Mergers and Acquisitions: Indian Banking Consolidation

Mergers and Acquisitions Indian patoising ConsolidationGlobally it has been strand that the amalgamations and acquisition engender become wizard of the major ways to unified easementructuring which has as wellspring as struck the pecuniary services industry which has experienced uniting waves leading to the ontogenesis of huge avows and pecuniary institutions. The primary(prenominal) reason for fusions is thick competition among the companies in the same industry which put focus on economies of crustal plate, efficiency in cost and geltability. Some whatsoever an separate(prenominal)(a) factors leading to the jointures is the as well as big to fail principle foldepressioned by the authorities. In few countries desire Germ any(prenominal), vulnerable bevels were forcefully merged to avoid the problem financial melancholy arising out of bad loans and erosion of capital funds. Several academic studies view analyzed amalgamation related gains in lingoing and these studies brace adopted 2 approaches. The low gear approach deals with evaluating the long term effect of the nuclear fusion reaction by analyzing the accounting in castingation such as return on assets, operate costs and efficiency ratios. A conjugations is considered to perplex led to changed performance if the the change in the accounting based performance is superior to the changes in the performance of the comparable bounds that were not involved in the optical fusion occupation during that ut virtually. Another approach is to analyze the gains in stock price of the bidder and the intention company around the announcement of the merger. In this approach the merger is take for granted to create nourish if the combined look upon of the bidder and put vernaculars increase on the announcement of the merger and the consequent and the stock prices reflect the potential value of the acquiring shores.The objective of this piece of music is to present a panoram ic overhear of merger trends in India and to ascertain two important perceptions of stake-holders, sh beholders and managers and to discuss dilemmas and other issues of this topic of Indian cambering.Review of Literature for impingement of mergersThe two important issues which be examined by variant academic studies relating to rim mergers argonimpact of mergers on the operating performance and efficiency of the cursesImpact of mergers on the trade value of the fair play of both bidder and the stain coasts.Cornett and Tehranian (1992) and Spindit and Tarhan (1992) provided evidence for increase in post-merger operating performance. However the studies of Berger and Humphrey (1992), Piloff (1996) and Berger (1997) did not find any evidence in increase in post-merger operating performance. Berger and Humphrey (1994) overly reported that most of the studies that examined pre-merger and post-merger financial ratios found no impact on operating cost and profit ratios. The re asons for mixed evidence ar lag mingled with completion of merger cultivate and the realization of clears of mergers, sample selection and the methods adopted in the finance of mergers. Further, the financial ratios whitethorn be misleading indicators of performance because they do not take into account for product mix or input prices. On the other hand researches may too could buzz off conf employ scale and scope efficiency gains with what is known as X-efficiency gains. Recent studies have explicitly employed frontier X-efficiency methods to identify the X-efficiency benefits of swan mergers. Few studies have to a fault analyzed the potential benefits and scale economies of mergers. Landerman (2000) explored variegation benefits to be had from tills merging with non swearing financial service besotteds. Simulated mergers of US banks and non-bank financial service firms demonstrated that diversification of banks into insurance business and securities brokerage is optim al for reducing the probability of loser for bank holding companies. Wheelock and Wilson (2004) found that expected merger activity in US banking industry is positively related to management rating, coat of the bank, warring position and geographical location of banks and is negatively related to market place concentration.The consequence issue memorized was the analysis of merger gains in terms of the gains in stock price performance of the bidder and the bulls eye banks on announcement of merger. In this national a merger is expected to create value alone if the combined value of the bidder and target companies increases by and by the declaration of the merger. However a lot of studies have failed to find any direct relationship amid the merger and the gains in performance or in sh beholder wealth. exclusively thither argon reasons for mixed evidence as a merger announcement also takes in to account the way the deal is financed .If equity offerings atomic number 18 us ed it may be interpreted as overreckoning by the issuer. in that locationfore the negative announcements returns to the firms that ar bidding can be attributed to the negative signalling which is completely unrelated to the value which is created by the merger. Returns to the bidders companies shareholders is greater when the merger is totally financed with bullion than in mergers in which financing is done through equity offering. There is one more problem with this event record analysis as if there is a consolidation wave dismissal on mergers are anticipated by stockholders and analyst. Potential candidates for the mergers are highlighted and do popular by the financial press and the stock market analysts. In these cases the event study analysis may fail.Therefore an analysis of mergers crossways the world and a books review does not provide lovesome evidence on the benefits gained by banks in the mergers in the banking industry. Also the findings of the literature als o contrast with the findings of the consultants who find a considerable cost nest egg and running(a) efficiency get throughd through mergers. The reasons why academic study do not find cost benefits and the consultants highlight this fact