An analysis of Mergers & Acquisitions in the Indian Banking Industry

A Project Report presented to

Dr Gita Kumta
Faculty Member Narsee Monjee Institute of Management Studies on 19th March 2005 in partial fulfillment of the academic requirements for the FULL TIME MBA Programme by

Ms Manasi Lad (225)

NARSEE MONJEE INSTITUTE OF MANAGEMENT STUDIES (Deemed University)

Certified that the project titled Mergers & Acquisitions in the Indian Banking Industry, presented by Ms Manasi Lad, Roll No: 225, represents her original work which was carried out by her at the Narsee Monjee Institute of Management Studies under my guidance and supervision during the period from __________________to__________________2005. Name of guide: Dr Gita Kumta Signature of guide: Date:

Preface
With a total asset base of close to Rs 17000 bn and a growth rate of over 10% per annum, the Indian Banking Industry remains a significant contributor to the countrys economic well-being. The industry is poised to witness massive growth given the increasing standard of living of the people and the rapid transformation of the industry to being extremely consumer focused and technical. Small is no longer considered beautiful in the industry with balance sheet size being an important prerequisite for survival. The regulatory authorities having realized this need for consolidation and have facilitated merger activity amongst banks through various reform measures like allowing banks to raise preference capital, tax benefits, stringent dividend, NPA norms etc. Since the industry is at the threshold of a transformation, it would be interesting to study the M & A activity that the industry has witnessed in the past and attempt to chart out its future direction and hence the choice of topic. Manasi Lad Mumbai 19th March 2005

Acknowledgement:
Any accomplishment requires the efforts of many people and this work is no different. I would like to thank Dr. Gita Kumta whose patience and support was instrumental in accomplishing this task. The examples, insights and other data are the result of a collection from various sources, such as newspapers, magazines and the Internet and a brief interaction with the management of the respective organizations covered in the analysis.

Manasi lad

Executive Summary:
The thrust of this report is to gain an insight into the future of the banking industry in India. The industry remains a significant contributor to the countrys GDP and employs lacs of people. The increasing integration of the country with economic powers globally would expose the domestic banking players to their might and would necessitate them to build their credibility and leverage the challenges and opportunities that the new landscape lends them. The Reserve Bank has therefore ushered in a series of reform measures towards non-performing assets, dividend payment to strengthen the regulatory landscape and ease the implementation of international norms such as the Basel II. These stringent requirements would necessitate enhanced capital, IT and human skills, list smaller banks may find difficult to fulfill. Given this scenario, there could be a series of Mergers and Acquisitions in the industry and the formation of a few large-scale international/national banks offering a range of product offerings to the end consumer. This project therefore attempts to analyze the M & A activity that has taken place in the industry in the past decade and to chart out the future path for such consolidation. It also studies the rationale for mergers, the prime motivating factors, regulatory and valuation parameters and tries to arrive at certain key learnings from the same. The emerging industry structure could comprise of SBI & associates forming a single entity, nationalized banks consolidating into 4-5 banks and the private sector grouping into not more than 5 banks over the next 5-7 years. However, the author is of the opinion that though Mergers and takeovers maybe a tool to attain massive growth it cannot be used as a one size fits all model. It could be explored as an option only when other methods to enhance growth have been exhausted. Consolidation today has been largely confined to the private sector or the merger of bankrupt banks with stronger players. A gradual approach to the problem considering the way the macro economic parameters are shaping the industry would be the appropriate way forward.

Table of contents:
Chp.N o. Item Acknowledgement Preface Executive Summary 1 2 3 4 5 6 7 8 9 10 11 12 13 Introduction Key concepts Prime reasons for mergers Prime motivations for mergers Why do acquisitions fail? Planning for a merger Procedure for a merger How is a merger financed? Valuation ICICI Ltd-ICICI Bank HDFC Bank- Timesbank The journey begins-Key Learnings Road Ahead Page (i) (ii) (iii) 5 6 8 12 13 14 17 22 24 27 35 43 45

Chapter 1 Introduction:
Banking is becoming an increasingly global industry, which knows no geographic and territorial boundaries. The main goal of cross-border mergers is to fill the gaps on the market for banking services and to gain access to an existing network of branches, which would otherwise have to be built at great was increased by liberalization of the movement of capital and services, including banking services. The trend towards mergers and acquisitions in banking is also affected by the unprecedented growth in competition, the continued liberalization of capital flows, the integration of national and regional financial systems and financial innovations. In India, the Narsimham committee envisioned a structure of 3-4 large banks of international character and 8-10 national level banks paving the way for Consolidation in the industry. However, mergers then were largely concentrated in the private sector or the compulsory acquisition of the weaker players by Public sector banks. The consolidation in the present arena is not the mergers of weak and strong banks; instead it is the merger of two banks, even two large or strong banks to be a mega entity amongst the top 200 banks of the world. Currently, only SBI could boast of enjoying that status. The consolidated entity would not only have a sound financial position, large clientele base, overseas presence but also large resources, better risk management, stability and asset base. This would enhance public confidence and improved credit ratings both of the country and the organization concerned. Consolidation has become necessary due to unhealthy competition, unviable expansion, regional imbalances, improper deployment of staff and the need for computerization and networking.

