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Consolidation in the Indian Banking Industry
Contemporary Concerns Study
Under the guidance of
Professor P.C. Narayan
Indian Institute of Management, Bangalore
June’ 07- August’07
Submitted by:
Akshant Goyal 0611215
Gautam Gurnani 0611020
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Acknowledgement
We acknowledge the help and guidance provided by our instructor Professor
P.C. Narayan without which it would have been impossible to come up with
this report. He provided timely feedback and encouragement throughout the
duration of the project.
We also express our sincere gratitude towards all the people who have
directly or indirectly, knowingly or unknowingly, helped us in making this
report take a notable form.
Akshant Goyal
Gaurav Gurnani
PGP-II, IIM-B
28 August, 2007
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Table of Contents
I.
Objective ..................................................................................................................... 4
II.
Capital Shortfall .......................................................................................................... 6
III. Case for foreign minority stake in PSBs .................................................................... 10
Evidence on bank efficiency in developing nations ................................................. 10
Evidence related to minority foreign ownership of banks ........................................ 11
IV. Why consolidation? .................................................................................................. 14
Case Studies .............................................................................................................. 14
Literature Survey ...................................................................................................... 20
Conclusion ................................................................................................................ 21
Consolidation in Private Sector Banks ..................................................................... 22
V.
A Proposed Merger ................................................................................................... 24
Choice of Parameters ................................................................................................ 24
One of the possible merger ....................................................................................... 29
Merger Model ........................................................................................................... 33
Conclusion ................................................................................................................ 40
Other Suggestions for PSBs ...................................................................................... 40
VI. ICICI Bank ............................................................................................................... 44
History of ICICI Bank .............................................................................................. 44
Strategy of ICICI Bank ............................................................................................. 45
VII. References ................................................................................................................ 50
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I.
Objective
This paper aims to address some of the contemporary issues facing the Indian Banking
industry today. Overall it attempts to cover the following issues:
1. Post 2009, foreign banks will be given the same freedom to open branches,
acquire competitors and plan for growth that their domestic counterparts now
have. This will be a big event for the Indian banking industry which will
transform the business of banking in many ways, which would be reflected in
terms of greater breadth of products, depth in delivery channels and efficiency in
operations. Indian banks which were till now protected in some sense will be
exposed to the big multinational banks. In this light, consolidation by Indian
banks seems to be a good and probably the only option to stand up to the
competition. This paper builds a case for consolidation in the Indian banking
industry based on case studies of countries worldwide and by highlighting other
positive effects of consolidation on the sector.
2. Currently, the Government of India is not allowed to dilute its stake in the public
sector banks below 51%. For many of these banks the government holding is
already around the 51% mark. As these banks grow they will need more funds to
satisfy the minimum capital requirements. Also, the impending Basel II norms
will costs these banks a lot and will hit their Tier 1 capital. This paper, by way of
numerical analysis, attempts to find out the potential capital shortfall that these
banks might face in the next few years and lays down the option in front of the
government to respond to the same.
3. While in most other countries foreign bank entry took the form of direct takeover
or majority shareholding, foreign investments in China’s banks have been
minority shareholdings with very limited management involvement. Increasing
foreign participation has been one of the key trends in the Chinese banking
system in recent years. The paper studies the positive effects of foreign minority
stakes on the Chinese nationalized banks and argues for the same for the Indian
banking industry.
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4. ICICI Bank has been the star performer in the Indian private sector banking
industry over the past few years. It has been the one driving the changes in the
retail banking and has been aggressively pursuing various new initiatives. Off late
there has been a spree of fund raising by the bank the purpose of which can at best
be guessed. This paper tries to speculate the possible reasons for this capital build
up and extend them to the growth path of private sector banks in India.
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II.
Capital Shortfall
One of the major issues looming over the Indian public sector banks is the uncertainty of
availability of sufficient capital to fund the future growth. As the loan book expands,
banks will need more capital to support the existing business as well as provide for future
growth. This would mean that some banks will have to tap into capital markets. Also,
looming over the landscape is the imminent implementation of Basel II norms and the
one time hit that the banks would be required to take on their General Reserve to
accommodate the increased provisioning on account of changes made to AS-15 on
Provisions for Retirement Benefits to Employees. All this while, it has to be kept in mind
that the government of India cannot dilute its stake below 51% in these PSBs. The current
holding by government in the 10 major PSBs listed on Bankex is as follows:
Figure 1
Bank
Allahabad bank Ltd
State Bank of India
Punjab National Bank
Bank Of India
Canara Bank
Bank of Baroda
Union Bank of India
Indian Overseas Bank
Oriental Bank of Commerce
Andhra Bank
% of Government holding
55.23
59.73
57.8
69.47
73.17
53.81
55.43
61.23
51.09
51.55
A shortfall of capital is expected to adversely affect the growth of the banking industry in
India. The following analysis tries to calculate potential capital shortfall that Indian
banking industry, specially the public sector banks, might face in the next few years.
Only the banks listed on BANKEX have been chosen for analysis as they form the
majority of the Indian banking industry. Following steps have been followed for this
purpose:
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1. Calculate the average growth rates of the assets of these banks in the last 4 years.
During these 4 years, the GDP has grown by around 8% and thus it can be
assumed that the B/S will grow by this average number over the next 3 years.
2. Project the assets of each of these banks by the average growth rate calculated in
point 1.
3. Given the RBI directive to bring Tier I capital to 6 per cent by 2009-10, we have
defined under-capitalised banks as those where Tier I capital falls below 7 per
cent, as it restricts their future loan growth. Therefore, calculate the additional
Tier 1 capital required at the end of 2010 assuming risk weighted assets = total
assets.
4. This requirement will be fulfilled by the growth in reserves and the additional
equity capital raised from the markets. For calculating the reserves for the next 3
years, we have taken the average growth in PAT for the last 3 years for various
banks and used that number to project PAT for the next 3 years. The projected
PAT for each of the year has been assumed to be the only addition to reserves.
5. The balance left after subtracting the growth in reserves from the total
requirement is the equity capital that needs to be raised.
The following are the assumptions made for the analysis:

It has been assumed that the banks will grow their assets over the next 3 years at
the average of their growth rates of assets over the last 4 years. We have used a
similar assumption to grow the reserves of the banks.

Our calculations are based on the assumption that all banks would like to maintain
a Tier I CAR of 7%

The share price of the banks is based on market price as on 31st July 2007

The PSBs would take a shot of 17000 crore rupees on their capital in the form of
provisions to accommodate the change caused to AS-151.It has been assumed that
it would be equally divided between Tier 1 & Tier 2 capital

The hit of around 15% on account of Basel II implementation is assumed to be
equally divided among Tier 1 & Tier 2 capital.
1
http://in.biz.yahoo.com/070715/32/6i2tg.html
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Note that this analysis will result in the shortfall in the equity part of the Tier 1 capital.
This will be the minimum capital that will be required by these banks after taking into
account money raised through debt & the accretion to reserves. Also the analysis will be
more focused on the nationalized banks as the private banks are expected to be able to
raise as much money as they want without much problem.
Results
The findings of the analysis are:
1. The total capital required by BANKEX banks over the next 3 years is 228,000
crores. Total Tier 1 capital required is 181,370 crore rupees
2.
The total capital required by nationalized banks in BANKEX is 163,830 crore
rupees. Total Tier 1 capital required is 132,900 crore rupees.
3. Assuming that the government dilutes its stake to 51% in every bank, the total
Tier 1 shortfall in PSBs listed on BANKEX is 50,490 crore rupees. To maintain
its 51% stake and still cover the shortfall, the government will have to infuse
25,750 crore rupees.
4. Government need not infuse any money if the lower ceiling on government
holding is reduced to 40% from 51%.
5. On an average 8.77% of the BANKEX bank’s assets will be under capitalized if
nothing is done by the government. The situation will be more grave in PNB,
OBC & BOB where around 23, 17, & 16% of the assets will be under capitalized.
The government thus has the following options:
Option 1: Dilution of Government stake to 51% in all Public Sector Banks
The dilution of government holding in public sector banks to 51% helps the PSBs raise
approximately Rs. 27,830 crores, leaving a shortfall of Rs. 50,490 crores on the Tier I
Capital. So this option while feasible and easy to implement does not help resolve the
problem on hand for the PSBs in India. We thus believe that the government should go
ahead and dilute its stake but this option has to be coupled with some of the other options
mentioned below to help resolve the capital requirement problem.
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Option 2: Raising Capital from Equity markets with the government infusing capital to
ensure a holding of 51%
If the government wants to continue to hold its stake of 51% in the public sector banks it
would have to infuse Rs. 25,750 crores from its kitty. These numbers include the capital
required to meet Basel II norms and the increased provisioning for changes in AS-15. But
note again that this amount is only on account of Tier 1 and much more money might be
needed to be put in by the government to satisfy the CAR. Based on the statements from
the Finance Ministry on the PSBs we do not believe that the government would be
willing to invest the amount of money required by them.
Option 3: Dilution of government holding to 40%
While this option does help solve the problem to a great extent and helps the banks raise
the money they require over the next 3 years we believe that this would be very difficult
to implement by the government given the strong stance of the Left on the issue.
However, we do believe that the government would require diluting stake sometime in
the future and should lobby extensively to convince the concerned parties to help
implement this option at a later date. Hence this may not be the immediate solution that
can be pursued but the Indian Banking System may not be able to avoid this situation of
dilution 5 – 7 years from now and hence this option must be pursued by the government.
