WEIGHING THE ISSUE OF

MERGER OF INDIAN BANKS

Team Members
Anjani Kumar(11)
Anshuman Pant(14)
Charumathi R.(28)
Indrani Pramanick(44)
Amrita Marwah(62)
Sharda. N(93)
 Agenda
 Introduction
 Arguments
 Empirical Studies
 Why are large banks Unsuitable?
 Illustrations
 Conclusion
 Indian banks in Global Arena
20 Indian banks in top 500 global banking list

Brand Finance® Global Banking 500 (Feb 2010 )

 SBI: 1st Indian bank to break into the world's Top 50

 HSBC retained top slot

 SBI brand value (>tripled) to $4,551 Mn: Rank 36

 ICICI in Top 100 with 130% jump in brand value at $2,164 Mn

 No of Indian banks more than tripled last year to 19 from 6 in 2007

 Differentiation through strong brand & customer base value: Becoming a key

economic lever for Indian banks

 A significant shift in the balance of power globally away from US & towards banks

in emerging markets
Indian banks in Global Arena
 The worlds biggest bank as per the asset size is BNP Paribas
having an asset of 3.2 trillion $ - the largest Indian bank has an
asset size of 256 bn $. (12.5 times less than the top bank)
 Indian Bank does not even feature in the list of top 20 Asian banks
– BW (Dec, 2010)
 SBI ranked 177 in terms of profitability.
 SBI's ranking in terms of asset size globally remains low at 57

Some Positives:
 Indian Banks Weathered the Global crisis in a much better way
compared to other banks in US and UK
 The Indian Banks have a very high capital Adequacy ratio with a
large Tier 1 (equity) capital base
 The Quality of Growth has also been good (High retained reserve &
Provision for NPA in excess of 70%)
Comparison of Indian Banks with Global Banks
History of Bank Mergers

(Source: Publications of RBI)

Mergers in the post-reform period
Mergers in the post-reform period
 Arguments in Favour
 To be among top banks of the world
 To gain access to different markets
 To Improve market share
 Bring more stability to the banking sector
 Economies of scale (managerial efficiency, cost & revenue &
operational efficiency)
 To enhance Global competitiveness
 Narasimham committee–II recommendation:
 To tackle international competition
 Merger should not be seen as a means of bailing out weak banks
 Mergers between strong banks/Fis for greater economic & commercial

sense
 Merged entity will be in a better position to raise capital than individual
banks
 To improve profitability
 Empirical Studies -Efficiency Gains
 Cost efficiency gains from merger:
 Merged banks gain access to cost saving technologies
 Spread their fixed cost over a larger base -> Thus reducing
average cost

 Frei et al. (1996): Cost efficiency effects of M & A depends on

 Type of M&A
 Motivation behind M&A
 Manner the management implements its plans

 Vennet (1996) : Impact of mergers on efficiency of EU banking

 Used key financial ratios & stochastic frontier analysis for the
period 1988-93
 Finding: Merger improved efficiency of participating bank
 Empirical Study -Efficiency Gains
 Akhavein et al. (1997): Price & Efficiency effect of mega
mergers on US banking industry
Finding: After merger, banks experienced higher level of
profit efficiency than before merger

 Berger (1998) : Very little improvement in efficiency for M&A

of large/Small banks

 Gourlay et al. (2006): Efficiency gains from mergers among

Indian banks over the period 91-92 to 2004-05
Finding: Improvement of efficiency for the merging banks