Chapter 2 Key Concepts:

A merger can be defined as the combination of two relatively comparable organizations, while an amalgamation is the takeover of a smaller company by a larger one. Under Section 2 (1B) of the Income Tax Act, an amalgamation is a transaction involving the vesting of all properties/liabilities of the amalgamated company with the acquirer; atleast 90% of the shareholders should become shareholders in the combined entity. In many cases a merger is preceded by a transitional phase called a strategic alliance which is used mainly in cross border co-operation. On the basis of a strategic alliance agreement, a large foreign bank can sell its products through a local banks network of branches. Such co-operation can also be seen on the domestic market, where a small bank uses the services of a large bank, e.g. in the area of cross-border payment operations. Essence of an amalgamation: The essence of an amalgamation is the blending of two or more undertaking into one unified entity. The blending could take any one of the following forms: One or more undertakings blending with another- Absorption. Two or more undertaking blending to form a new entity- Merger

Types of mergers:
A merger or an acquisition depends on the purpose of the offeror company wants to achieve. Enumerated below are the combinations of mergers that are possible in the market place from the offerors point of view: Vertical combinations: One of the prime motives for a merger could be the acquiring companys desire to control its sources of supply and forward integrate towards the market outlets. Through a merger the company therefore attempts to reduce its inventories of raw material and finished products, implement its production plans as per its objectives and economize on its working capital investments. The following benefits would accrue from a vertical combination to the acquirer company: It gains a strong position because of imperfect markets of the intermediary products, scarcity of resources and un purchased products. Control over product specifications

Horizontal combinations: This refers to the integration of two companies engaged in the same stage of industrial process. The acquiring company belongs to the same industry as the target company. The main purpose of such mergers is to achieve:

Economies of scale in production by eliminating duplication of operations and facilities Broadening of the product line Reduction in the working capital requirements Elimination of competition concentration in the product Reduction of the advertising costs Better control of the market

Circular combination: Companies producing distinct products seek to amalgamate to share common distribution and research facilities to obtain elimination of the cost of duplication and promoting market enlargement. Conglomerate combination: It is an amalgamation between two companies engaged in totally unrelated industries. A merger of this nature enhances the overall stability of the acquirer company and creates a balance in the companys overall portfolio of diverse products and production processes. The prime reasons for such a merger are: Optimum utilization of the financial resources and enlarge the debt capacity through reorganization of the firms financial structure. Lowering the average cost of capital and thereby enhances the overall present worth of the company

Chapter 3 Prime reasons for mergers in the Banking industry:

Eliminate competition: Acquiring a competitor is an excellent way to improve a firms position in the marketplace. It reduces competition, and allows the acquiring firm to use the targets resources and expertise. Cost efficiency: Reduction of the operating costs could be achieved on account of closing down of unviable branches, increased utility of ATMs, reduction in the payment of maintenance charges for software etc and reduction in the number of controlling offices. Revenue Enhancement: Consolidation may lead to increased revenues through its effects on firm size, scope or market power (through either product or geographic diversification). Core banking solution: Introduction of the core banking would become viable and this would further reduce transaction costs by more than 15%. This would enable the bank to handle transactions to the extent of 25m a day, implement RTGS, ETF and maximize the use of electronic banking. Diversification of income from both products and geographic area: Such gains are likely to arise due to asset diversification across geographies, across products and services. On the other hand post consolidation some firms may shift towards riskier portfolios, increasing operating risks and managerial complexities. Stabilization of asset quality: Small banks would find it difficult to survive in the absence of additional capital. The average NPA level for such banks whose size is lesser than Rs 10,000 crores is around 4.98%, which is high. Weaker asset quality necessitates infusion of capital and would result in stabilization of asset quality.

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Increased productivity: The closure of some branches would generate surplus staff, which could then be deployed to open new branches at potential centers. This would increase the business per employee. Customization: Being a large entity, it would be financially viable for the bank to develop its won systems, software and lease lines. It could even increase the number of products offered to its customers. Acquire needed resources: The consolidation would result in sharpening the knowledge and skill of the staff and ensure optimum utilization of the locational advantages of its premises, ATMs, technology and branch network. Other prime motivations for mergers include tax incentives, fear, acquisition of asset reconstruction companies, enhanced value for stakeholders, HR issues, and synergy and enhanced capital requirements.

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Chapter 4 Prime motivations for a merger:

Mergers and takeovers are a permanent form of combination between companies which vest in the management complete control in the acquired company and provide a centralized administration which is not available in the combination of a holding and its partly owned subsidiary. A merger leads to certain benefits to the stakeholders involved a brief description is provided below: Investors/FIIs/Depositors: No individual would invest his savings into any company unless he is assured of its growth prospects, either through organic or inorganic means. He must be assured of the safety of his investment and enhanced negotiability. Therefore a merger should give rise to enhanced value for the companys shareholders and compensate him for his opportunity cost of investing it. Managers: Managers are concerned with improving the operations of a company, effectively managing the affairs of the company for all round gains and growth, which would provide better business deals and enhanced compensation packages. Mergers may become difficult when there is a possibility of displacement at the hands of the new management and the resultant depreciation may cause them to oppose the move. Promoters: Mergers give the promoters, the advantage of increasing the size of their company and enhance its financial structure and strength. They can convert a closely held or private limited company into a public one without parting with much wealth or control. Consumers: The customer would gain through better and competitive pricing of all products. He would have a vast array of products to choose from, access to improved and upgraded technology and would be provided with a host of value added services. Government/Regulator: Through consolidation, the industry would become less fragmented and the regulatory bodies would be in a better position to monitor a smaller number of institutions. This would improve surveillance and ensure swift and stringent redressal of complaints.

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Chapter 5 Why are do so many acquisitions fail?

Setting luck aside, most acquisitions turn out badly because purchasers have paid too mucha situation from which it is hard to recover since it happens upfront. There is a tendency on part of the management of the acquisitor company to be overoptimistic about the potential merger, the future market for the product, its synergies and hence be generous in negotiating a payment consideration, overlook certain looming problems and overpay. However, once the deal process begins, events and rationalizations prey upon even the most disciplined acquirers. The more time and effort that has gone into a deal, the harder it is to admit that it won't create value for shareholders at a given price or on particular terms, regardless of sheer business logic. An analysis of merger disasters worldwide identifies over optimism on the part of the management as a prime reason for failure. Exaggerated expectations, difficulty in capturing perceived cost savings and expertise sharing subsequently create frustrations and disappointment. Other reasons commonly sighted for a failed marriage are the differences in the age of firms, their size, technology platforms and demotivated/underutilized workforce. Failure of the management of the two companies to effectively integrate the cultures and business ethics of the organizations may create frictions.