Option 4: Sale of stake to foreign banks and financial institutions
The government can sell a minority stake to foreign banks to raise money. This option
will be better than diluting their stake in equity markets as it provides some other benefits
which will be discussed in one of the next section.
Option 5: Consolidation of Banks in the public sector
Merger of two banks which generate synergies could lead to an increase in CAR. Thus
consolidation amongst the public sector banks could lead to some improvement in the
capital adequacy ratio. We explore this idea more in the following sections.
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III.
Case for foreign minority stake in PSBs
Evidence on bank efficiency in developing nations
Foreign banks, state-owned banks, and private domestic banks have a number of
efficiency advantages and disadvantages relative to one another, and the measured
efficiency of each ownership type reflects the net effects of these comparative
advantages/disadvantages. Foreign banks headquartered in developed nations have
generally superior managerial expertise/experience, access to capital, use of hardinformation technologies, and ability to diversify risk in most developing host nations,
where domestic institutions have not acquired comparable skills. However, foreign banks
also generally suffer from disadvantages due to distance-related diseconomies, language
and cultural differences, and poor ability to access and process locally-based soft
information. State-owned institutions may have funding advantages due to government
subsidies, but also often have disadvantages because of mandates to make certain types of
loans. State-owned banks may also be inefficient due to a lack of market discipline.
The most common findings for developing nations are that on average, foreign
banks are more efficient than or approximately equally efficient to private domestic
banks. Both of these groups are typically found to be significantly more efficient on
average than state-owned banks, but there are variations on all of these findings. To
illustrate, some research using data from the transition nations of Eastern Europe finds
foreign banks to be the most efficient on average, followed by private domestic banks,
and then state-owned banks (Bonin, Hasan, and Wachtel 2005a,b). However, another
study of transition nations finds the mixed result that foreign banks are more cost
efficient, but less profit efficient than both private domestic and state-owned banks
(Yildirim and Philippatos 2003). A study using 28 developing nations from various
regions finds foreign banks to have the highest profit efficiency, followed by private
domestic banks, and then state-owned banks (Berger, Hasan, and Klapper 2004). For cost
efficiency, the private domestic banks rank higher than the foreign banks, but both are
still much more efficient than state-owned banks. Two studies using Argentine data (prior
to the crisis in 2002) find roughly equal efficiency for foreign and private domestic
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banks, and that both are more efficient on average than state-owned banks (Delfino 2003,
Berger, Clarke, Cull, Klapper, and Udell 2005). A study employing Pakistani information
finds foreign banks are more profit efficient than private domestic banks and state-owned
banks, but all of these groups have similar average cost efficiency (Bonaccorsi di Patti
and Hardy 2005).
Evidence related to minority foreign ownership of banks
While in most other countries foreign bank entry took the form of direct takeover or
majority shareholding, foreign investments in China’s banks have been minority
shareholdings with very limited management involvement. Increasing foreign
participation has been one of the key trends in the Chinese banking system in recent
years. Foreign banks do business in China either directly through their own branches and
subsidiaries or indirectly as minority investors in Chinese banks. The indirect
participation has grown rapidly in recent years, particularly in 2005, as almost all major
Chinese banks now have a foreign strategic investor. Foreign investors have: (i) increased
bank capital, even though part of their investment went to SAFE Investments as foreign
investors partly bought existing shares; (ii) provided credibility needed to launch IPOs of
relatively large size; (iii) induced improvements in corporate governance and
management, with some board seats being occupied by candidates nominated by the
foreign investors; and (iv) provided limited technical assistance. Evidence suggests that
even when foreign investors have only one or two board seats on Chinese banks,
corporate governance and risk management improves significantly. The foreign board
members/owners also appear to have convinced senior managers to be more aware of
shareholders’ interests and to use more modern management techniques. In at least one
instance, foreigners have taken over senior positions on the board and in management. In
some cases, the Chinese banks with minority foreign ownership are also able to send
employees to the foreign bank’s headquarters for advanced training (Ling and Lu 2004,
Wall Street Journal 2004, Lin 2005, Liu 2005).
An empirical study by Allen N. Berger (Wharton Financial Institutions Center,
Philadelphia, June2006) suggest strong favorable efficiency effects from reforms that
reduce the state ownership of banks in China and increase the role of foreign ownership.
The most important findings concern the effects of minority foreign ownership, given
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that this is the current direction of bank reform. The data are strongly consistent with
efficiency gains for this type of foreign investment. For both efficiency concepts (profit
and cost) and for both categories of majority domestic ownership that have minority
foreign ownership (non-Big Four state-owned and private domestic), minority foreign
ownership is associated with higher efficiency. These results are also robust to checks for
“selection effects.” For instance, foreign owners could have selected relatively efficient
institutions in which to invest and the efficiency of these banks did not improve as a
consequence of their ownership. The checks suggest that efficiency improves after
foreign investment, rather than just “selecting” efficient Chinese banks in which to invest.
The finding that minority foreign owners have superior skills to transfer to
Chinese banks is consistent with the findings in the previous section that majority foreign
banks are generally much more efficient than state-owned banks and either more efficient
than or equally efficient to private domestic banks in developing nations. These net
comparative advantages may be even larger in China, given that the banking sector has
been so tightly regulated until recently. It is not as clear why the senior management
agrees to implement the reforms suggested by the minority foreign ownership,
particularly for the majority state-owned banks that may have very different objectives
from maximizing shareholder value. Nonetheless, some research on other nations
suggests why minority ownership can result can result in benefits. Research on corporate
governance of nonfinancial corporations in developed nations suggests that large,
minority shareholders such as institutional investors and individual block shareholders
may improve monitoring of managers and mitigate free-rider problems (e.g., Shleifer and
Vishny 1986, McConnell and Servaes 1995, Agrawal and Knoeber 1996). A study that
tests these governance effects on the bank efficiency using U.S. data in some cases finds
positive effects of institutional holdings (Berger and Bonaccorsi di Patti 2006). Finally, a
study of partial privatization in India is consistent with favorable effects of minority
private ownership of majority state-owned nonfinancial companies (Gupta 2005). The
author finds that allowing non-controlling shares of state-owned enterprises to be held
privately has positive effects on profitability, productivity, and investment. Other studies
that explored the relationship between foreign bank entry, market structure, and interest
rate spreads and margins (Barajas, Steiner, and Salazar, 2000 and Demirguc-Kunt,
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Laeven, and Levine, 2004) also find a positive relationship between foreign bank entry
and intermediation efficiency.
Thus from the Chinese case study and other international experience it is clear
that there are positive outcomes of minority foreign ownership of state owned banks. In
this context, if we look at the Indian state owned banks, we find that none of them have
any foreign shareholding. Letting the foreign banks hold some minority stake with some
management stake will go a long way in improving the performance of these banks.
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IV.
Why consolidation?
The liberalisation of Indian banking since more than a decade has seen a host of private
players entering the market and has led to cut-throat competition in the overwhelmingly
state-owned industry. The Reserve Bank of India (RBI) has chalked out a roadmap that
would likely allow foreign banks to play a bigger role in the domestic market, post March
2009. We believe foreign banks’ expansion is likely to put pressure on incumbent players
to consolidate. Further, if this opening up of the banking sector was to accelerate, Indian
banks will face stiffer competition as large international banks with varied market
experiences enter the Indian banking arena. To keep pace with these changing realities,
size will be a critical element in the chase for avenues of profit.
Case Studies
The following case studies analyzing the growth of banking industry in various countries
go on to show that consolidation has been the way forward for the banking industry
worldwide and it has had positive effects as far as the growth of the same is concerned.
Malaysia
Malaysia is an example of an emerging market with a relatively large and wellestablished foreign presence in the banking sector. The first phase of consolidation in the
Malaysian banking industry witnessed a substantial reduction in the number of banks
from fifty five to ten. This was followed by a subsequent merger wave which involved
mergers between banks and subsidiaries of financial companies as well as mergers among
the ten banking groups of the country. The consolidation of the banking sector resulted in
improved asset quality, higher transparency and better corporate governance, which were
reflected in one of Moody’s ratings that ranked the Malaysian banking system 15th in the
world in terms of transparency. Detragiache and Gupta (2004) compared performance of
different types of foreign banks (those whose operations were not concentrated in Asia
and others) and domestic banks during the Asian crisis. They found that the foreign banks
had relatively low nonperforming loans and relatively high profitability and
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capitalization, and these indicators even improved during the crisis. The domestic banks
had a large concentration of loans in the property sector and the share-purchase business,
where most of the losses occurred during the crisis. Contrary to popular belief, foreign
banks did not abandon the Malaysian market during the crisis; on the contrary, their
lending and deposits contracted less than domestic banks, perhaps because depositors
perceived them as safer and switched their deposits to them.