 RBI (2008): Public sector banks get higher efficiency than

private sector banks during post merger period
 Empirical Study on Indian Banks
 A study on market based mergers in Indian
Banking Institutions
 Efficiency & Performance Measurement
 Using CRAMEL-type variables
 Measured Pre & Post merger
 For selected public & private banks which are
initiated by the market forces
 Performed statistical tests on CRAMEL
variables to determine
 If there was significant relationship of variables
during Pre & Post-merger periods
 CRAMEL
 Capital Adequacy: D/E, Advances to Total Assets, Capital
buffer Ratio
 Resource Raising ability: Cost efficiency, Cost/Total Asset
 Asset Quality: Gross NPA /Net advances, Loans/
Deposits
 Management & Systems evaluation : Operating rev. /
Turnover per share, Total Advances / deposits
 Earning Potential: EPS, Interest Earning Ratio, P:E,
ROA , Profit Margin, Return on Shareholders Funds
 Liquidity / Asset Liability Management: Current Ratio,
Solvency Ratio, Liquid Asset / Deposits, Liquid Asset /
Total Advances
 Key Findings
 CRAMEL variables indicate which variables
should be closely monitored
 Variables such as Advances to total assets,
Profit margin grouped together: Highly
significant
 Both are highly significant during both Pre &
Post merger
 Merging banks should carefully analyze these
2 variables before & after merger, since they
are closely associated with performance of
the banks
Bank of Punjab + Centurion Bank
 Swap ratio : 9:4
 Combined bank : Centurion Bank of Punjab
 Presence of 240 branches & extension
counters, 386 ATMs, ~2.2 million customers
 Combined NPA (31 March 2005): 3.6
 CB & BoP had net NPA of 2.49 % & 4.6%
respectively
 Capital Adequacy of the combined asset is
16.1%
 CB & BoP had capital adequacy of
23.1% & 9.21% respectively
 Gains from the Merger
 Combined entity among top 10 private banks in India
 Nationwide reach
 CB strong in South India, Maharashtra & Goa
 BoP strong in Punjab, Haryana & Delhi
 CB: 82% of business from retail
 BoP strong in SMEs segment & agricultural sector
 Combined bank : Full-service commercial bank with
strong presence in Retail, SME & Agricultural
segments
 Book value: ~Rs 300 crore
 Higher BV helps the combine entity to mobilize
funds at lower rate
 During 2006-07, Net profit up by 38% to Rs 121.38 cr
against Rs 87.8 cr in the previous year
Arguments Against Merger
 Large banks are harder to manage
 Required when there is a low potential of growth in market
 Huge demands on HRD capabilities
 No amount of consolidation will give Indian banks a global size in
foreseeable future
 Scale of economy is essential, but beyond a certain size the benefit
of size taper off & offset by growing complexity
 Some large requirements of corporate, such as overseas finance,
cannot be met by Indian banks, however large they may become
 RBI not in favour of consolidation just as yet
 Need for greater financial inclusion
 Need to strengthen capital base
 To carry out better risk management
 Financial Inclusion
Why are large banks Unsuitable?

Operating Cost /Unit of loan

 Large banks disburse loans, usually, a min of $10,000
 MFI Avg loan size : $100
 Need to make 100 loans of $100 to lend equivalent $10,000
 If loan term = 4 months, these 100 loans must be processed 3 times/year
 300 loans of $100 with 4 month terms = 1 loan of $10,000 with a 1-year
term
Inference
 For both systems to be sustainable at same r% , MFI must be 300 times as
efficient in loan disbursement as the large bank
 Efficiency are compared on Operating cost/ unit of loan portfolio
 Operating costs includes costs associated with establishing a realistic bad

debt reserve
 Risk factor differs in these 2 types of loans
 Other Issues
 RBI not in favor of bank consolidation
 Need for greater financial inclusion
 Need to strengthen capital base to carry out

better risk mgmt

 Merging of PSBs is a highly complex task
 Many legal hurdles will have to be crossed &
parliamentary approvals obtained
 Govt. needs a lot of preparatory work
 Regional & Cultural Barriers
 Merging with Foreign Banks would mean
following a uniform set of practices Eg:-
Reporting of financial data
 Conclusion
 Need for a balanced view-point
 Large Size may not be beneficial after all !
 Problems of Hubris, Arrogance
 Inertia & Lack of Innovation
 TBTF & Asset-bubble in US stands a testimony
 No guarantee of Managerial + Operational + Financial
Synergy
 Culture & HR issues: Change mgmt, dealing with
layoffs
 Focus on Key issues lost, while concentrating on size
 What applies to one nation, need not apply to others!