Chapter 6
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Planning for a merger:

A decision for a merger or an acquisition involves a substantial commitment of time, energy and money and therefore should be based on a through investigation of the circumstances involved therein. The alternatives available to a firm to dispense with the acquisition of a particular firm needs to be analyzed in the true perspective. The acquirer will have to view the cost effectiveness of a takeover from three angles qualitatively and quantitatively a) the price paid for the company should be lower than the estimated costs of internal developmental activity b) anticipated benefits must be achieved and the results should meet the projected requirements and planned objects c) the net outcome should be increased shareholder welfare. Other factors such as opportunity costs, resistance and ease of integration should also be considered. For the acquired company, the objective maybe confined to the disposal of assets or a fair realization.

Stage I
Analysis of business strategies: A companys inclination to inorganic growth or choose of a potential partner may largely depend on the fundamental strategy it adopts, which could be broadly classified into the following three distinct categories; a) Portfolio strategy b) Business Brotherhood strategy c) Business Elements strategy The Portfolio strategy hints towards the companys aim to diversify its operations and therefore it would require a partner who is financially or technologically strong. Such companies would seek Concentric combination. Companies adopting the Business Brotherhood strategy would look for companies with a fair degree of common operations so as to use the financial, human or technological resources to produce complimentary goods and expand market segments. The success of any acquisition depends on certain elements such as customer, raw material etc which are crucial for performance. The acquisition is aimed at achieving greater market share or customers and therefore would be beneficial to those enterprises possessing business elements that are crucial to success and growth. Search for the target company: Based on one or more of the above strategies and securing the commitment of the top management, the company would then begin to search for a target company. The selection would have to be based on the fact that the acquisition is a business related or unrelated entity.

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Services of a middleman: Unless the management is in the know of any specific company for acquisition, it would be thoroughly difficult to find a suitable partner. Information about companies in the public domain may not provide any sufficient basis to make any decision. In such cases, the company would have to engage the services of a middleman. The middleman could be an individual or an institution and performs the role of an interface between the two companies. He studies the potential target and also aids in the negotiation process in return for a fee. Merchant Banker: Merchant Bankers are the middlemen in settling negotiations for a merger between any two companies. Being a professional expert he is required to safeguard the interest of every stakeholder though the entire process of any acquisition. Primary investigation about the target company: Prior to starting any negotiations, the acquiring company must undertake a through analysis of the numerous facts and figures, concerning the economy, the industry in which the company operates and finally the potential takeover target. The following is a summary of the factors that must form an essential part of any such report: Industry Analysis Accounting and Financial Analysis Management Analysis Marketing Analysis Manufacturing and Distribution Economic Analysis Non balance sheet analysis Miscellaneous Analysis The Industry Analysis would comprise of a through study of the internal and external competition and their strategies, the barriers to entry and exit, sales and profitability and the projections for the future. An analysis of the financial ratios, future capital requirements, taxation, depreciation issues, the balance sheets and income statements and forecasts would comprise the accounting and financial analysis. The Management analysis and investigation would include a review of their experience and background, personnel schemes, union contracts and agreements. A through study of the sales, products life cycle, promotion and customer preferences would also be required. The acquirer company would also need to study the Manufacturing and distribution setup to gain an understanding of their production facilities and sales force.

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The above study would be incomplete without an analysis of the broad picture comprising of a study of the economic parameters, the business cycles affecting the industry, the policies of the government and the conditions in the securities market. Selection of a mode of payment: The selection of an appropriate method of payment should be affected on the basis of the information received about the target company and the means available with the acquirer:

Chapter 7

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Procedure to be followed for a merger:

Securing Top management commitment towards the merger: The top management of any company is responsible for formulating the goals and objectives of the organization and outlining the framework to achieve them. It is therefore of paramount importance that they are convinced of the need for a takeover so that they are in a position to provide effective strategic direction and vision to the organization Search for a merger partner: The management may through their own contacts or the services of middlemen, identify suitable merger partners based on a primary study of their organizational history, products, profitability, assets profile and manpower. Negotiating with the merger partner: Negotiations between the top management if the two companies takes place to agree on settlement terms and identify the most favorable ones. Negotiations can be held with the target companies before making any acquisition attempt. Scheme of Amalgamation: Mergers are governed under the Indian Companies Act 1956 whereas takeovers are regulated by the SEBI (Substantial Acquisition of shares and Takeovers) Procedure laid down. The beginning to amalgamation must be made through common agreements between the transferor and the transferee company, but mere agreement does not provide a legal cover to the transaction unless it carries the sanction of the court of law. Procedures enumerated in section 391- 396 A, should be followed for giving effect to the amalgamation through the statutory instrument of the court sanction. The procedure is complex involving not only compromises between the two companies or their creditors but also safeguard of public interest and strict adherence to public policy. These aspects are looked after by the Central Government through the official liquidator on Company Law Board, Department of Company Affairs and the court of Law. The parties to any merger have to prepare a scheme of amalgamation in association with their merchant bankers or financial consultants, the main contents of which are given below: Description of the companies involved and their businesses; their authorized and paid up capitals Basis of the scheme: main terms of the scheme, valuation, transfer date, consolidation of capital Change in the object clause, name or accounting standard. Protection of employment 17

Dividend position and prospects Details about the management Amalgamation expenses Conditions and the date/time/conditions by which they would become operative and effective

Essential features of the scheme of amalgamation are as follows: Determination of the transfer date i.e. the date from which all properties etc are sought to be transferred from the amalgamating company to the amalgamated company. Determination of the effective date: this date is determined by the time all the required approvals under the numerous acts like the Companies Act 1956, Income Tax Act 1961, SICA (Special provisions) 1985 are obtained. This date is important from the income tax purposes It should clearly state the arrangements with the secured and unsecured creditors including the debenture holders It should delineate the exchange ratio based on the valuation of the shares of the companies by an independent party. The scheme must provide for the transfer of whole or part of the undertaking to the amalgamated company, continuation of the legal proceedings, absorption of employees and obtaining the consent of the dissenting parties.