Korea
The ever increasing Non Performing Loans (NPLs) position in South Korea forced the
Government to close down the non-viable financial institutions. Post financial crisis,
major impetus was given to resurrect the struggling players in the banking sector. The
first round of consolidation witnessed 5 banks with CAR below the 8% limit required by
BIS1 guidelines, being taken over by stronger banks of the country in 1998. This was
followed by a series of mergers during the next four to five years, which significantly
contributed to the consolidation of the banking sector. However, most of the banks which
were granted public funds in order to facilitate a turn around could not initially survive
the restructuring process and required further assistance from the government. This led
the government to devise a three-pronged consolidation strategy under which troubled
banks were taken over by government led financial holding companies, provincial banks
were merged with national banks and strong banks were consolidated. The South Korean
government established two financial holding companies in 2001-Shinhan Financial
Group and Woori Financial Group, as a part of government initiative in the process of
consolidation. Four nonviable nationalized banks were taken over by the Woori Group
and the government invested substantial public money to boost their CAR to 10%. This
enabled the banks to improve their credit ratings through economies of scale and scope.
Japan
Japan, inspite of being the world’s second largest economy in terms of GDP, lagged way
behind in developing its banking sector. Since the early 90s, the government made
majority of the investments in the banking sector while the private players remained quite
inactive. Not much emphasis was given on the development of basic infrastructure of the
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industry, profitability or maximizing shareholders’ wealth. Traditionally, Japan had a
weak banking system plagued by NPLs and inefficient risk management systems. But the
effective consolidation process resurrected the fragmented banking system and witnessed
the emergence of five major banking groups accounting for nearly 48% of the total bank
deposits in Japan. The consolidation of the Japanese banking sector was aimed at creating
stronger and bigger banks of global standards. The first of such “mega banks”, with
assets over U$ 1.3 trillion, was created with the merger of MTFG bank and UFJ bank.
This market driven merger signified the success of the consolidation process and marked
the re-birth of the Japanese banks in the global economy. According to an OECD survey,
Japanese banks lagged way behind compared to international standards in terms of return
on total assets, interest as well as non-interest income. Thus, in order to compete with
global majors, Japanese banks were required to improve their profitability, generate
higher interest as well as non-interest income and minimize credit cost. To achieve this
goal, the Japanese banks diversified into retail banking and consumer finance, which
yielded higher returns. UFJ bank’s brand image and expertise in the field of consumer
finance was believed to be one of the major reasons of the merger.
A study titled “Consolidation, Scale Economies and Technological Change in
Japanese Banking” done by Solomon Tadesse, University of South Carolina shows that
in spite of observation of diseconomies of scale because of consolidation, there has been
an underlying change in bank technology that has increased the minimum efficient size as
well as favored large banks to smaller ones. It shows existence of a technological change
that has operated to lower the cost of production, with larger banks achieving higher cost
reductions. There is evidence that the underlying technological progress has increased the
comparative advantages of large-scale production in the industry. Furthermore, and more
directly, the evidence shows that, over the period, the underlying technological progress
sweeping the industry has been increasing the industry's minimum efficient size – i.e., the
scale of production at with total cost is minimized. Hence, the technological dynamics
that have been operating to favor and necessitate large-scale banking, despite the
observation of diseconomies, provide the economic logic for consolidation in the
industry. The results further suggest that, to the extent that consumers can benefit from
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lower costs of bank production, policies that promote a more concentrated banking
structure would not be inconsistent with public interest.
Taiwan
Taiwan was rated as the most over banked country in Asia with a highly fragmented
market consisting of more than 50 domestic banks, though almost two-thirds of the total
banking assets were held by only a few leading domestic banks. Intense market
competition, eroding profit margins and shifting base of customers to mainland China
forced several small domestic banks to close down or merge with the stronger banks. The
process of consolidation in Taiwan got underway in 2001 with the initiation of the
Financial Holding Company Act. The Act not only encouraged the formation of financial
holding companies but also facilitated mergers between them. The Act was primarily
aimed at downsizing the number of financial holding companies from 14 to 7 by 2006.
Italy
At the beginning of the 1990's, the structure of the Italian banking system was highly
fragmented with a large number of relatively small banks and a significant presence of
the State in the industry. In 1990 there were 1,064 banks operating in the Italian banking
sector. At the time almost 70 percent of the banking system's total assets were in fact
under public control Directly or indirectly publicly owned banks comprised six publicsector banks, three banks of national interest and 84 among savings banks and institutions
specialized in credit against collateral. In addition to the public banks there were also 106
private commercial banks, 108 cooperative banks, 715 mutual banks, 37 branches of
foreign banks and 5 group-specific central institutions. The structure was radically altered
in the course of the 1990's. The objectives of efficiency, performance and
internationalization replaced the old goals of supporting the development of certain
industries, sectors and economic regions. Two main regulatory changes heavily
influenced the reshaping of the banking system: the law reforming public banks and the
implementation of the Second Banking Directive (89/646/EEC). The first accelerated the
privatization and consolidation process of the banking industry. The second removed
substantial barriers to entry and allowed banks to perform a wider range of financial
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activities. Together with the reform of the ownership structure of public banks, a set of
other important reforms took place in the 1990's. Several provisions of the Italian
financial laws were substantially changed compared to the previous decade. The Italian
banking reforms of the previous decade substantially changed the entire nature of the
banking system. As of 2005 the number of banks operating in Italy had dropped by
26.3% per cent to 784. At the same time, the liberalization of branching saw the number
of bank outlets jump: at the end of 2005 there were 31,501 branches, an increase of
around 78 per cent compared with the end of 1990. As a consequence, the availability of
banking service improved substantially. Since 1993 banking groups have also been
created; as of 2005 their assets represent around 90 percent of the total for the banking
system. The share of total assets controlled by public banks has dramatically decreased,
from 70 to around 9 percent. Since the mid-1990's the average size of banks increased
substantially, both at the individual and the group level. Between 1994 and 2004 the
average size of banks more than doubled. The same happened for the largest banking
groups. This trend is mainly the result of a process of mergers and acquisitions among
banks which, measured in terms of the number of institutions involved, reached its peak
in the course of the nineties. Between 1990 and 2004 a total of 620 mergers were
recorded, involving target banks accounting for 51 per cent of the assets of the entire
banking system at the end of 1989. Put differently, in terms of banks' total assets more
than half of the Italian banking system was affected by the wave of mergers and
acquisitions during the considered period.
These developments were accompanied by a clear improvement in Italian banks'
profitability indicators. The substantial completion of the privatization process
undertaken at the beginning of the decade had significantly increased the discipline
exerted by the market on bank managers and directors. As a ratio to total assets, netinterest income declined from 2.5 to 2.2 percent while non-interest income increased
from 0.9 to 1.4 percent. This means that the share of total revenues originating from nontraditional (intermediation) business rose from 27 to 39 percent. Operating expenses
decreased from 2.4 to 2.1 percent of total assets and the share of staff costs diminished
from 47 to 38 percent. The cost-income ratio - often used as an indicator of accounting
cost efficiency - significantly improved from 70 to 58 percent. The return on equity
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(ROE) increased from 1.1 to 10.7 percent, after having reached a peak of more than 13
percent in 2000. All these trends are, to some extent, amplified when one looks at the
performance of the largest banking groups, the ones that were privatized during the first
half of the nineties.
Argentina
The Argentine banking system has undergone major structural changes over the past 20
years, but especially during the last decade. These structural changes largely reflect
changes in the economic and political environment in Argentina, where the economy
went from hyperinflation to some years of deflation, and the military gave way to a
democratic government. The process of bank consolidation in Argentina was largely a
consequence of these crises and the entry of foreign banks. While this has proved to be a
common pattern in emerging markets, the proactive role that both the public and private
sectors played in the consolidation is more unusual. Consolidation resulted in the number
of small banks falling from 105 to 66 and the number of large banks increasing from 26
to 29. Looked at from an another point of view, during the period covered, the Argentine
banking system experienced a structural change that reduced the number of banks by 27
percent, increased the amount of assets in that system by 20 percent, and left the number
of branches largely the same. Large banks and the largest of the large banks seemed to be
driving these changes, with the small banks often either being swallowed up or closing.
Brazil
The banking system in Brazil is the largest and the most complex one in Latin America.
Like in many parts of the world, the banking industry in Brazil is undergoing a process of
rapid and radical transformations. The common features of this process, in Brazil and
elsewhere, include: an increase in competition from within the industry as well as from
the outside; a wave of merger and acquisition (M&A) activities, including several crossborder deals; more globalized capital markets with highly volatile capital flows, which
are capable of causing havoc in some national financial sectors; new financial products,
with increasing reliance on off-balance sheet activities; new banking practices brought
out by the information technology revolution.
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The banking sector in Brazil has been strongly influenced by the changing
domestic macroeconomic scene of the recent period, especially by the transition from a
high to a low inflation environment. After many years of making a living out of
inflationary rents, this transition was far from smooth for many banks. Among those most
affected by the many changes in the industry were the state owned banks. Due to their
poor performance, many of the state-owned banks in Brazil were either closed down or
privatized. Less than half (14) of the 32 state-owned banks operating in the country by
1994 were still active by 2002.
The Brazilian experience represents an interesting case study on bank
privatization not only because of its quantitative relevance but also due to the varied
options given to the state-owned banks following their restructuring. Thus, some state
owned banks were straight privatized by their controllers (namely, the Brazilian states)
whereas some others had their control first transferred from the states to the federal
government and then privatized. Some other states also kept the control of their banks
after restructuring. There are also some other state-owned banks that were just liquidated.
Studies done on the effects of privatization on Brazilian industry show a positive
association between productivity and bank market share. They also show negative effects
from the number of bank branches on productivity. Moreover, state-owned banks seem to
be less productive than their private competitors. Bank privatization had positive “over
time” impact on productivity but restructuring the state-owned banks and keeping it
under state control has negative effects on productivity.