areConsulates may study a potential cost savings which may not materializeThey tend to highlight potential cost saving activities and the economist study all the activities.They tend to be biased towards successful cases and handle the unsuccessful ones.They tend blow up the benefits achieved objet dart the benefits may be miniscule if accounted on a relative terms.The academic studies provide motivation for the examination and evaluation of two important issues pertaining to the mergers and acquisition to the Indian banking.Do mergers help in ameliorate the processal performance and result in cost savingsHowever in India most of the mergers are strained by the rally bank in smart set to protect the pertain of the depositors and avoid f inancial distress therefore the above mentioned reason is seldom found in the mergers activities.Do merger provide irregular gains and returns to the merchant bank and the target banks upon the declarationConsolidation Trends Observed in IndiaImproving the operational performance and cost efficiency has always been a anteriority in Indian banking domain and has been a major issue of discussions in the constitution formulation by the government of India in the consultation and with the central bank (Reserve margin of India). Several committees have also been create in gild to suggest structural changes to achieve this objective. Some of the major committees form are lodgeing Commission, 1972 Chairman R.G Saraiya, 1976 head Manubhai ShahCommittee for the functioning of public field banks, 1978 chairman James S RajThese committees have suggested the restructuring of the Indian banking form with an objective to improve the parade of assent deli really and also suggested the idea of having around 3 to 4 large banks which have a pan India presence and the rest of the bank should be present at the regional level. The major overindulge on consolidation started with the Narasimham committee in 1991. It emphasised and embarked upon consolidation and merger in order to make the Indian banks huge in size and also comparable to the global banks. A second Narasimham committe was also formed in 1998 which suggested mergers and consolidation among the strong banks in public as well as private domain and also with other financial institutions, NBFC (Non Banking fiscal Companies). Now we give have a look at some of the recent trends in consolidation in Indian banking.Restructuring of vulnerable Indian BanksAmongst other routes government of India has adopted mergers as a means to achieve restructuring of the Indian banking system. Many banks which are small in size and are weak are merged with other banks which are stronger and are bigger to protect the cha se of the depositors and also to avoid financial distress. These lineaments of mergers can be termed as coerce mergers. Hence when a banks shows symptoms of sickness standardized increase size of NPAs, reduction in the net worth and substantial down celestial latitude in capital adequacy ratio, RBI forces moratorium to a lower place the section 45(1) of the Banking rule act 1949 for a specified period on the activities and the operations of the operative of the sick bank. In this period a strong bank is identify and asked to prepare and present a scheme of merger with the weak bank. In this case the acquirer banks takes hold of all the assets of the weak bank and ensures the depositors of their notes in case they want to withdraw. The mergers which took place in the pre-reform period fall into this category. In the post reform period 21 mergers have interpreted place out of which 13 are forced mergers where RBI has intervened. The main reason for these mergers was the protec tion of the depositors interest and avoids the financial distress.Mergers which took place voluntarily obscure from forced mergers there have been few mergers in which expansion, diversification and harvest- beat were the major motives and in which RBI did not intervene or force. The first merger of this kind took place in 1993 when the Times Bank was acquired by HDFC bank which was followed by acquisition of Bank of Madura by the ICICI Bank. The latest of these is merger of Lord Krishnan Bank with Centurion Bank of Punjab. Although in all these deals the target bank suffered with low profitability, Increase in NPA and lack of alternate revenues in order to provide cushion for capital adequacy but these mergers were not forced. There was no regulatory intervention in these mergers however the motives behind these mergers may not necessarily be scale of economies and achieving market power. For instance ICICI bank acquired bank of Russia with a motive of entry in to Russia although it just had one branch. SBI acquired 51% stake in Mauritian Bank through Indian Ocean International Bank which will be merged with the bring up Bank of Indias International business as a subsidiary.Integration of pecuniary Services and Achieving Universal Banking ModelSeveral developmental financial institutions have been formed over a period of time in India in order to improve the efficiency of allocation of resources to different segments of the economy. However because of the tractability given by the RBI to the banks in the credit deliin truth process the banks have increased and diversified their loan portfolio to various areas such as project finance, long-term loans, and other specialised sector lending. This is the reason why DFIs have become redundant. A working capital group (1998) was establish by RBI which has recommended the universal model of banking by exploring the possibility of mergers between various sets of financial entities based on economical considerati ons. also in the private sector ICICI merger with its subsidiary bank and IDBI (industrial Development Bank of India) was incorporates as a public sector bank which acquired private sector bank IDBI bank in 2004. In order to provide integrated financial services and achieve operation efficiencies many public sector banks have acquired their subsidiaries, for instance Andhra Bank acquired its housing finance subsidiary Andhra Bank Housing Finance LTD, Bank of India acquired BOI finance Ltd