Mergers in Indian Banking Industry

Introduction

Banks are the pillars and responsible for making the present world what it is today. They are the avenues, which facilitate investment and stimulate economic activity by mobilizing the savings of the public and channelizing funds to borrowers with promising investment propositions and needs. Keeping this view in mind, the world economies have undertaken several measures to ensure that the banks are strong and can cater to the needs of the ever-changing business environment.

In the Indian Banking system, there have been rapid changes like the entry of new foreign banks with substantial financial resources, new technological innovations to smoothen the banking operations, the introduction of complex financial products and the changing customer behavior, who are demanding a wide range of products at lower prices with excellent service quality. The increasing competition has reduced the profit margins of the banks considerably and many are struggling to achieve profitability in this dynamic environment. They are looking for new ways to increase their market share and enhance their profitability.

One of these ways is Mergers

A merger is one of the most prevalent methods used by firms to increase their market share by creating synergy and economies of scale. A merger implies a combination of two or more firms into a single entity, while Acquisition indicates one firm taking over another. The word merger can be abbreviated as – M – Mixing, E -Entities, R – Resources for, G – Growth, E – Enrichment and R – Renovation Mergers is considered to be one of the methods which can strengthen market share and allow a firm to tap into new markets within a very short period of time. Economists refer to the phenomenon of the “2+2 = 5” effect brought about by synergy.

Need of the study

Since the early nineteen nineties the structure of the banking sector has considerably modified due to the liberalization, in the course of divestment of public sector banks, entry of foreign banks and merger of many banks in India and within the world. In the post reform period about twenty five bank mergers took place in India. These mergers have vital implication on the performance and efficiency in the banking sector. So, from the view point of both managerial and policy interests, it is very vital to understand the impact of these merges on the potential levels of banks and their temporal behavior thus, to understand how the banking system has been reacting to the emerging challenges and which banks are performing better than others in this age of transition. With the globalization of the world economy, firms are growing by merger and acquisition in a bid to expand operations and stay competitive. The complexness of such transactions typically makes it troublesome to assess all risk exposures and liabilities, and needs the talents of experts. Banks are facing an increasingly competitive business environment, which is driving them to perpetual to improve services and increase potentiality of the banks

The main objective of this paper is to review the advantages and disadvantages of bank mergers and acquisitions in India and analyze the expected challenges and important considerations due to these mergers.

Why Banks Go For M&A?

M&A is driven by a set of motives and no single reason might provide full explanation. The causes for mergers and acquisitions may be segregated into people who enhance shareholder value and others. Shareholder value may be increased through enlargement of operations resulting to increased market share and cost savings through large scale economies or by cross selling of products and scope or synergy.

Motives for M &A

Large Scale Economies- Economies of scale – means benefit of the large production. If two persons do their business separately then they have bear the cost individually. But, if they combine then there is a chance that the cost may come down because of large production. For example – two different tutorials organised by two different coachers then cost is rent 10,000 each, furniture 5,00 each notes 5,000 each so total 40,000 . If combined then rent 10,000 furniture 5000 and notes 10,000 then total cost is 25000 .this is because cost reduced when there is a combination.

Elimination of severe and extravagant expenditure –The combined operations result in cost savings, in any of the areas like. Manufacturing, marketing, operations, manpower, corporate overheads etc.,would be the case of cost reduction synergy bulk discounts from your suppliers as you buy in bulk quantity& which leads to cost reduction. The second thing is depending upon the business we can also reduce the fixed overhead cost, for example the head office functions, the support functions or human resources, this leads to more efficiency in cost reduction .SO, there are range of possible reasons why the merger & Acquisition is beneficial through these synergies. The other reason is M&A is easier than Starting a company.
Desire to enjoy monopoly power –M&A is planned and executed to achieve market share and market power at times including pricing power. M&A is primarily used as a growth strategy.