Literature Survey
Several works have been carried out that have tried to establish a correlation
between the size of the banks and its performance. Most of them have observed that
increase in bank size leads to increase in bank performance. Notable among such studies
are: Studies conducted by Halkos and Sala Mouris (2004) who observed that in Greece,
banks having a larger asset base achieved better level of efficiency. Similar observations
were made by Bikker (1999) in his study of the European banks. The idea of achieving
greater efficiency by creating bigger banks through mergers can also be backed by the
fact that, in certain countries, four to five banks which have a large asset base are also the
top ranking banks in those countries. Logically, bank mergers are only desirable for a
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bank if the merger is expected to enhance the acquiring banks' capacity so as to enhance
profits, as observed by Dmyski (1999). The basic idea being that the cost of the resultant
entity gets lowered through economies of scale. In cases where economies of scale and
economies of scope are existent, the increased size of banks will help create synergy in
operational efficiency and add to the shareholder value. But in case of diseconomies of
both the parameters, nothing fruitful will be achieved. In their work, Milbourn, Boot and
Thakor (1999) observed that the increase in merger activity may result in increasing the
shareholders' total wealth or simply add to the reputation of those who are likely to
receive a higher amount of compensation.
Conclusion
Thus the international experience clearly suggests that consolidation in the Indian
banking industry is imperative if we have to compete with sought after foreign banks that
will be entering India soon. Also now that many Indian banks are exploring the idea of
setting up their own operations abroad it is necessary that they are comparable with the
foreign banks in terms of size, capital, quality of service and technology. In this
backdrop, consolidation in the Indian banking industry is all the more needed. Merger
can create synergy and compliment in various operational areas to reduce cost. At the
same time, merger in the public sector banks would lead to stronger public sector units.
This would, in turn, help to channelize more lending in the priority sector, in tandem with
keeping a human face to reforms. In India, public sector banks have stood the test of
time, with asset base growing in size, the level of non performing advances on the
decline, rise in technological upgrades and efforts to comply with capital adequacy
norms, as suggested by Basel II committee. The 19 nationalized banks alone constitute
almost half of the total business of all the scheduled commercial banks in India, which is
followed by the State Bank of India and its seven sisters. Further the 19 nationalized
banks have uniform rules that govern them, the same wage structure and the same types
of products for their customers. Thus, having a merged entity can create synergy and
issues like ethnic base, cultural identity can also be avoided.
Some other evident benefits of consolidation are:
1. Merged entity will have greater access to capital from markets at lower costs.
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2. Consolidation would be a prudent decision as compared with organic expansion,
given the numerous smaller banks and the available infrastructure, and also
considering the time required for organic growth.
3. Owing to the diversified operations and credit profiles of merging banks,
consolidation is likely to serve as a risk-mitigation exercises as much as a growth
engine.
4. With the coming up of Basel 2, significant expenditure needs to be incurred for
technology upgradation, which may be beyond the means of many smaller
players.
5. It will help Indian public sector banks in improving their CAR (Capital Adequacy
Ratio), thus providing them more space to grow. The PSBs are expected to face a
shortfall of capital in future of the minimum 51% government holding rule.
All these benefits make a compelling case for consolidation in the Indian banking
that has been a topic for debate for quite a while now. Whereas the big banks have a
choice as far as consolidation is concerned, some of the weak smaller banks will have no
option but to sell out to one of the bigger players once Basel II norms are implemented
and minimum required Networth is increased. Infact in India, so far, most of the mergers
of banks have been of these types which were undertaken not for growth but to salvage a
weak bank. This type of merger generally weakens the strong bank that merges with the
weak bank. This obviously is to be avoided if we are looking at merger as a tool for
strengthening the bank that merges with the other. In fact, efforts are already afoot to
seek merger for expanding reach and enhancing resource, both capital and intellectual.
Such consolidations would obviously enrich the bank and will provide better competitive
edge to face the challenges created by the globalization. Thus, apart from gobbling up
these weak small banks, the big banks should also look at consolidation amongst
themselves which will truly increase their size.
Consolidation in Private Sector Banks
In the public sector banking domain, acquisitions so far have been the result of regulatory
interventions. On the other hand, in the private sector, key drivers for consolidation have
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been growth, acquisition of regional market share and future growth potential. ICICI
Bank’s acquisition of Bank of Madura, HDFC Banks’ acquisition of Times Bank,
amalgamation of Centurion Bank with Bank of Punjab, acquisitions like those of Lord
Krishna Bank by Centurion Bank of Punjab and Sangli Bank by ICICI Bank, are pointers
towards the private banking systems inclination towards consolidation. From the
perspective of the private sector banks, achievement of economies of scale i.e. reduction
in per unit cost due to increase in the scale of operation is an important goal. In addition,
economies of scope i.e. reduction in per unit cost due to synergies in producing multiple
products within the same firm is another objective. A bank can leverage on its existing
infrastructure to maximize opportunities to cross sell.
Size acts as probably one of the biggest constraints for the private sector banks,
even though ICICI Bank is the second largest bank in the country its total assets are
approximately 40% of SBI’s assets. In terms of branch strength, SBI has over 9,000
branches while ICICI Bank has only 755 branches, which is the highest amongst the
private sector banks. In China, the biggest strength against competition from foreign
banks has been the branch network of the Chinese banks. The branch network enables the
Chinese banks to cater to the demand of banking services from the interiors of China; an
area where the foreign players have not been able to make their presence felt. This
advantage has helped the Chinese banks to compete with the foreign banks inspite of
their poor credit and risk management.
Thus it can be concluded that size of the balance sheet and branch network will be
critical factors for the private sector banks to face competition from PSBs and foreign
players in the future. There is a considerable scope for M&A activity in the private sector
banking domain with several small (in terms of size) banks available for merger or
acquisitions. Larger private sector banks should look at these smaller banks as possible
targets. This will help the larger private sector banks grow their balance sheet and branch
network and put them in a better position to face the growing competition in the banking
industry in India. Mergers and acquisitions could be made on the unique positioning that
these smaller banks offer. The owner management of these smaller banks would be more
than willing to sell their stake if offered good valuations.
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V.
A Proposed Merger
Choice of Parameters
The government owns approximately 70% of the banking sector in India, through over 21
banks (not including the subsidiaries of SBI). As has been shown above, it is high time
that these 21 institutions be folded into 6-7 entities through a consolidation scheme.
However, while deciding on which banks should merge together it is important for the
government authorities to give some thought on the choice of parameter on the basis of
which banks to be merged should be selected. The ministry of finance has so far been
advocating geographically complimentary banks to merge and one such popular proposed
merge was that of Bank of India with Union Bank of India. In the next section some of
the very popular parameters of mergers in the banking industry globally have been
evaluated to finally arrive at the recommendations for the parameter to be adopted by the
Indian PSBs.
1. Geography
As said above, this is the favorite parameter of the Finance Ministry, because of the
following reasons:
1. The PSBs in India have bulk of their business concentrated in specific regions. A
merger of the banks based on different geographies would help the combined
entity get a pan India presence.
2. The pan India presence would enable the merged entity to diversify its risks and
also be able to tap alternative pools for raising and deployment of funds
3. It has been found in China that a strong and well distributed branch network has
helped the local Chinese banks compete effectively with foreign banks in China.
The finance ministry is hoping for a similar kind of situation in India after 2009.
4. The overlap between branches of the merged entity will be minimized and thus
loss of jobs would be reduced and thus the reaction from the bank unions would
be avoided
However, a little deeper reading of the situation reveals the following criticisms for this
method:
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- This method involves no analysis of the financial statements of the entities
involved in the merger while deciding on the mergers. The financial
statements of the entities may reveal information that may not merit a merger,
which may not be considered.
-
There are a few critics who say that instead of merging banks with strengths in
different regions it would be better to merge banks with strengths in the same
region and create a strong entity in that region. This is expected to enable the
entity to leverage on its existing presence in the region.
It is thus concluded, that though geography is important it should not be taken in isolation
while merging the PSBs. Thus it is recommended that the finance ministry looks at
certain important financial parameters in evaluating the mergers between banks.
2. Asset Complimentarity
This is one of the most popular parameter on which banks decide to merge
internationally. There are some very successful examples of the same and JP Morgan
Chase Bank is one of the best ones. Discussed next is the historic growth of the JP
Morgan Chase Bank.
Case Study: JP Morgan Chase Bank
JP Morgan Chase Bank is the third largest bank today in terms of asset size. The growth
of JP Morgan has been through a series of mergers, the key transactions leading to the
formation of JP Morgan Chase:
-
In 1991, Chemical Banking Corp. combined with Manufacturers Hanover
Corp., keeping the name Chemical Banking Corp., then the second-largest
banking institution in the United States. Chemical Banking Corp. had a good
corporate banking business, while Manufacturers Hanover Corp had a good
mortgage business.
-
In 1995, First Chicago Corp. merged with National Bank of Detroit's parent
NBD Bancorp., forming First Chicago NBD, the largest banking company
based in the Midwest.
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- In 1996, Chase Manhattan Corp. merged with Chemical Banking Corp.,
creating what was then the largest bank holding company in the United States.
-
In 1998, Banc One Corp. merged with First Chicago NBD, taking the name
Bank One Corp. Merging subsequently with Louisiana's First Commerce
Corp., Bank One became the largest financial services firm in the Midwest,
the fourth-largest bank in the U. S. and the world's largest Visa credit card
issuer.