and BOI Asset Management association Ltd. Acquisition of similar types took place in the private sector as well.Alignment of Operations of Foreign Banks with Global TrendsAs the Parent banks went under reconstruction process their parts operating in India also started restructuring. For example, regular Charted Grindlay bank was formed ascribable to acquisition of ANZ Grindlay by the Standard Charted Bank. Similarly due to acquisition of two Japanese banks like Sakura Bank and Sumitomo Bank Ltd the Indian operations of Sakura Bank were merged with Sumitomo Bank in 2001.Forign banks were permitted to innovate into merger and acquisition transaction with any of the private sector bank in India with a condition that the overall investment condition limit will be 74 per cent after the second configuration of WTO commitments which commenced in April 2009. This may lead to further consolidation in the Indian banking sector.Merger and Consolidation of Cooperatives, RRBs and UCBsSmall banks present in India apart from other banks are co-operative banks, Regional Rural Banks (RRBs) and Urban Co-operative Banks (UCBs). These are formed for fulfilling the credit requirements of agriculture, small traders and SSI and other rural economic activities. All of these institutions are misfortunate from bad loans, operational inefficiencies, and Poor reco very of loans. This proved to be a barrier for further lending and financial intermediation. A committee formed under Jugdish Capoor suggested uncoerced amalgamations or merger of these co-operatives based on various criterias like economies of scale, especially in areas where the operations of these banks have become unviable and there are no more in a position to lend credit to agriculture sector. 28 RRBs were consolidated into 9 pertly RRBs in September 2005.A high powered committee on Urban Co-operative Banks (1999) recommended that UCBs which are sick should be liquidated in a time bound mode as the operation of large number of financially sick banks is ruin for UCBs and also for the interest of depositors. Due to this more mergers are expected in the future and RBI also has taken a lot of new initiatives for restructuring of banks including the issuance of guidelines in May 2005.Shareholders Perception of MergerAs say above the Indian banking sector has experienced two types of mergers focussed and free mergers. Forced mergers were initiated by RBI and their main objective was to protect the interes t of the depositors and prevent financial distress of the banks. Whenever a bank showed symptoms of sickness like huge NPA levels, erosion of net worth etc, RBI intervened and merged the weak bank with a stronger one by force. Thus we can form a hypothesis that in case of forced mergers the target banks shareholders will gain abnormally with the declaration. The second type of merger is voluntary type where the motivation behind the merger is to achieve cost reduction, increase in size, diversification, strategic entry into a market. In these cases the acquired banks reaped the benefit of branch web and customer clientele of the banks acquired. In these cases both the acquirer bank and the target bank must have had benefit out of the merger. In this paper the mergers between 1993 to 2006 are considered. There were 21 mergers out of which only v were voluntary. These are mainly mergers of private sector banks with other private sector banks. Two cases are conversion of financial in stitution to commercial bank where the objective was to form a universal bank model which offers a wide range of financial services. Ina study conducted which is presented in this paper 6 cases of forced mergers were selected for the purpose of analysis as in other cases the target banks were not listed and the size of the banks were much lower than the acquirer banks therefore these cases are of less merit for further analysis.In this study the wealth personal effects of almost all the banking mergers during the period 1999-2006 is analyzed. The event study analysis used in this analysis is very straight forward and conventional. The merger period consist of four solar days prior and four days after the event. The reason for taking such window is to analyze the change in wealth of the shareholder around the day of the declaration on the merger. mundane adjusted closing prices of stocks and the market index is taken for the analysis. The abnormal returns are calculated as follows .ARit= Rit a + BRmHereRit daily return on firm i on day tRmt is the return on the terrace mark indexa and B are the regression parameters.The abnormal return is calculated for both the acquirer and the target firm and the import of these values are tested by finding standard flaw and the t-value Analysis of Research ResultsIn forced mergers case the stockholders of target banks have not achieved any portentous returns on the declaration of the merger. However in the case of Nedungadi Bank, the stockholder did gain profound on the 2nd day of the announcement but after that no abnormal returns were found. In the case of GTB the stockholders had deeply discounted the merger. As it was a case of serious case of bank failure the merger did give a confidence to the depositors but the merger declaration did not provide any abnormal returns. United bank did gain marginally on the announcement but it was not significant statistically. Thus the hypothesis that target banks shareholders welcome merger announcement as a safety net can be rejected. The shareholders of the acquirer bank lost their market value of equity. In case of ICICI bank, it was signalled as an emergence of a large private sector bank and hence due to which the banks shareholders expectations go up with significant increase in the returns. In other cases of acquisition the acquirer bank lost on merging with the weak banks. Hence in all the forced mergers neither the acquirer bank nor the target bank gained on declaration of the merger and the stockholders of the acquirer bank lost wealth as the announcement of the merger was taken as a negative signal. It is argued that merger of weak banks with strong ones is essential for