In practice, Monopoly works in three ways:

1) Market leaders trying to consolidate their position further

2) Profitable and cash rich companies trying to gain market leadership

3) Market entry strategy

Survival option – Business wants to survive, competitors don’t lead them to survive, so, the option is either to be a competitor or merge. Small companies will not be able to compete with large company because large company have lot of money they can invest in technology, they can invest in advertisement, small companies cannot have enough resources, So they fail to compete with the large company, then the left out option in to survive is merge. cannot fight then join this is all about business first fight if not join.i.e merge to survive rather than to die
Specific assets – it is easy to get tangible assets like land, building, machinery but what cannot get in the open market is n intangible asset i.e., specific asset like goodwill . Customers are addicted to brands, they are not bothered about the promoter of the company or the shareholders of the company or where is the company located or where is the company’s registered office and head office is located
Cross border motivations – sometimes it may be difficult to company A to sell its product in other country so then it acquire a company in other country or there may be another scenario like market imperfections for example there would be a software company in US and that company acquires software house in India, where they are low cost developers so, that is an another motivation or sometimes the technology may transfer to other companies in other countries where they can use the technology much better and this can happen only through acquiring the company. So, like this there are several cross border motivations. Cross border means a company acquiring another company in other country.

Benefits

Regulatory change – Deregulation has played a significant role in mergers. Industries subjected to deregulations in the years like, telecommunications, health care, insurance, media, Banks also had been actively indulging in merger activities. Deregulation promotes the mergers by eliminating the barriers
Financial Synergy – It involves combining both the acquirer and target company balance sheets to achieve either a reduction in the weighted average cost of capital or a better gearing ratio or other improved financial parameters. This deals with the impact that a merger has on the cost of capital of newly formed fm resulting from merger. The minimum return required motivating the investor and lenders to buy a firms stock or lend to the firm s known as cost of capital. Lower cost of borrowing results when a firm has excess cash flows combines with a firm that has internally generated cash flows insufficient to fund its investment opportunities in a matured industry. Firms with low growth may produce cash flow sin excess than the available opportunities. Another firm with high growth may lack enough cash required for the available investment opportunities. Thus firm in a mature industry may have a lower cost of capital than the one in which high growth industry when combining such firms could lower the average cost of capital of the merged firm. In other words there could also be a benefit of offsetting the risk in cash flows. If the two companies have fluctuating cash flows, like one company may a have a surplus cash flows at one moment of time and other may have deficit cash flows. Then the company can offset these cash flows and to a large extent they can be saved from the burden of interest charges. If the company borrow in bulk they get a better rate and asset based security is easy & charged at low rate. This is another benefit
Marketing Synergy –It also involves leveraging on the brand equity of one of the two companies to push the sale of the other company’s products. v Revenue Synergy – This can be described as the generation of much higher growth rate and turnover than the individual company’s growth rates during independent operations. This includes the market power (brand awareness, increase the share of market and attract more customers).The second thing to consider are complementary products- this leads to increase in sales. Another advantage is it reduces the competition.
Tax Synergy –It involves merging a loss making company with a profitable one so that the profitable company can get tax benefits for writing off accumulated losses of the loss making company against the profits of the profit making company. It is called as reverse merger. Losses can be set off by profits of the company and on the remaining amount of the profit company the tax is paid and saved to the extent of setoff. When the entities are separate, indirect taxes are paid twice, like sales tax, excise duty, service tax are paid at two levels. If these two companies are single unit then the taxes will be paid only once. So there can be saving in taxes.
Diversification – Company buying affirm which does not belong to its existing line of business is termed as diversification. Depending upon the business there could be diversification of risk. This is proved in the capital asset pricing model (CAPM), that the more company are added to portfolio it reduces the unsystematic risk, therefore the whole business will be less risky as compared to before. Diversification leads to risk reduction. If there is economy slow down for some reason the cash flow can be off set and this leads to continuous flow of cash, and for survival of business continuous cash flow is required and this can be achieved through M&A. Benefit – reduces the risk. How does it matter? this results in cost competitive, because taxes ultimately form the part of the cost and this reduces the cost and to create / enhance competitive advantage- having edge over the other competitors
Technological synergy – Technological changes encourages M&A activity. By using M&A activity the firms can acquire new technology and prevent the new and important technologies from slipping into the hands of their competitors. v Operational benefits – It involves rationalizing the combined operations in such a manner that through sharing of facilities such as warehouses, transportation facilities, software and common services such as accounts and finance, tax, HR, administration, etc, duplication is avoided or logistics are improved leading to quantum cost saving. Operating synergy comprises of both economies of scale and economies of scope. both these components of synergy at as a important determinant of shareholders wealth creation. Efficiency gain can be either from component of synergy or from improved managerial practices. Economies of scale are realized by spreading fixed cost over increasing production levels. Here scale is defined by fixed costt, such as depreciation of equipment, etc. Utilization of set of skills or an asset specific to production of a given or service to produce another product leads to economies of scope. This happens when it is more cost effective to carry out production of multiple products in one firm than producing them in separate firms.