-
In 2000, J.P. Morgan & Co. merged with Chase Manhattan Corp., in effect
combining four of the largest and oldest money center banking institutions in
New York City (J.P. Morgan, Chase, Chemical and Manufacturers Hanover)
into one firm called J.P. Morgan Chase & Co. JP Morgan had a strong
investment banking business, while Chase Manhattan had a good retail
banking business.2
These mergers culminated in July 2004 with the joining of J.P. Morgan Chase & Co. and
Bank One Corp. to form today's JPMorgan Chase &Co.
As can be seen in the above mergers, the entities involved were always
complimentary to each other in terms of business and that is what has led to the success
of these mergers. This success has helped JP Morgan become the third largest bank in
terms of assets today. There are some other successful mergers that are based on
complimentary assets; Bank One and Citigroup too have had some very successful
mergers in which the evaluation criterion has been complimentary assets.
Applicability to Indian Public Sector Banks
An analysis of the Public Sector Banks depicts the “look-alike” nature of these banks.
These banks have been owned and managed by the government, which has used its
ownership and management to ensure that bank credit is used in helping the priority
sectors like agriculture. The RBI has mandated all banks to advance 40% to the priority
sector and there are such caps which the regulator has levied on the Indian banks. As a
result of this the assets and business distribution of the public sector banks are quite
similar.
2
http://www.jpmorganchase.com/cm/cs?pagename=Chase/Href&urlname=jpmc/about/history
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The table below shows the segmental break up of revenues and assets into the reporting
segments of 8 of the public sector banks as on 31st March 20073.
Figure 2
In Rs crores
Revenues
Assets
Bank
Banking
%
Treasury
%
Banking
%
Treasury
%
Bank of Baroda
6,618
64%
3,768
36%
96,621
68%
44,691
32%
Canara Bank
9,358
73%
3,458
27%
115,809
71%
46,780
29%
Punjab National
Bank
Union Bank of
India
Oriental Bank of
Commerce
Bank of India
9,305
74%
3,274
26%
114,639
71%
46,592
29%
5,782
72%
2,287
28%
65,591
65%
35,383
35%
5,360
75%
1,824
25%
53,045
72%
20,140
28%
7,553
70%
3,169
30%
89,107
64%
50,745
36%
Indian Overseas
Bank
Allahabad Bank
4,429
72%
1,723
28%
48,310
59%
33,943
41%
4,837
92%
423
8%
61,457
92%
5,151
8%
As per the above table, it can be observed that other than Allahabad Bank (which is the
smallest bank of the sample chosen) all the other banks have assets deployed in the
banking business in the small range of 59-72% and in the treasury business from 28-41%.
The revenues generated by the banking business (excluding Allahabad Bank) lies in the
range of 64-74% and from the treasury business lies in the range of 26-36%. This table
helps in depicting the “look-alike” nature of the PSBs in India and thus makes
complimentary assets a difficult parameter to choose for mergers.
Based on the above analysis it is difficult to pick public sector banks that have
complimentary businesses. Hence though this model has been highly successful
worldwide it cannot be implemented for the PSBs in India. The parameter, however, can
be used for mergers in the private sector banking space in India and should help the
private banks make successful strategic acquisitions.
3
Company Annual Reports for March 2007
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3. Financial Ratio’s
A frequently used parameter for evaluating partners for mergers across industries is use
of popular ratios of that industry and based on complimentary in strengths a merger could
be adopted to benefit both entities strategically. For e.g. a low cost company with a low
asset turnover could merge with a high cost company with a high asset turnover to ensure
over all synergies.
When the public sector banks were analyzed on ratios like Business per
employee, Profit per employee, Interest Income/Total Income and Operating
Expenses/Total Income, their “look alike” nature became more apparent.
Figure 3
Interest
Income/
Total
Income
91%
Total
Investment/
Total
Advances %
24.41
RoA (%)
Business/
Employee
Profit/
Employee
0.8
5.55
0.03
Canara Bank
93%
27.6
0.96
5.49
0.03
Punjab National Bank
87%
27.85
1.01
4.07
0.03
Union Bank of India
89%
27.35
0.89
5.09
0.03
Oriental Bank of Commerce
92%
26.97
0.89
7.43
0.06
Bank of India
91%
24.41
0.8
5.55
0.03
Indian Overseas Bank
89%
29.16
1.43
4.67
0.04
Allahabad Bank
90%
28.07
1.24
4.56
0.04
Bank
Bank of Baroda
As can be seen from the table above that the PSBs are similar on almost all ratios except
for one bank in some of the ratios that may have a deviation as compared to the others but
on the whole it would be difficult to identify any complimentarity between the banks
based on the ratios. Thus financial ratios was another parameter which could not be the
factor deciding the merger of PSBs in India.
4. Maturity of Asset and Liabilities
Banks have advances (assets) and deposits (liabilities) maturing at different points of time
due to the nature of fund deployment and fund raising done by them. The duration of the
advances and deposits varies significantly with the interest rate expectations in the
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economy. The difference in outlook between depositors and borrowers exposes banks to
liquidity risk. As per RBI regulations, banks are required to disclose a break up of the
advances and deposits in various time frames as it helps in understanding the liquidity
and the interest rate risk that the bank is exposed to. It also helps in understanding how
the bank is funding its advances to borrowers. It was analyzed that if banks which have
complimentary asset – liability maturity profiles merge, it would help in reducing the
overall liquidity and interest rate risk that the combined entity would be exposed to.
On analyzing the Indian public sector banks on their asset liability maturity
profile it was found that complimentary asset liability profiles do exist within the PSBs.
This parameter could thus be a good start off point for deciding on which banks should
merge together. Since the Indian PSBs are similar on almost all other counts (as
discussed above), use of this parameter to choose merging banks helps in ensuring that
the merged entity would be exposed to lesser liquidity and interest rate risk.
One of the possible merger
Asset Liability profile
On analyzing the various GAP buckets for the last 4 years, one of the potential mergers
that comes to the fore is the merger of Bank of India & Indian Overseas Bank. Following
are their GAPs for various time buckets for the last 4 years:
Figure 4: Bank of India (BOI)
Rs. Crore
1 to
14
days
15 to
28
days
29
Over 3 Over 6
days to months months
3
& up to & up to
months
6
1 year
months
Over
1 year
& up
to 3
years
Over
3
years
& up
to 5
years
Over
5
years
Total
BOI 2007
(12497)
(7507)
(789)
(8032)
(1927)
(27347)
6223
27696
(24180)
BOI 2006
(4014)
(6746)
(3442)
(2786)
(3376)
(8853)
3301
23069
(2847)
BOI 2005
(8430)
(3086)
(3604)
442
(983)
(9037)
5457
16815
(2426)
Average
(8314)
(5780)
(2612)
(3459)
(2095)
(15079)
4993
22527
(9818)
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Figure 5: Indian Overseas Bank (IOB)
Rs. Crore
1 to 14
days
15 to
28
days
29
days to
3
months
Over 3
months
& up
to 6
months
Over 6
months
& up
to 1
year
Over 1
year &
up to 3
years
Over 3
years
& up
to 5
years
Over 5
years
Total
IOB 2007
3301
176
(8)
1026
860
2990
1126
(9131)
340
IOB 2006
3600
307
1752
832
1494
2503
(2167)
(4410)
3912
IOB 2005
652
(136)
1233
797
1046
5921
(5117)
(3787)
609
2518
116
992
885
1133
3805 (2053)
(5776)
1620
Average
We see from the above 2 tables that the signs of almost all the buckets are exactly
opposite for each of the last 3 years. This clearly shows that the 2 banks have a
complimentary asset liability management strategy which if combined will result in a
reduced liquidity and interest rate risk. On the other hand if we look at the same table for
UBI we find that the GAP signs for most of the buckets are infact same. Thus, a BOI –
IOB merger makes more sense than a much talked about BOI – UBI merger.
