BUSINESS

Financial sector consolidation through mergers

Merger between banks or between banks and other financial institutions, though uncommon in India, has been popular in many countries, where it is a potent means and a visible symbol of financial sector consolidation. At a global level, consolidation through mergers or takeovers has taken place creating gigantic financial institutions. The takeover of the American bank, Bankers Trust, by Deutsche Bank of Germany comes readily to mind. In the U.S. itself there has been a massive consolidation within the banking sector - once mighty banks, well known names such as Manufacturers' Hanover Trust and Chemical Bank have disappeared.

Size is surely a desirable criterion for withstanding competition, to increase the reach of traditional banking services and more recently to measure up to the regulatory requirements. Mergers have been driven by stock market forces - the relative valuations of the two banking companies coming into play. In Japan, bank mergers have spawned banking colossus but in the context of the spectacular problems faced by the financial sector there, it is to be seen whether those mega mergers will ultimately help in putting the world's second largest economy back on track.

The experiences of the developed economies do matter to a large extent. But do they offer tailor made solutions for emerging economies such as India? Specifically will the merger and acquisition route (M&A) spur banking and financial sector consolidation in India? As the Reserve Bank of India recently released Report on Trends and Progress of Banking in India (2000-01) points out, the conditions here are similar to those of many emerging economies. The banking system is fragmented in terms of the number and size of the institutions, ownership, profitability and competitiveness, use of modern technology and certain other structural features.

Three or four large banks, usually in the public sector, dominate the scene. On the other side are a number of smaller urban and rural banks. Another distinguishing characteristic of the banking system in the emerging economies is that very few of the banks are listed on the stock exchanges. There is plenty of heterogeneity among banks in matters such as profitability, technology absorption and managerial competence. Some banks have adapted the latest technology while others are still struggling to put in place liquidity management and risk assessment tools.

India specific recommendations

To overcome many of these shortcomings in India, the Narasimham Committee had suggested mergers among strong banks, in the public and private sectors and even with financial institutions and non-banking finance companies. So far, however the M&A route has not caught the fancy of either the private or the public sector banks. The ICICI group which has been in the forefront of recent mergers - first by merging Bank of Madura with the ICICI Bank (in March 2001) and more recently through the reverse merger of the ICICI with the bank - has been a notable exception. Earlier another new generation private bank - the Times Bank was merged with HDFC Bank (February 2000). An once prominent NBFC - 20th Century Finance merged with Centurion Bank (January 1998). Apparently that merger irrevocably contaminated the balance sheet of the new entity, which is still struggling to find its feet. Over the past three years, there have been two other bank mergers. In June 1999 Bareilly Corporation Bank merged with Bank of Baroda and in December of that year Sikkim Bank merged with Union Bank of India.

The above mergers, sporadic as they have been, do not reveal a pattern. None of them has been market driven and none arose out of a hostile bid. Even the all stock swap merger between Bank of Madura and ICICI Bank arose out of a friendly arrangement. And reverse mergers - IDBI is reportedly considering one - are an ingenious way for financial institutions to get the universal bank status. The point is none of the usual circumstances that propel banks to come together is readily found here. It will need a special policy or regulatory push to propel banks towards consolidation.

There are special features of the Indian financial sector that have to be reckoned with. Well into the second decade of financial sector reform, public sector banks continue to dominate. (According to the latest RBI's Trend and Progress of Banking PSBs have almost 80 per cent of all the banking assets). But government ownership brings with it certain negative connotations. Only a minority of the government owned banks are listed on the stock exchanges. Most new entrants to the exchanges have commanded pathetic valuations.

The general outlook for the PSBs is not bright as far as the stock markets are concerned. This means, the market access as a means of mopping up resources is ruled out at least for now. If individual PSBs are forced to take that route, it will suggest that the government is willing to sell them at bargain basement prices. A year ago, the Government wanted to modify the relevant legislation to bring down its stake in each of the PSBs to 33 per cent and somewhat inappropriately said that it would continue to preserve their government character even after that. The big question is how will the Government achieve those contradictory-objectives?

It is in that context that the M&A route will be discussed. And not just academically. The RBI has also underlined another point when it says that the PSBs require Rs. 10,000 crores to beef up their capital to match their expected asset growth. Individually, many banks are going to falter in their bid to meet the increasingly stringent capital adequacy norms. So far there have been no overt hints from either the regulator or the government asking banks to come together. However, the general direction of thinking is clear. For instance, when the RBI says that it will license not more than one or two new private banks, it obviously has in mind the potential of M&A to restructure Indian banking. Simply put, when there are ever so many PSBs waiting to be taken over why create new entities? However inevitable as they look, M&As need not be an unmixed blessing but then financial sector consolidation will not be a painless exercise.

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