Approvals for the schemes: The provisions of sections, 391-394 of the Indian Companies Act 1956 governs the scheme of merger. The legal process requires approval of the schemes as detailed below: Approval from the Directors for the scheme: The Board pf Directors of the both the companies, are required to give their assent to the scheme. They are obligated to hold a board meeting to a) finalize the appointed and the effective date b) to approve the scheme and the exchange ratio c) Authorize them to make the necessary applications to the high court d) To inform the stock exchanges of the merger e) To inform the stakeholders through a press release f) to inform FIIs atleast 45 days in advance so that their approval is available at the time of the above Board Meeting. Approval of the Shareholders: In terms of Section 391, shareholders of both the companies should hold their meetings under the direction of the court and consider the scheme of amalgamation. Further under section 81 (IA), the shareholders of the amalgamated company must pass a special resolution for the issue of shares to those of the amalgamating company.

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Approval from the creditors/FIIs/ Banks: Approvals from the Respective High courts: Approvals of the respective high courts confirming the scheme are required. The courts issue orders for dissolving the company without the winding up on the receipt of reports from the official liquidator, the Regional Director and the Company Law Board, that the affairs have been conducted in a manner not prejudicial to the interest of its members or the public. Intimation to the Stock exchange: Listing agreements between the stock exchange and the companies require them to intimate the exchange about any price sensitive information when the same has been communicated to electronic media on the conclusion of the Board meeting. Alteration of the Object clause: The object clause of both the companies needs to be examined, in order to assess their power of amalgamation. The object clause of the transferee company should allow for the carrying on of business post merger and if not it should be amended. It should also be ascertained that its authorized capital is sufficient after the merger and should be suitably amended. Application to the court for directions: Under Section 391 (1), an application to the respective High Court must be made seeking permission for holding a meeting of its members. The two companies must submit separate applications supported by a copy of their Memorandum and Articles of Association, an audited Balance sheet and a copy of the Board resolution authorizing the Directors to make an application to the court. High Court directions for holding members/creditors meeting: The High court will fix the date and time of the members meeting and appoint an Advocate Chairman to preside over the meeting and submit a report. Notice to members and Advertisement of the same: A notice of the meeting must be sent to the members at least 21 days before the scheduled date of the meeting. The court may also direct the issuance of an advertisement of the same in the newspaper at least 21 days prior to the meeting date. Holding of the meeting:

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The next step is to hold separate meetings of the shareholders and the creditors to seek their approval to the scheme. The resolution must be passed by atleast three-fourths of the members. Report of the Chairman to the court: The chairmen of the above meetings must submit a report of the result of the meetings either within the stipulated time or within 7 days from the date of the meeting. This should accurately state the number of creditors or their class who were present and who voted either through proxy or in person. Presenting petition before the court: Within 7 days from the date on which the Chairman has submitted the report to the court, a joint petition to the High court must e filed by the companies for approving the scheme. This petition must be made in Form 40 of the Companies Rules. Subsequently, the court will hear the case and take up any objections before passing an order directing the transfer of property between the companies. Filing of the court order with the ROC: Both the companies must obtain the Courts order sanctioning the scheme and file the same with the ROC within 30 days after the Courts order. Dissolution of the Transferee Company and transfer of assets: Section 394 (1) (iv) and 394 (2), vests powers in the High court to order the dissolution and transfer of the companys assets provided it is convinced that the deed is not prejudicial to public interest. Allotment of shares: Pursuant to the amalgamation, the shareholders are entitled to get shares in the transferee company in the exchange ratio provided for under the scheme. There are three different situations in which allotment could be given effect to: When the transferor company is an unlisted entity, the allotment could take place by asking the shareholders to surrender their old certificates in exchange for new ones. When the transferor company is a listed entity, the stock exchange is to be intimated of the record date (for the allotment of shares) at least 42 days in advance or as provided in the listing agreement. When the allotment is to Non Resident Indians, permission of the RBI is required. Listing of shares at the stock exchange:

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After the amalgamation formalities are completed, the company should apply for listing the new shares to the stock exchange. Preservation of the books of the amalgamated company and Post merger formalities: Section 396A of the act requires that the books of the amalgamated company must be preserved. The two companies must duly complete any other post merger formalities.

Chapter 8
Stage II

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How a merger is financed?

Financing of a takeover involves the payment of a consideration to the acquiree for acquiring the undertaking, its assets and controlling voting power of the shareholders as per a valuation done by an unbiased party. To achieve the objective of an optimum funding mix knowledge of the financial packages is required: Financial Packages: Payment for cash Financial package involving a Financial Institution Rehabilitation Financing Management Buyouts The choice of a particular method of financing would depend on a host of factors primarily: the suitability of the financial structure of the companies involved; a desirable level of gearing; acceptability to the vendors; economic advantages. Payment of cash/issuance of shares: This would involve a selection of one or more of the following methods: Cash payment Issue of equity shares Debt or loan stock Issue of Preference shares Convertible securities Cash Payment: Cash payment would be easier for the parties involved and would also provide flexibility from the acquirers taxation point of view. This method is usually preferred when a private limited company is being acquired, as the share liquidity is low. Issue of shares: Payment of the consideration through the issuance of shares offer the advantage of being simple and fairer for the companies involved. At times, the acquiree companys shareholders are interested in obtaining payments in equity shares rather than cash to reduce their tax liability. The only disadvantage could be the dilution of the EPS and the depression of the share prices due to the issuance of additional shares. Debt or Loan stock: This method is suitable in large transactions when financing is a problem and is widely used for those transactions, which are negotiated or friendly in nature.

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The issue of loan stock is beneficial to the acquirer from the following angles: The payment is free from capital gains tax It is cheaper as compared to equity since the interest paid by the acquirer is a taxdeductible expense. Interest payment can be deferred through warrants.