Figure 6: Union Bank of India (UBI)
Rs. Crore
1 to
14
days
15 to
28
days
29
Over 3 Over 6
days to months months
3
& up to & up to
months
6
1 year
months
Over 1
year &
up to
3
years
Over 3
years
& up
to 5
years
Over
5
years
Total
UBI 2007
(3001)
(712)
(3087)
(769)
(9830)
(23197)
21046
20239
690
UBI 2006
193
(518)
(945)
(3369)
(11221)
(10019)
8450
19054
1625
UBI 2005
(678)
(900)
(1055)
(386)
(8358)
(10976)
7191
14678
(484)
Average
(1162)
(710)
(1696)
(1508)
(9803)
(14731)
12229
17990
610
Geography
Apart from ALM point of view, we see that BOI-IOB merger will also be more
preferable from geography point of view as compared to BOI-UBI merger. BOI-IOB
merger results in a less overlapping of branches and a more even coverage of the country
when compared to the BOI-UBI merger. The following tables help in understanding that:
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Figure 7
North
Total number of bank
branches in India
BOI
IOB
UBI
West
South
East
Total
15690
7976
11191
9567
44424
729
247
908
858
143
494
348
987
480
743
209
287
2678
1586
2169
North
West
South
East
Total
27%
16%
42%
23%
34%
32%
9%
23%
23%
28%
13%
62%
22%
31%
17%
28%
13%
13%
22%
21%
100%
100%
100%
100%
100%
North
West
South
East
Total
5%
2%
6%
6%
10%
11%
2%
6%
13%
17%
3%
9%
4%
12%
7%
8%
2%
3%
10%
11%
6%
4%
5%
10%
11%
Figure 8
% of ones own network
BOI
IOB
UBI
BOI + IOB merged
BOI + UBI merged
Figure 9
% of total bank
branches across India
BOI
IOB
UBI
BOI + IOB merged
BOI + UBI merged
The above tables show that:
1. BOI-IOB results in an entity which has its branches more evenly spread out
across the country (Table 2). Thus the BOI-IOB entity will have 23% of its total
branches in north, 23% in the west, 31% in the south & 22% in the east. Same
numbers for BOI-UBI combine are 34%, 28%, 17% & 21%. Though the BOIUBI numbers are not bad, BOI-IOB provides a better spread. To see this, the
volatility (equal to standard deviation divided by mean) was calculated for each
of these sets of 4 numbers. See the attached excel sheet for workings. The
following results were obtained
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Figure 10
Bank
BOI
IOB
UBI
BOI-IOB
BOI-UBI
Volatility
33.15%
99.33%
48.77%
16.94%
30.11%
We see that a BOI-IOB merger reduces the volatility between the percentage of
branches in different regions from 33.15% for BOI & 99.33% for IOB to 16.94%
for the merged BOI-IOB whereas the same number in case of BOI-UBI is
30.11%
2. BOI-IOB has a more even percentage of market share in the 4 regions as
compared to BOI-UBI (Table 3). BOI-IOB will have 6% of the total number of
bank branches in the north india, 13% of the total branches in west, 12% of south
& 10% of east. The same numbers for BOI-UBI are 10%, 17%, 7% & 11%.
Again if we see the volatility we find that BOI-IOB numbers are better.
Figure 11
Bank
BOI
IOB
UBI
BOI-IOB
BOI-UBI
Volatility
51.72%
97.24%
30.36%
28.00%
35.35%
As we can see, BOI-IOB merger reduces the volatility between the percentage of total
bank branches in different regions from 51.72% for BOI & 97.24% for IOB to 28% for
the merged entity. The same number in case of BOI-UBI merger is 35.55% which is
infact greater than standalone UBI number.
The above analysis shows that BOI-IOB merger clearly scores over BOI-UBI merger as
far as complimentarity of geography coverage is concerned.
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Merger Model
As discussed above, the BOI-IOB merger holds good on the asset liability buckets and
the geographical spread and is better than the much talked about BOI-UBI merger. The
following merger model is aimed to test if the merger between Bank of India and Indian
Overseas Bank would help improve key factors like Capital Adequacy and NPAs of the
combined entity. Also we would see if the combined entity is better than the simple
arithmetic sum of both the entities, as this would depict synergies. So to summarize, the
objectives of the merger model are:
1. Check if the capital adequacy of the combined entity is better than that of the
individual banks
2. To check if the merger helps in reducing the NPAs of the combined entity
3. To find out if the merger is adding any value
4. To validate if this merger is more valuable than the merger between Union Bank
of India and Bank of India
The following steps were followed while making the merger model:
1. To forecast the individual financial statements, median broker estimates were
taken from Bloomberg for Net Income and Return on Equity. The average ratios
for the individual entities were taken for the last 3 years to build the entire
forecasted financial statements. The following ratios were used:
-
Growth in Advances
-
Total Advances/Total Deposits
-
Investment/Deposit
-
Interest Income / Total Funds
-
Interest Expense / Total Funds
-
Implied NIM
-
Non Interest Income/Total Income
-
Employee Expense/Total Income
-
Other Expense/Total Income
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- Cash/Deposit
-
RWA/Advances
-
Additional Provisions for NPA/Net Profit
2. To forecast the financial statements of the merged entity, the asset weighted
average of the above ratios for the individual banks was used.
3. The asset weighted average ratios were then synergized at different rates to study
the impact on the financial statements of the merged entity. Thus the first level of
synergies could be derived by asset weighting the ratios and then by synergizing
these ratios further.
Based on the above assumptions, the forecasted financial statements were prepared for
the individual entities and the combined entity. The analysis of each of the objectives
mentioned above follows:
1. Check if the capital adequacy of the combined entity is better than that of the
individual banks
The table below shows the Capital Adequacy ratios of the combined entity using the asset
weighted ratios.
Figure 12: BOI+IOB
Capital Adequacy
CAR
Tier I
Tier II
2007
2008
2009
2010
12.36%
7.11%
5.26%
12.45%
7.19%
5.26%
12.60%
7.34%
5.26%
12.72%
7.46%
5.26%
When the above numbers are compared with the individual forecasted capital adequacy
ratios, as per the tables below, it is observed that though the combined entity has a CAR
lower than that of Indian Overseas Bank but on a much larger balance sheet than each of
the individual banks, we have a high and comfortable capital adequacy. Also, the
combined entity has sufficient head room in the Tier-II bucket to raise capital to fund the
growth of its business. If the asset weighted numbers and the synergized numbers are
used, the CAR significantly improves and is even better than the stand alone numbers of
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Indian Overseas Bank as can be seen in the chart (figure 15) below. BOI+IOB in the
chart is the simple arithmetic addition
Figure 13: BOI
Capital Adequacy
2007
2008 2009 2010
11.96% 10.22% 9.75% 9.09%
CAR
6.62% 5.67% 5.86% 5.76%
Tier I CAR
5.34% 4.55% 3.89% 3.33%
Tier II CAR
Figure 14: IOB
Capital Adequacy
2007
2008
2009
2010
13.27% 14.42% 13.70% 12.57%
CAR
8.20% 8.49% 8.74% 8.42%
Tier I CAR
5.07% 5.93% 4.96% 4.16%
Tier II CAR
Figure 15: Change in CAR in various scenario
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Figure 16: Change in Tier 1 capital in various scenarios
- How would the Union Bank of India and Bank of India merger fair on the above
numbers?
Based on the forecasted financial statement of the merger between Union Bank of
India and Bank of India, the capital adequacy numbers are shown in the table
below:
Figure 17: BOI+UBI
2007
2008
2009
2010
Capital Adequacy
12.32% 11.95% 11.87% 11.81%
CAR
7.09% 6.69% 6.61% 6.55%
Tier I
5.23% 5.26% 5.26% 5.26%
Tier II
As can be observed from the above tables, the merger between Indian Overseas
Bank and Bank of India does give the combined entity a better CAR in all the
years. This benefit arises due to the complimentary assets of IOB and BOI, which
is lacking in the merger of UBI and BOI. Thus, the synergies derived on merging
IOB and BOI provide a better CAR.
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2. Does the merger help in reducing the NPAs of the combined entity?
The table below depicts the NPA numbers of the combined entity, using the asset
weighted ratios and thus providing the base case of synergies.
Figure 18: BOI+IOB
NPAs
2007
2008
2009
2010
2.44% 1.66% 1.13% 0.77%
Gross NPAs
0.82% 0.40% 0.20% 0.12%
Net NPAs
Provision Cover 66.52% 75.94% 82.46% 84.92%
These numbers when analyzed with the NPA numbers of the individual entities, help us
understand how choosing complimentary banks helps in improving the overall ratios of
the combined entity. As can be observed from the tables below, on a large advance base
the NPAs are better than those of Indian Overseas Bank for each of the forecasted years
and are at a very manageable rate for the combined entities significantly large balance
sheet size. If we include synergies the numbers for the combined entity improve even
further as can be seen in the chart below (figure 21)
Figure 19: BOI
NPAs
2007 2008 2009 2010
Gross NPA/Advances 2.47% 1.80% 1.30% 0.93%
0.74% 0.40% 0.15% 0.05%
Net NPA/Advances
64.5% 78.0% 88.6% 94.9%
Provision Cover
Figure 20: IOB
NPAs
2007 2008 2009 2010
Gross NPA/Advances 2.38% 1.93% 1.45% 1.09%
0.71% 0.53% 0.40% 0.34%
Net NPA/Advances
70.3% 72.6% 72.3% 68.7%
Provision Cover
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Figure 21: Net NPA movement under various scenarios
- How would the Union Bank of India and Bank of India merger fair on the above
numbers?
Based on the forecasted financial statement of the merger between Union Bank of
India and Bank of India, the NPA numbers are shown in the table below:
Figure 22: BOI+UBI
NPAs
Gross NPAs
Net NPAs
Provision Cover
2007
2.70%
0.92%
65.87%
2008
1.91%
0.49%
74.22%
2009
1.35%
0.26%
80.75%
2010
0.95%
0.14%
84.88%
As can be observed from the above tables, the NPA numbers for the Bank of India
and the Indian Overseas Bank look better than those of the merger of Union Bank
of India and Bank of India.
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3. Is this merger adding value?
Value here is defined by the present value (discounted at 10%) of surplus profits
generated by the combined entity vis-à-vis the sum of the profits generated by the
individual entities. Here it is assumed that synergies (if any) would be derived by asset
weighting the ratios used as assumptions to build the model (discussed above).
The below table shows the profits generated by the combined entity over the years
(assuming asset weighted ratios) vis-à-vis the simple summation of the profits generated
by the individual entities.