restructuring of banking system and also a step in the consolidation of the banking sector. But in almost all the mergers it was found that the target banks for the merger were determined at the time when they were at the verge of getting collapse. The acquirer bank which was forced by RBI was left with no option but to fill the proposed merger. It is recommended that RBI should pursue Prompt corrective action system and should determine the weak banks on the basis of some defined criterias so that the acquirer bank can choose the target banks on the strategic issues which benefit all the parties.Abnormal Returns of Target BanksAbnormal returns of Bidder banksIn case of voluntary mergers it can be seen that the target banks have obtained higher returns that the acquirer banks. both the acquirer and the target banks stockholders benefitted on declaration of the merger. Therefore the stock market welcomed the merger which will lead to growth and efficiency aspects of the merged entity and benefitted the shareholders of both the banks. For instance in the case of acquisition of times banks by HDFC bank it was viewed as a positive signal by the shareholders of both the bank. At the time of the merger the Times Bank was crippled with increasing NPAs and low profitability, the acquisition by the HDFC bank gave relief to the depositors of the Times Bank. On the other hand HDFC bank emerged as the largest private sector bank by gaining from the retail portfolio of the Times Bank. In case of BOM acquisition by the ICIC bank the BOM gained the advantage of being able to provide services like exchequer management, cash management services to its customers and ICICI bank increased its size by acquiring BOM and reached the position of large private sector banks in 1999. At the announcement of the merger there was a steep rise in the gains which was reaped by the BOM shareholders however the stockholders of ICIC bank did not get any significant returns.In all the even study analysis revealed that neither the acquirer bank nor the target bank stock holders have perceived any potential gain on the declaration of the mergers. Hence the share holders who are important stakeholders of the banking companies did not consider the mergers as a signal of improving health, economies of scale and the market power of banks.Managers take on the MergersManagers provide highest priority to the merger of the two public sector banks which provides a signals the banking sectors view on the need for consolidation of public sector banks. Managers do not like the merger of bank and NBFCs or financial services entitiesThere are some issues which are needed to be taken care of while proposing a merger of banks according to the managersValuation of the Loan portfolio of the target bankThis is one of the main factor which is needed to be considered at the time of the merger. As in the management of the credit portfolio the accounting and the exposure norms suggested by the RBI are the same which helps in figuring out the book value of loans easily. However Indian banks have adopted divergent practices in rating the borrowers, loan pricing and maintenance of collateral securities therefore a detailed audit of the loan portfolio, cash flow generati on and collaterals is very essential in order to get an opinion on the value of the loan portfolio of the target bank.Valuation of In tactile assetsThe valuation of the assets of the banks is a very critical factor for the success of any merger or consolidation. The tangible assets of the bank are loans, investment part apart from other flash-frozen assets like buildings, ATMs and the IT infrastructure the bank owns. A commercial bank also holds a lot of intangible assets like clientele based on core deposits, safety value contracts, computer softwares, human resources, brands and goodwill. Determining the intrinsic strength of the bank based on the valuation of the intangible assets is also very important.Determination of the value of equityDetermining the value of the target banks assets, liabilities and valuation of its equity value is the major aspect of a merger process. Various approaches can be used like dividend discount model, cash flow to equity model and excess return m odel. However banks have totally different operations than a normal manufacturing firm as they are highly leveraged because they have more than 90% of the resources as borrowed or as debt and banks are highly regulated institutions and regulatory instruction have vast implication in asset and income recognition. Interest rates volatility, regulatory capital adequacy ratios and restriction on dividend pay put ratios also have influence on the earnings of the banks.Human Resource IssuesIt is the most complicated issue in the merger process.HR issues like the service condition, strategy for rewarding people, employee relation, benefit plans and compensation, provision of pension, law suits and the trade union actions are very critical for the viability of the merger and the deal to go through.Cultural IssuesThis is also a critical issue in the pre-merger and post merger period. It is central to an organizational environment and recognizing cultural friction is very difficult as it res ults in various problems such as poor productivity, riff in the top management, increase in the turnover rates, delays in the integration process and failures in realizing the projected synergies.Information Technology platform integrationIn todays banking banks are highly dependent on the information technology. It has become a key strategic issue due to the impact it has on the operation of the bank. A significant portion of the synergy depends on the information technology integration. Divergent IT platforms and software systems have proven to be major constraints in the consolidation.Customer RetentionCustomers also major stakeholders of banks and are needed to be communicated properly about the merger and the customers of the target bank should be tended to(p) with utmost care. Various studies have shown that firms borrowing from target banks are very likely to lose their relationship with the bank on its merger.