employees perceived that the merger would only lead SBI

to be a monolithic bank that would slowly shed its social responsibility.

Moreover, there are some internal factors, which could be a major set-back for its

consolidation strategy. This case intends to make a study on different financial

and behavioral issues in this proposed merger. Moreover, this case endeavors to

provide a futuristic study of the effect of this merger in the Indian banking

scenario.

Pedagogical Objectives :

To an overview of the transformation that took place in the Indian banking

industry through a series of reforms.


63/72

To identify the need for consolidation in the Indian banking industry.

To analyze the reason for consolidation of the State Bank of India (SBI) with

its associate banks.

To analyze whether SBI would be able to cope with the various internal and

external challenges arising out of the consolidation proposition.

Keywords : India, Banks, State Bank of India (SBI), Consolidation, Non-

performing assets (NPA), Reserve Bank of India, Basel II Accord, Debt

Recovery Tribunal (DRT), All India Bank Employees Association (AIBEA),

Voluntary retirement scheme (golden handshake), Parivartan, Asset

reconstruction companies (ARC), Bombay Stock Exchange (BSE), Prime

lending rate (PLR), Urban Co-operative Bank (UCB)


64/72


65/72

Impact Of Consolidation

Since the consolidation process has not gone very far in India, its impact has not

been significant.

Consolidation of certain foreign banks at the global level has also not affected the

Indian market, as their market share is currently very low. However, the

deregulation process has brought in more competition in the banking sector,

resulting in delivery of innovative financial products at competitive rates. The

consolidation of banks may not significantly affect the functioning of various

segments of the financial markets. In a liberalized environment, the mere size ofthe bank may not be an enabling condition for distorting the pricing mechanisms or

liquidity in the market. The presence of large banks would result in more

competition and narrowing spreads.

Impact On Branch Network Of The Consolidation

It may be mentioned here that one of the likely effects of consolidation in the

banking sector may be the rationalization of the branch network of the banks

concerned, resulting in the likely closure of certain branches of the merging banks,

where there might be an overlap in their catchment area. The merged entity is

likely to prefer closure of the rural semi urban branches. However, the current

regulatory regime for branch authorization does not generally permit closure of the

rural branches of the banks. Such a requirement is in tune with the philosophy of

financial inclusion which emphasizes increasing penetration of the bankingservices in the unbanked and under-banked areas of the country.


66/72

Motives For Consolidation Of Banks

The primary motive for consolidation is maximizing shareholders value. In the

absence of capital frictions, all actions by the firms including consolidation

activities would be geared toward maximizing the value of shares owned by

existing shareholders the preferences of other shareholders would be taken into

account only in so far as they affected the value of shares through the cost of funds,

supply of labor or other factors of production, or the demand for services. In

practice, however managers and government affect consolidation decisions more

directly.

We outline and review the literature on the value maximizing andnon-

value maximizing motives for financial consolidation. We then identify some types

of changes in the economic environment that may have led to the recent

accelerated consolidation.

The Value-Maximization Motive

Financial service firms can maximize value in one of the two main ways through

consolidation by increasing their market power in setting prices or by increasing

their efficiency. It is difficult to determine the goal of merger and acquisition

participants, but there is evidence consistent with the nation that some mergers and

acquisitions are designed to increase market power which lead to increase in profit.

Studies suggests that in market merger and acquisition that subsequently increase

market consolidation may increase market power in setting prices on retail services

which will increase profit. Presumable, this was an expected consequence of many

of these merger and acquisition and provided at least part of the motivation. Also


67/72

supporting this presumption are the findings that about half of the Indian bank

mergers and acquisitions are in market and European bank mergers and

acquisitions are of this type as well, suggests that merger and acquisition may

increase efficiency, consistent with the presumption that expected efficiencyimprovements provide part of the motivation for consolidation. In addition, a

number of studies have found that in a substantial proportion of merger and

acquisition, a large, more efficient institution tends to take over a smaller, less

efficient institution, presumably at least in part to spread the expertise or operating

policies and procedures of the more efficient institutions over additional resources.

In the Indian acquiring banks appear to be more cost efficient than target banks on

average.

Non Value Maximizing Motives

As noted above, stakeholders other than shareholders may have a direct effect on

consolidation decision we consider here the roles of managers and governments,

who appear to have more influence over consolidation decisions for financial

institutions then for non financial firms.