Figure 23
2008
PAT
IOB
BOI
IOB + BOI
Merged Entity
Value Added
1,305.11
1,287.98
2,593.09
3,622.38
1,029.28
2009
2010
1,564.99
1,579.12
3,144.11
3,717.61
573.50
1,789.19
1,845.89
3,635.08
4,700.66
1,065.58
The present value of the value added by the merged entity is Rs. 2,210 crores, assuming
synergies derived by asset weighting all the ratios. The values of these synergies improve
even further if further synergies are taken into account. Hence, it can be concluded that
this merger is value additive.
- How would the Union Bank of India and Bank of India merger fair on the above
numbers?
The table below shows the value added by the merger of Union Bank of India and Bank
of India
Figure 24
PAT
UBI
BOI
UBI + BOI
Merged Entity
Value Added
2008
1,120.71
1,287.98
2,408.69
3,369.11
960.43
2009
1,445.10
1,579.12
3,024.22
3,503.24
479.01
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2010
1,628.16
1,845.89
3,474.05
4,403.96
929.92
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The present value of the value added by this merger is Rs. 1,968 crores. Thus, based on
similar assumptions it is observed that the merger between Bank of India and Indian
Overseas Bank adds more value. The return on equity and return on assets would also be
better for BOI-IOB merger as it creates a relatively smaller but healthier balance sheet.
Also, the balance sheet is exposed to lesser liquidity and interest rate risk because of the
complimentary ALM gaps as was discussed above.
Conclusion
From the above analysis and the merger model, it has been observed that a better merger
would be created if the basis is the ALM gap & the geographies. It can thus be stated that
using the ALM gaps as a starting point to evaluate and choose banks for mergers could
help the finance ministry create banks that would be inherently exposed to lesser liquidity
and interest rate risk at the start. The merged bank could then grow from there based on
the management and strategy adopted by it, but what has been identified here is a good
starting point for choosing banks to merge. We have also seen that Bank of India – Indian
overseas bank merger makes more sense than the much talked about BOI-UBI merger.
It has also been shown that though consolidation will help in improving the CAR,
but as we can see from the numbers, it will still fall short of the minimum required. Thus
there is no way for the government of India but to dilute its holdings in the public sector
banks or to pump in more money. We recommend that dilution by selling minority stake
to foreign banks will be a better idea as it will help in improving the operational
efficiency as has been discussed in the report.
Other Suggestions for PSBs
After nationalization of the banks in India in 1969 and 1980, it is the government that has
controlled the banking industry. State banks in India have, over the years, played a very
significant role in the development of the economy and in achieving the objectives of the
nationalization undertaken in 1969 and 1980, namely to reach the masses and cater to the
credit needs of all segments, including weaker sections, of the economy. The period
1969-90 witnessed rapid branch expansion and an adequate flow of credit to all sectors,
including the neglected sectors of the country. From 1990, however, it was recognized
that steps were needed to improve the financial health of banks to make them visible,
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efficient and competitive to serve the emerging needs and enhance the efficiency of the
real sector. While the role of the large state banks has not undergone any structural
changes and they continue to serve the varying needs of the economy, what has changed
significantly, as a result of the reform process, is the focus on their consolidation,
efficiency, resilience, productivity, asset quality and profitability through liberalisation,
deregulation and adoption of prudential standards in line with international best
practices4. However, now with increasing globalization and the increased interest by
foreign banks in India, the state run banks would have to get their act together quickly
and improve efficiencies at a rapid pace. Based on the readings on the Indian Banking
industry and case studies of how the banking industry has evolved in other countries
worldwide, highlighted below are some suggestions that the state run banks should
implement almost immediately.
Consolidation of branch networks
State owned banks are concentrated in specific geographies and close to 70% of their
branch network is located in 2-3 states. This makes all these banks very specific regional
players which do not have diversified access to funds. It has been found that many banks
have branches located in the same area (many times there are 5 branches of different
banks on the same road) and thus they land up competing for access to funds and for
deployment of funds. While this is advantageous to have in industrial and business areas
where competition among banks would help businesses in garnering better terms from
banks, we believe that at some places this leads to wasteful investments.
Consolidation of branch networks between state owned banks will help avoid
these wasteful investments and help banks deploy money released for alternative
purposes. A consolidation of branches should be determined on a regional basis, whereby
a bank which has the market leadership in a particular area would determine the
requirement of funds in that region. Based on the requirement of funds, the RBI should
determine the number of branches that would operate in that area. While determining
which specific banks should operate in the area preference would be given to banks
which have maximum market share in the area
4
Competition, consolidation and systematic stability in the Indian Banking industry by S.P. Talwar
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This exercise should help free considerable amount of capital for the State owned
banks, which could be deployed in alternative areas to ensure higher growth rates in
profitability. Profitability would also improve on account of reduction in operating
expenses of banks on completion of this exercise.
For implementation of this suggestion, RBI should appoint consultants to study
the branch networks of various banks and help in determination of consolidation
opportunities.
Manpower Sizing
State owned banks are highly overstaffed and there exist undisguised unemployment in
abundance in these institutions.
Figure 25: Public Sector Banks
Bank
Business/Employee
Profit/Employee
Allahabad bank Ltd
0.04
4.56
State Bank of India
0.02
3.57
Punjab National Bank
0.03
4.07
Bank Of India
0.03
4.98
Canara Bank
0.03
5.49
Bank of Baroda
0.03
5.55
Union Bank of India
0.03
5.09
Indian Overseas Bank
0.04
4.67
Oriental Bank of Commerce
0.06
7.43
Andhra Bank
0.04
5.36
0.035
5.077
Business/Employee
Profit/Employee
0.06
6.07
ICICI Bank
0.09
10.27
UTI Bank
0.08
10.22
Centurion Bank
0.02
4.2
Kotak
0.03
0.01
0.056
6.154
Average
Figure 26: Private Banks
Bank
HDFC Bank
Average
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This is evident from the above two tables which clearly show that private banks have a
higher Business per employee & a higher Profit per employee.
We there is considerable scope to reduce the manpower employed in the state
owned banks. A matrix should be defined to determine the number of employees that a
branch should employ based on the volume and size of transactions that the respective
branch is expected to cater to. This exercise should again help improve the operating
efficiency of the state owned banks by reduction in operating expenses of these
institutions which will result in better profitability of these entities.
To ensure a smooth downsizing exercise public sector banks should re-launch the
voluntary retirement scheme. The scheme does tend to affect the short term liquidity and
profitability of the bank but it is bound to be highly beneficial to both the liquidity and
the profitability in the medium to long term. Re-launch of this scheme could also mean a
possible loss of some very capable staff of the public sector to the private and foreign
players in the industry, however, we reckon that the risk of this would be minimal due to
higher demands of the job in the private and foreign players which may act as a deterrent
to most of the talented staff.
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VI.
ICICI Bank
Since their formation institutions like ICICI Bank and HDFC Bank have been leading the
way forward for the Indian Banking industry in terms of efficiency, product development
and deployment of funds. Both these banks have adopted their own unique strategy for
growth and have been very successful in implementing their respective strategies.
However, now that very soon we expect foreign banks to come all out with their India
growth plans, it is time for these institutions to improve the pace of their growth and alter
their strategies to accommodate rapid growth rates.
Discussed next is the history of growth of ICICI Bank & what its strategy has
been so far.
History of ICICI Bank
ICICI Bank was originally promoted in 1994 by ICICI Limited, an Indian financial
institution, and was its wholly-owned subsidiary. ICICI's shareholding in ICICI Bank was
reduced to 46% through a public offering of shares in India in fiscal 1998, an equity
offering in the form of ADRs listed on the NYSE in fiscal 2000, ICICI Bank's acquisition
of Bank of Madura Limited in an all-stock amalgamation in fiscal 2001, and secondary
market sales by ICICI to institutional investors in fiscal 2001 and fiscal 2002. ICICI was
formed in 1955 at the initiative of the World Bank, the Government of India and
representatives of Indian industry. The principal objective was to create a development
financial institution for providing medium-term and long-term project financing to Indian
businesses. In the 1990s, ICICI transformed its business from a development financial
institution offering only project finance to a diversified financial services group offering a
wide variety of products and services, both directly and through a number of subsidiaries
and affiliates like ICICI Bank.
In October 2001, the Boards of Directors of ICICI and ICICI Bank approved the
merger of ICICI and two of its wholly-owned retail finance subsidiaries, ICICI Personal
Financial Services Limited and ICICI Capital Services Limited, with ICICI Bank. The
merger was approved by shareholders of ICICI and ICICI Bank in January 2002 and the
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Reserve Bank of India in April 2002. Consequent to the merger, the ICICI group's
financing and banking operations, both wholesale and retail, have been integrated in a
single entity. On merger with ICICI Limited, ICICI Bank inherited a very large portfolio
of non-performing assets, which could have impacted its profitability. However, by
adopting a “grow big, grow fast” strategy, ICICI Bank has been able to make this
seemingly large portfolio of non-performing assets look very small as a percentage of its
large book value.
ICICI Bank has adopted this unique strategy of growing big, they have gone all
out deploying their funds, raising money from customers, making capital issues in the
international markets and raising money in the Indian markets. This has meant that ICICI
Bank has been able to grow their book to a significant size and today it’s the second
largest bank in India in terms of asset size and the largest bank in India in terms of market
capitalization.