Preference shares: The issuance of preference shares offers the same advantages to the acquiree as in a debt transaction since a fixed amount of dividend is payable and the payment of liability can also be deferred through the attachment of a warrant. Convertible Loan securities: The issuance of convertible debt is an appropriate source of funds, as it does not lead to share dilution. However, the issuance of convertible debentures beyond 18 months would mandatorily require a credit rating through an approved agency. Convertible securities carry a lower rate of interest since on conversion the holders will be entitled to capital gains and higher dividends. Financial Institutions and banks: These organizations play a very important role in takeovers in their capacity as moneylenders, debt recovery agents or equity shareholders. FIIs hold a substantial portion of the equity capital of companies under project financing proposals, devolvement of underwriting obligations, rights issues or conversion of existing loans into equity and can support the acquirer company by selling shares of the acquiree in the market. They acquire possession of the undertaking of a company defaulting in the payment of dues and arrange for the sale of such entities with other client companies by granting further financial assistance to the acquirer. Rehabilitation Finance: Financially sick companies get merged with healthy entities to ensure their swift rehabilitation. These mergers rank in the category of leveraged buyouts: i.e. acquisitions involving a high degree of borrowings from FII and banks, a method approved by the BIFR for nursing the sick companies back to health.

Chapter 9

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Valuation: Quality valuation advice is critical to success

Valuation is the device to assess the worth of the enterprise, which is subjected to a takeover so that the consideration amount is quantified, and the price fixed. Valuation of both the companies is necessary for fixing the consideration amount in shares. There are three primary reasons why every entrepreneur and executive should understand how organizations are valued and master the process of valuation. They are: Make decisions to optimize company value when you run a business Obtain the best price and terms when you buy a business Obtain the best price and terms when you sell a business Fixing price for acquisition: The fixation of the appropriate price for any company would largely depend on the intensity of the demand for the shares by the offeror, the eagerness of the Offeree Company to sell and willingness of its shareholders to become shareholders in the new entity. Other factors like the nature of the business, the future earnings of the company, taxation, P/E ratios etc would also play a significant role. Basis of valuation: There are several Basis on which the valuation can be carried out though the Earnings or Assets value are popularly used. Other methods include the market price, Investment Value, Book Value, Cost Basis, Reproduction Cost Basis and the Substitution Cost basis. Assets value: Under this method, it is assumed that the business is a going concern and the realizable value of the assets is considered. The open market value or fair value of the freehold land and building and that of tangible assets is assessed as per existing business practices. Another method (mainly for unlisted companies) suggests the capitalization of the maintainable dividends at a dividend yield applicable to listed companies and then discount it to compensate for the non-marketability of shares. Capitalized Earnings: Under this method, the popular method in use is the predetermined rate of return expected by an investor on his investments. This is the simple rate of return on the capital employed. In order to minimize a major drawback of this method being based on past performance of the company, a reliable forecast of its future earnings is necessary. Another point of view suggests using the accounting rate of return or the P/E ratio. Valuation of listed companies:

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Shares of listed companies are quoted on the stock exchange and it is presumed that the share prices reflect all the available information about the company. However, caution must be exercised while using this method since complete information may not be available to the investors at all times and the market prices maybe manipulated through insider trading activities. Valuation of unlisted companies: Since the open market prices of such shares are not available, the price to earnings ratio of a group of representative companies maybe used as a suitable benchmark for evaluation. Other factors such as the shareholding pattern, their rights and obligations, nature of the industry, major competitors and market share are also considered while valuing the company.

Market value of shares:

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Provided the two companies to a merger are listed, their stock exchange prices prior to the negotiations should be taken into consideration. The relative bargaining of the companies i.e. the weaker companys financial strength or earning capacity generally determines share exchange ratio. Other indicators like the Dividend payout ratios, Price earning ratio, and the Debt Equity ratio are also used to determine the exchange ratio for valuation purposes. Net assets value (NAV): The assets and liabilities at the historical costs are considered to calculate the NAV for the firm. Further there is a need to provide for contingent liabilities and explore hidden assets under this method. The NAV value thus obtained, is divided by the number of shares to obtain the NAV per share. Discounted cash flow method (DCF): DCF analysis uses future free cash flow projections and discounts them to arrive at a present value, which is used to evaluate the potential for investment. The Weightage average cost of capital (WACC) is commonly used to discount the cash flows. If the value arrived at through DCF analysis is lower then the current cost of the investment the opportunity may be a good one.

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ICICI LTD-ICICI BANK Chapter 10 Introduction:

Size, range and low cost resources seem to be a recurring theme in ICICIs strategy. Ever since a significant portion of the loans given by Development Financial Institutions s were cut off from concessional funding in the early 1990s and asked to face heightened competition, ICICI has relentlessly pursued its goal of becoming an universal bank to survive the changed environment. Following significant proportion of loans made in the early and mid-1990s turning bad, a drive to increase its size and range of activity, and thereby cushion the impact of loans turning bad, have been the defining features of ICICI's strategy. The move to embark on a reverse merger with its offspring, ICICI Bank, seems to be the watershed in its dream of becoming a universal bank. The merger also involved the amalgamation of two wholly-owned subsidiaries of ICICI, ICICI Personal Financial Services Limited and ICICI Capital Services Limited, with ICICI Bank.

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The merging entities

ICICI Ltd
ICICI is a diversified financial services provider, which along with its various subsidiaries and affiliates, offers a range of products and services to its corporate and retail customers, and operates as a virtual "universal bank". It 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 1999, ICICI become the first Indian company and the first bank or financial institution from non-Japan Asia to be listed on the NYSE. As on September 30, 2001, ICICI had total assets of Rs. 74,371 crore and shareholders' equity of Rs. 8,777 crore.

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The merging entities

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 American Depository Receipts 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. It is largely a technology oriented private bank widely acknowledged for its aggressive forays into retail and corporate lending. Prior to the merger, it had an asset base of Rs. 20,809 crore and shareholders' equity of Rs. 1,444 crore, a distribution network of 396 branches and Indias largest ATM network of 601 ATMs.