Managers Role

Managers may be pursuing their own objectives in consolidation decisions,

particularly in banking where corporate control may be relatively weak. Banking

regulations in India weak corporate control market by generally allowing only

banks to acquires banks. The regulatory approval/disapproval process may also

deter some acquirers. In addition, most India banks are small and are not publicly

traded. Perhaps as a result of these conditions, hustle takeover that replace

management are rare in Indian banking. However, corporate control appears to


68/72

improve when interstate and interstate banking deregulation increases the number

of potential acquirers, which has been found to increase market discipline, reduce

the market share of poorly run banks, and generally raise profitability.

Governments Role

The government plays a direct role in consolidation decision through restricting the

types of merger and acquisition petted and through approval/disapproval decisions

for individual consolidation. In part, this to limit governments liability and prevent

exploitation of TOO BIG TO FAIL and expansion of the safety net. Regulatory

review of bank merger and application in the US attempts to prevent consolidation

in which excessive increases in risk are expected. Regulators also prevent in

market consolidation if he increases in concentration are expected to result in

excessive increase in market power.

Technological Advancement

Technological progress may have increased scale economies in producing financial

service, creating opportunities to improve efficiency and increase value through

consolidation, new tools of financial engineering such as derivative contracts, off-

balance sheet guarantees, and risk management may be more efficient produced by

larger institutions. Some new delivery methods for depositor services such as

phone center, ATM, and online banking may also exhibit greater economies of

scale than traditional branching networks. The new tools of financial engineering,

advanced depositor, delivery services, or payments technologies may be distributed

to small financial institution through correspondent banking systems, through

franchising or outsourcing to firms specializing in the technologies, shared

ownership or mandatory sharing of payments networks etc


69/72

Excess Capacity Or Financial Distress

Consolidation may also be an efficient way to eliminate excess capacity that has

arisen in the consolidating firms industry or local market. When there is excess

capacity, some firms may be below efficient scale, have an inefficient product mix.

Consolidation may help solve the efficiency problems. Consolidation help remove

excess capacity more efficiently than bankruptcy or other means of exit in part by

preserving the preexisting franchise value of the Consolidation firms.


70/72


71/72

these recommendations, the RBI had released a Discussion Paper (DP) in January

1999 soliciting wider public debate on the issue. The DP had, inter alia, envisaged a

transition path for the DFIs for becoming either a full-fledged NBFC or a bank.

Based on the feedback received on the DP, the Monetary and Credit Policy for theyear 2000-2001, outlined the broad approach proposed to be adopted

for considering the proposals in the area of Universal Banking. The Policy stated

that the principle of "Universal Banking" was a desirable goal and any DFI, which

wished to transform into a bank, should have the option to do so, provided it was

able to fully satisfy the prudential norm applicable to the banks. For the purpose,

such a DFI was expected to prepare a transition path for consideration of the

Reserve Bank. Thus, in due course, the recommendation of the Narasimham

Committee to have only banks and the restructured NBFCs in the system, could

be operationalised.Accordingly, in April 2001, the FIs were advised several

operational and regulatory issues relevant in evolving their transition path to a

universal bank and for formulating a road map forth purpose. In the light of the

RBI guidance, two leading term lending institutions viz., the erstwhile IDBI and

ICICI Limited got converted into a commercial bank, each. The four term-lending

institutions (IDFC Ltd., IFCI Ltd., IIBI Ltd. since wound up, TFCI Limited)

which were in the category of NBFCs, are now regulated as per the norms

applicable to the NBFCs. However, the EXIM Bank and the three RFIs

(NABARD, NHB and SIDBI) continue to be under the regulatory domain of the

RBI and are regulated as per the norms applicable to the financial institutions.


72/72

CONCLUSION

There is a need to convert large number of small banks to small number of large

banks to make them more competitive in the open regime. India require big banks but itshould be noted that small banks co-exist it is essential to conduct a due diligence

before embarking upon consolidation.

Indian banking industry is presently at a crucial juncture. With increasing

globalization in sight, there have been calls for greater consolidation in the industry

from both the government as well as regulator.

ProjecCHALLENGES AND CONSOLIDATION OF BANKS IN INDIAt

Documents

Transcript of ProjecCHALLENGES AND CONSOLIDATION OF BANKS IN INDIAt