ICICI Bank with assets in excess of USD 79 billion and a market capitalization of
63483 crore rupees does not feature in the list of the top 50 banks in the world. The
market capitalization of ICICI Bank is only one-tenth of the top 10 banks in the world.
Thus, even with its “grow big, grow fast” strategy ICICI Bank may not be able to catch
up with the large international banks quickly.
Strategy of ICICI Bank
ICICI Bank today is the largest bank in the country in terms of market capitalization and
has been on a fund raising spree in the year 2007. The various fund raising programs of
ICICI bank in the last few months are:

In August, ICICI Bank has mandated 10 firms including Goldman Sachs
International and Calyon to arrange a yen denominated loan equivalent to USD
1.5 bn

In its annual general meeting on July 21st, the shareholders of the bank authorized
the Board of the bank to have borrowings upto Rs. 200,000 crore at any given
point of time. In the same shareholder meeting, shareholders approved plans to
raise funds from domestic or overseas markets through securities with a face
value of up to Rs 150 crore
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 In June, ICICI Bank, in the biggest offering by an Indian company, raised $4.3
billion in a global follow-on issue, half of which was in the form of American
Depository Shares

In June, raised approximately Rs. 10,000 crore through a follow on public issue
which is the largest fund raising exercise by an Indian company after the ONGC
public issue in 2004

In January, ICICI Bank sold $2 billion of dollar-denominated bonds, the biggest
debt sale by an Indian company. The bank has about $11.2 billion of loans and
bonds outstanding, according to data compiled by Bloomberg.

In addition to these, the bank has continued to securitize its assets on a regular
basis and place the same in the markets
The question that the analyst community is trying to answer is that what ICICI Bank is
planning to do with all this money. Even if it is to be assumed that ICICI Bank is likely to
take a significant hit on account of its bad loans inherited from the erstwhile ICICI
Limited, the amount of capital raised is significantly large.
Based on reading of some of the growth stories of international banks and trying to look
at the trends in statements made by the banks management, the following options can be
speculated for the utilization of the large pool of capital raised by ICICI Bank:
1. International Acquisition coupled with a few small acquisitions locally
A popular speculation is that ICICI Bank is preparing a war chest to make acquisitions
and scale up its size to compete with the foreign banks. The acquisition strategy that
could be adopted by ICICI Bank if linked to acquisition strategies of international banks
like Citigroup can be speculated to be two fold:
a) Small local acquisitions
ICICI Bank could look at small local acquisitions of banks like Karnataka Bank,
Centurion Bank of Punjab or maybe Catholic Syrian Bank to gain access to local regions
where these banks operate and also access to their customers as some of these banks are
known to have niche customers. A popular example of this is that of Lord Krishna Bank,
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which is being acquired by Centurion Bank of Punjab. Lord Krishna Bank has a very
good branch network in the state of Kerala and also has very good access to NRI
deposits, which made it an attractive buy. ICICI Bank could look at such small ticket
buys like the one of Sangli Bank made by it in the recent past in India, while it continues
to grow its book organically.
b) Significant international acquisitions in emerging markets
ICICI bank has been quite interested in making an international presence and has been
doing so by setting up offices and branches in the major financial hubs like London,
Singapore and Hong Kong. It has also applied for a branch license in New York. If ICICI
Bank were to follow the Citigroup route of growth in size, it would look at acquisitions in
emerging economies like South Africa, Brazil, Canada or Russia, like Citigroup’s
acquisitions in Brazil. If a similar strategy is to be mapped on ICICI Bank, South Africa
may be the preferred destination for a big ticket acquisition by ICICI Bank, the reasons
for the same are:
-
Citigroup made its initial international acquisitions in growing economies
with proximity to its base i.e. US market. Extrapolating the same to ICICI
bank; it may want to make a global acquisition in South Africa which has
proximity to India vis-à-vis the other countries mentioned above
-
ICICI bank already has a presence in South Africa and has relatively a better
idea of the market there.(It also has a presence in Russia and Canada)
-
A good presence in South Africa would help ICICI bank gain access to the
rapidly growing African economies. This would help the long term growth of
ICICI Bank in the Africa.
The above analysis assumes that ICICI Bank has raised capital to fund acquisitions.
However, this could be criticized as traditionally banks have not used capital raised from
markets
to
fund
their
acquisitions.
The
most
popular
method
for
bank
mergers/acquisitions globally has been a share swap.
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2. Organic International Growth in key financial markets
Indian banks have had the going tough when it comes to acquiring branch licenses in the
international markets. This is primarily because the regulators in international markets are
not too comfortable with the relatively smaller size of the Indian banks. An alternative
speculation of ICICI banks fund raising spree could thus be that it would demonstrate its
huge capital base to international regulators to help gain operating licenses in markets
like New York. Even in markets where ICICI bank has a presence like London,
Singapore and Hong Kong, the bank would want to receive licenses to provide its entire
basket of financial services. ICICI bank has 6 branches in UK and plans to add another 6
more by the year end. The bank has also started its Belgium operations and will begin
operations in Germany in the latter part of the year. Its operations in UK, Canada and
Russia have started making profits in the current year. It has applied for a license to
operate in New York and awaits regulatory approval for the same. At the end of the first
quarter, total assets of the bank’s international branches stood at $13.2 billion (Rs 53,550
crore), up from $7.9 billion (Rs 32,000 crore) in the previous year. Total assets of
international banking subsidiaries increased to about $8.9 billion (Rs 36,100 crore) from
$4.1 billion (Rs 16,500 crore) during the same period. The bank’s international
operations accounted for nearly 20% of its assets base.
The management of ICICI bank has gone on record stating its interest in funding
the global acquisitions of the Indian corporate and is aiming to concentrate on acquisition
financing for Indian corporates, local corporate banking for mid-tier corporates with
turnover between $100-200 million and active participation in syndication of loans in the
international locations where it has a presence.
Based on the above, the interest of ICICI bank in the international markets cannot
be escaped; however, there exist certain issues with the banks global foray, which are:
-
The international markets at which ICICI bank is concentrating are saturated
with MNC banks like Citigroup, HSBC and Barclays in the corporate and
retail banking space and by Goldman Sachs, Morgan Stanley and Merrill
Lynch in the investment banking space. The challenge for ICICI bank would
be to compete with these institutions in their own domain.
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- Acquiring licenses and convincing regulators to give them complete banking
licenses to operate. This would be an issue because of the relatively smaller
size of ICICI bank in comparison to the likes of Citigroup and HSBC (ICICI
Bank is 1/10th of these institutions in terms of market capitalization); thereby
making it difficult for the regulator to have faith in the capital adequacy of
ICICI Bank.
-
Attracting and retaining talent in these highly competitive markets
Based on the above analysis it can be concluded that ICICI Bank’s fund raising spree is
aimed at addressing the above mentioned issues and thereby ensure significant organic
growth by the bank in the international markets.
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VII.
References
1. The New Face of Banking in Asia By: Tirthankar Roy
2. The Rise of Foreign Investment in China’s Banks—Taking Stock. By:
Lamin Leigh and Richard Podpier
3. Bank Ownership and Efficiency in China: What Will Happen in the World’s
Largest Nation? By: Allen N. Berger
4. The effect of ownership on the prudential behavior of banks—the case of China.
By: Chunxin Jia
5. China & the WTO: Moving towards liberation in China’s banking sector. By: Wei
J. Lee
6. Bank Consolidation and Performance: The Argentine Experience By: Ritu Basu,
Pablo Druck, David Marston and Raul Susmel
7. Bank Privatization and Productivity: Evidence for Brazil By: Daniela B.
Weintraub, University of Sao Paulo, Brazil
8. Productivity Change, Consolidation, and Privatization in Italian and German
Banking Markets
9. Consolidation, Scale Economies and Technological Change in Japanese Banking
By: Solomon Tadesse
10. The Dynamics of market entry: The effects of mergers & acquisitions on entry in
the banking industry. By: Allen N. Berger
11. Banking in Developing Countries in the 1990s By: James A. Hanson
12. Bank Consolidation, Internationalization and Conglomeration: Trends and
Implications for Financial Risk. By: Gianni De Nicolo, Philip Bartholomew,
Jahanara Zaman, Mary Zephirin
13. How Foreign Participation and Market Concentration Impact Bank Spreads:
Evidence from Latin America By: MARIA SOLEDAD MARTINEZ PERIA
ASHOKA MODY
14. Bank Mergers in India Need Vision and Innovation -SN Ghosal
15. Indian Banking: Consolidation Moves - K Seethapathi, T Jyotsna
Consolidation in the Indian Banking Industry
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[CONTEMPORARY CONCERNS STUDY , IM BANGALORE - 2007]
August 28, 2007
16. An Insight: Merger in Indian Banks - Arindam Banerjee
17. Wooing FDI in Banking: The Road Map - TS Rama Krishna Rao
18. Indian Banking: Coming of Age - D Satish and Y Bala Bharathi
19. Banking Consolidation: Size Does Matter - Amit Singh Sisodiya and Putta
Kavitha
20. Globalization: Impact on Indian Banking By Rohit Tandon
21. Globalization: Beyond Boundaries - Amit Singh Sisodiya and Sanghamitra Dhara
22. Indian Banking Industry : Gearing Up for 2009 By KNC Nair
23. Has the M&A wave started in India? By: Yash Paul Pahuja
24. www.capitaline.com
25. Prowess database
26. Bloomberg database
Consolidation in the Indian Banking Industry
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