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Motives for the merger:

FINANCIAL BENEFITS: Key Statistics (As on 30th September 2001) Rs bn ICICI Bank Total Assets 208.1 Net Worth 14.4 Profit after 1.3 tax EPS (Rs per 11.9 share) RONW % 19.1 CAR % 13.0 High Growth: The fee income that the top 50 corporates in India give to various banks is about Rs75-80bn per annum. ICICI groups share is Rs3.5bn and SBIs share is Rs35bn. While ICICI has excellent relationships to leverage and get a bigger chunk of the business, ICICI Banks balance sheet size prevents it from garnering high volume business. A merger would help ICICI Bank to have a balance sheet size in excess of Rs100bn and would be well positioned to compete with SBI and foreign banks for the high volume business. There is no other way for ICICI Bank to grow and the only other alternative is to raise funds from capital markets. ICICI 743.7 87.8 6.1 15.5 14.7 14.8

Low cost of operations: Lower cost of funds for ICICI at 11.71% since it will be able to accept checking accounts and float money due to active participation in the payments system. Combined Cost to Income ratio as at September 30, 2001 is 27%, would makes ICICI one of the most efficient Banks in India.

Economies of scale:

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The combined entity would be the second largest bank in India after the State Bank of India with an asset base of more than Rs 1 lakh crores. Economies of scale and scope place the Bank in a better position to fight increasing competitive pressures Fee Based Income:

The entity would have access to a vast retail clientele which would enable it enhance its income from fee based activities. NON- FINANCIAL BENEFITS: Excellent management skills:

Vast talent pool, optimizing use of human capital of the ICICI Group Benefit of cross selling: With a wide branch network and multiple channel access, customers deal with the bank in several ways. Each interaction is an opportunity to cross-sell another product. After all, historically it has always been cheaper to sell to an existing customer than to acquire a new one. Benefit of the strong brand franchise of ICICI and its extensive customer relationships could be utilized effectively for Banking operations. Technology: The combined entity would be able to leverage the strong technology focus of the bank through its internet and ATM initiatives to cross sell and serve customers at a lower cost. To gain an understanding of the magnitude of cost savings consider the fact that a transaction at the branch costs Rs 60 as compared to an ATM where it is Rs 15, in addition to lower labour requirements at the branches. The bank is growing at a fast pace and this rapid expansion can only be serviced through a reliable technology network.

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Valuation and Swap ratio Decision

Both the entities were listed companies at the time of the merger and their share prices were used as a basis for valuation purposes. The swap ratio has been decided at 2:1 that is 1 share of ICICI Bank for every 2 shares held in ICICI Ltd. The American Depository Shares (ADS) holder of ICICI would be issued five ADS of ICICI Bank in exchange for four ADS of ICICI. The share exchange ratio was based on a valuation process incorporating international best practices in respect of the merger of two affiliate companies, using the market prices, discounted cash flows and book values. The highest weight was given to future growth potential ie discounted cash flows of the merging entities. This parameter gave a swap range of 1.8 to 2.2 Market price of the companies over an extended period was also given a high weightage and the merger ratio as market price basis averaged between 1.8 and 2.0. The Asset base including Fixed assets was also considered while arriving at the valuation. The valuation based on asset base was largely in favor of ICICI averaging around 0.6.

The final ratio was arrived at after taking a combined view on the quantitative as well as other qualitative parameters. The merger has been undertaken under the Purchase Method, which is mandatory as per US GAAP. The book value per share of ICICI and ICICI Bank at end-September 2001 is Rs 111.81 and Rs 65.53 respectively. However, ICICI's shareholders will get only one share of ICICI Bank for every two shares held in ICICI. In other words, for surrendering a book value of Rs 223.62, a shareholder in ICICI will get Rs 65.53. This works out to a discount of nearly 71 per cent to the book value of ICICI. ICICI stake in Bank to be parked in SPV Currently, ICICI Ltd holds 46 per cent stake in ICICI Bank. In the case of merger, instead of extinguishing the shares, the company has decided to transfer the stake to a special purpose vehicle (SPV) to be created in the form of a trust. Post merger, this would form about more than 16 per cent of the total capital. This is an intelligent move by the company, as it would solve many purposes. First of all it is not prudent to extinguish capital in a scenario where the cost of raising capital itself is very high. Secondly, by doing so the bank would be able to safe guard its capital adequacy ratio. Thirdly, the plan is to divest the stake to a strategic partner few years down the line, which would fetch the bank considerable amount of cash. The shares would be transferred to the SPV at the price at which ICICI bought the shares i.e. Rs 12 per share.

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Post merger SWOT analysis

Strengths: The merger could be viewed as a move towards universal banking. It would be the second largest bank in India with total assets of about Rs 95,000 crore and a network of 396 branches of ICICI Bank and 140 retail centres of ICICI. Decrease in the cost of borrowing from 11.71% as that for a FII through bonds is relatively high as compared to a bank which can raise resources cheaply through savings and current deposits Would be better equipped to handle issues arising from potential asset liability mismatches due to more stable deposit base The high retail margins enjoyed by ICICI Ltd would now be available to its various subsidiaries as well. Reduction in the non-performing assets of ICICI bank. Excellent management with a strong track record of profitability and ethical business practices; the entity would be headed by Mr N Vaghul, Mr K V Kamath would be MD & CEO ably assisted by a team of Executive Directors.

Weaknesses: The combined organization would have to fulfill the priority sector lending norms at 40% of its advances, applicable to banking entities. The RBI norms for banks to maintain a Cash Reserve Ratio of 5.5% and a Statutory Liquidity Ratio of 25% (applicable at the time of the merger), would necessitate the entity to raise money to the tune of Rs 18000 crores and a significant portion of this would have to be brought in by ICICI Ltd. Decrease in the Gross yield for ICICI Ltd from 11.71% and 13.54% respectively. Reduction in the interest spread for ICICI Ltd due to decrease in the loan portfolio and diversion of funds for reserve requirements.