Demerits

Poor Strategic fit –The two banks may have different strategies and objectives and they may conflict with each other and as a result the M&A activity may fail.
Cultural and social differences – If two banks have a wide differences in culture, then the synergy values can be very elusive
Incomplete and Inadequate due diligence – due diligence plays role of watch dog in mergers and acquisition process. if the watch dog fails to do is job then it is leads to some serious problems within the mergers and acquisition process.
Poorly Managed Integration –The Integration of two banks requires a very high level of quality management , if this fails then as result M&A fails
Overly Optimistic – If the acquiring bank is too optimistic in its projections about the target bank , then an overly optimistic forecast leads to a critical issue and M&A activity fails

Challenges and opportunities Involved in the Bank Mergers in Indian banking sector

From now there would be larger presence of Global players in Indian financial system and some of the Indian banks would become global players in the coming years. The new mantra for Indian banks is to go globally in search of markets, clients and gains. There are numerous challenges involved in the process of M& A of banks. Some of the most common challenges that arise during M&A in the Indian banking Industry by examining the preceding bank mergers in the context of India are

Competition –suitable to face more competitive pressures and establish a strong institution, which will revise banking in the tremendous competitive age of globalization and liberalization
Tech Edge – ATM, Phone and internet banking will save the cost
Regulatory Ambiguity: M& A laws and regulations are still developing and trying to catch up with the global M&A
Legal Developments: There have been constantly new legal developments in the Competition Act, 2002, SEBI Takeover Regulations in 2011 and also the announcement of limited sections of the new Companies Act, 2013, has led to issues in India relating to their interpretations and effect on the deals valuations and process.
Shareholder Involvement: Institutional investors in the outnumbered position have enhanced active in observing the investee companies.

Considerations towards M&A

Should have a fairly large number of banks to match up with international banking standards
Value maximizations & performance magnification
Government should give high attention to the M&A process
Streamline HR functions
Study previous experiences before merger
Empirical study on M&A between big and small banks to greater gains
Capital Adequacy & NPA position improves
Not confined to one particular banking group but across groups
Since banks display analogous characteristics of performance scope of consolidation increases

Future Scenario

The upcoming outlook of the Indian banking sector has a lot of action plans set to be seen with respect to M & A as a key to competitiveness being the driving force. Some of the PSU banks are indeed planning to combine with their peers to consolidate their capacities. In the coming times there is also a chance of strong cooperative banks merging with each other and weak cooperative banks merging with stronger ones. While there would be numerous benefits of M&A like size and thereby scale of economies, considerable geographical penetration, enhanced brand name, increased negotiating power, and many more.; there are also likely to be threats involved in M&A like problems associated with size, variance in structure, systems and the procedures of the two companies, problem of valuation etc which would need to be solved before such M&A activity can give enhance value to different sectors

Conclusion:

Before allowing mergers to proceed, it must be ensured that certain conditions must be satisfied so that merger proves too beneficial for all the concerned. The merger process should insure that the merged entities should be adequately capitalized to meet these requirements. In a fast-growing sector like banking, Mergers is a, which, if used strategically after considering all the implications, will propel growth and prosperity not only in the domestic economy but also the global economy at large. Mergers should be designed in such a manner that the operational efficiency and financial performance improves. As presented above, these bank mergers can also cause some severe problems in implementation. To be able to completely reap the benefits of the mergers, all the stakeholders like the customers, employees, management should be satisfied. Other aspects like technology should be carefully considered before such mergers.