Opportunities: A decrease in the average cost of borrowing, would benefit the end customer Both the organizations would be in a position to leverage their huge balance sheet size and undertake various fee-based activities to enhance their income through them. One area where the impact could be telling is retail consumer financing business such as commercial vehicle finance, an area dominated by finance companies. Post merger these companies would not be in a position to compete with such a mammoth entity. ICICI bank would be able to leverage the huge customer relations and trust cultivated by ICICI Ltd through 5 decades of association with the customer.

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Under the merger agreement, ICICI may have to divest a large portion of its stake in companies such as ICICI Infotech, ICICI Knowledge Park, ICICI Web Trade, ICICI Econet and a few others. In addition, ICICI is likely offload the holdings of around 10.21 crore shares in ICICI Bank in 2003. These divestitures would lead to inflow of capital for the merged entity.

Threats: The assets quality of ICICI Bank, which has been its biggest strength would be affected post merger. ICICI Ltd has NPAs of 5.2% as against ICICI Bank's NPAs of 1.4%. At present ICICI Ltd can claim a deduction of upto 40% of its profits from its long term lending by transferring the amount to special reserve. Post merger, this benefit would stand withdrawn in the case of incremental loans. The period within which the priority sector targets are to be achieved would be quite crucial. ICICI may have to divert large portion of its borrowings into the priority sector and this will have a bearing on the profitability of the merged entity as incremental funds may have to be deployed in a sub-optimal manner to fulfill regulatory requirements Taxation is likely to emerge as an important issue post merger, ICICI, currently enjoys special tax treatment available for companies engaged in financing longterm projects, is likely to lose that status when it merges with ICICI Bank. This will lead to increased incidence of taxation in the case of long-term finance business, which could work out to 10-12 % of the profits earned from long term financing. The regulatory constraints and policy impediments could slow the growth rate of the merged entity - to considerably lower levels than what ICICI Bank has managed since its inception.

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HDFC BANK-TIMESBANK Chapter 11 The merging entities

TIMES BANK
Times Bank was promoted by Bennett, Coleman & Co Ltd and its subsidiaries, publishers of the famous Times Of India Group of publications, where the promoter had a stake of 66.81%. The Bank was incorporated as a limited company under the companies act, and it got the certificate of commencement of business on August 22, 1994. But it was only in June of 1995 when the first branch started its operations. TIMES Bank at the time of merger had 35 fully Computerized Inter Linked Branches in 23 cities, across the country with Round the clock ATM facilities at 34 branches. Also the bank had good financial health as is evidenced by its Capital Adequacy ratio of 9.97% as of March 31, 1999 compared to RBI statutory requirement of 8%. The Times Bank is "The Convenience Bank" and had introduced innovative deposit products like "Times Convenience Deposit" and "Times Dual Deposit" as early as 1995. It also offered the facility of "Sunday Holidays and Home Banking" service, in which the bank services were virtually brought at the customer's doorstep. TIMES Bank had an enviable network of 35 ATMs in 34 branches and offered several facilities such as Cash withdrawals, Cash/cheque deposit, Cheque book requests, Request for Access Draft, Transfer from one Account of the Card Holder to another account of his/her or that of another person through this network. Though a relatively new entity the Times Bank by end of March 1999 had amassed a deposit base of Rs 3011.18 Crores, and customer base of 148,000. It had a P/E multiple of 3.7 and a net profit of Rs 27.06 Crores, while the NPAs amounted to just 3.01% of its net advances.

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The merging entities

HDFC Bank
The Housing Development Finance Corporation Limited (HDFC) was amongst the first to receive an 'in-principle' approval from the Reserve Bank of India (RBI) to set up a bank in the private sector, as part of the RBI's liberalization of the Indian Banking Industry in 1994. The bank was incorporated in August 1994 in the name of 'HDFC Bank Limited', with its registered office in Mumbai, India. HDFC Bank commenced operations as a Scheduled Commercial Bank in January 1995. The bank at end of March 1999 had a total deposit base of Rs 2915 Crores, a deposit base of Rs 2915.11 Crores and net advances of Rs 1401 Crores. It had a total of 57 branches before merger. The bank had a net profit of Rs 82.4 Crores, and Capital Adequacy Ratio of 11.86%. HDFC Bank's mission is to be a World-Class Indian Bank. The Bank's aim is to build sound customer franchises across distinct businesses so as to be the preferred provider of banking services in the segments that the bank operates in and to achieve healthy growth in profitability, consistent with the bank's risk appetite. The bank is committed to maintain the highest level of ethical standards, professional integrity and regulatory compliance. HDFC Bank's business philosophy is based on four core values: Operational Excellence, Customer Focus, Product Leadership and People The bank is credited with many firsts. It was the first bank to come up with ATMs in vernacular language in, also was the first to give TELE BANKING Services in 1997. It was also the first private sector bank to conclude a structured interest rate option deal. HDFC Bank became the first bank in India to link up its automated teller machine (ATM) network with all the three major payment systems worldwide. Also it was the first bank in the Asia-Pacific region to connect the American Express (Amex) payment system.

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Merger Motives
The rationale for the merger from HDFCs viewpoint included the following. FINANCIAL BENEFITS Benefit of Inorganic growth: Through the adoption of the organic growth model, the bank would require 3-4 years to reach the level of operations it could acquire at once through the merger. Huge growth in Market capitalization:

Market Capitalization is one of the bases for evaluating any merger. HDFC bank witnessed a many fold increase in its post merger market capitalization from Rs 1383 crores in 1999 to Rs 6277 crores in 2000, thereby making the largest banking entity just behind the State Bank of India. Moreover, this was the first case of a healthy merger, since many earlier mergers had been forced due to some compelling reasons (such as liquidation threat, losses etc.) other than expansion of business and growth. Low Cost of Operations:

The costs of deposits for HDFC bank declined from 7.1% in 1999 to 6.3% in 2000. Due to centralized processing, economies of scale and opportunities to rationalize duplicate support infrastructure, there would be many incidences of saving of costs and operating expenses for the merged entity. NON-FINANCIAL BENEFITS Branch Network: As a result of the merger, HDFCs branch network increased by 50% from 57 branches in 1999 to 111 branches in 2000, providing increased geographical coverage as well as greater convenience to its customers. Acquisition of a strong customer base:

Post merger HDFC bank acquired a customer base of more than 8 lacs retail accounts through which it could leverage its aggressive foray into the retail-banking scenario. Delivery Channels:

Post merger HDFC would be able to use its lower cost alternative channels such as phone banking, internet and remote account transacting and other such services allowing better access while reducing operating costs.

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Benefit of Cross selling:

With a wide branch network and multiple channel access, customers deal with the bank in several ways. Each interaction is an opportunity to cross-sell another product. After all, historically it has always been cheaper to sell to an existing customer than to acquire a new one. This would enable them to market its relatively new and diverse product range of Loans against shares, Home Loans and Credit cards to an existing captive customer base. Depositary Participants:

The merger resulted in increased presence of HDFC in the depositary participant business because the current demat account base with Times Bank as well as the opportunity to cross sell DP accounts to other retail banking customers. Acquisition of good managerial skills:

Times Bank had huge staff strength of over 600 employees, with an average age of 25-27 years and 3-4 years work experience. HDFC Bank would thus have access to a vast pool of talent with little need for training and the experience to be able to retain employees, with the requisite experience to pursue its massive scale of operations. Even today, the head of Human resources and Treasury are ex-Times Bank employees. The rationale for the merger from TIMES viewpoint included the following. Group Strategy:

The Times Group found the banking business to be very distinct from the other publishing / newspaper businesses that formed the mainstay. Maintain Interests in Growing businesses:

Since banking and financial services formed a high potential, high growth sector, the Times Group opted to exit operational control, yet retain strategic interests. This manifested itself in the form of a stock swap as opposed to a cash transaction. Release from operational risk and managerial hassles:

HDFC Bank commenced around the same time as Times Group. Their primary focus being only banking with the financial muscle backing them, allowed them to achieve better performance than Times Bank. The merger would transfer all risks excepting investment risk to HDFC Bank. Moreover, the managerial and operational expertise of HDFC Bank could be leveraged for the new array of innovative retail products. 38

Poor performance in Times Guarantee:

The Times Group faced a very bad experience with one of their flagship products: Times Guarantee. This was a supporting factor that encouraged the strategic refocusing of the businesses that the Times Group wanted to retain.

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Valuation and Swap Ratio Decision

Both HDFC Bank and TIMES bank were listed companies at the time of the proposed merger and the stock market price of the listed companies was an indicator of price. As the basis for computing merger ratios the comparison of market prices is the generally accepted method. For the purpose of computing the exchange ratio on this basis the four week between 18th October 1999 and 18th November 1999 were considered by the Board of directors as by the 17th of October 1999, both the banks had announced their half yearly results and the market price of the shares of the banks would reflect this information. The exchange ratio on this basis (i.e. based on the average of Rs 94.95 for HDFC Bank and Rs 14.97 for TIMES Bank) worked out to be 6.34. Further for this ratio two additional factors were taken into consideration which were: The recognition that with the merger of the two banks the entire shareholding of TIMES bank would form approximately 10% of the merged entitys shareholding and consequently TIMES bank shareholders would not continue to enjoy the shareholders control as it existed prior to the amalgamation and The second factor was that the merged banks shares would have a much higher level of liquidity than the that available to the shareholders of TIMES bank in the current situation.

Taking both these factors into consideration a premium of 10 % was considered reasonable over the Base Exchange ratio of 6.34. Accordingly a share exchange ratio of 5.75 shares of TIMES bank for every one share of HDFC bank was approved by the Board of Directors. This methodology and rationale was also in line with the professional advice received by the Board in this respect.

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SWOT Analysis of HDFC Bank Post Merger

Strengths Total number of retail accounts increased from 345,000 in March 31, 1999 to 825,000 in March 31, 2000. Customers are serviced from a branch network of 111 branches (up from 57 in March 1999 and enhanced its presence in 33 cities across India. PAT increased by 45.7% to Rs 120.04 crores Expansion in HDFCs range of retail loan products to include loans against shares, auto loans, personal loans and short-term loans for primary issues. The bank's cash management services registered a volume growth of 141% and was expanded to include net based supply-chain management solutions The bank has also achieved exponential growth in its custodial and depository participant (DP) services with the total number of investor demat accounts going up from 50,000 in March 1999 to over 3,00000 in March 2000. The total value of the assets under custody increased many fold from Rs 4500 crores to Rs 25,000 crores in 2000. HDFC bank now has total deposits of around Rs 8428 crores. The balance sheet of the bank increased to over Rs 9,000 crore making it the largest private bank. The Market Capitalization of the combined entity increased from Rs 1383 crores in 1999 to Rs 6277 crores in 2000, making it the second largest entity after SBI. The Earnings per share increased from Rs 4.12 to Rs 5.93, thereby indicating that the merger was beneficial to the shareholders as well. The bank has one of the lowest levels of non-performing assets at 0.77% of its net deposits and this figure is down from 1.08% in the previous year.

Opportunities Leveraging the customer base of both banks and distribution network to cross-sell their products. The bank will, therefore, be able to market its wide range of banking products and services to over 2 million HDFC customers after the merger. The bank could leverage its strong position in stock exchange settlement services and broaden its network to more than its current list of 800 brokers and custodians. First mover advantage in the launch of mobile banking services in India. The costs of deposits reduced to 6.3% from 7.1% in the previous year. The bank acquired a 19% stake in CAMS, Computer Age Management Services, in 2000 and this could enable it to become a one stop shop for Registrar and Transfer, Custodial and sales & distribution services to Mutual Funds in India. The acquisition of a stake in Net Savvy solutions would be useful to the bank in its Net Banking initiatives. 41

Weaknesses Except for 7 branches, there was a massive overlap in the network of the two banks and hence the merger did not contribute significantly to the distribution network of HDFC bank.

Threats Human Resource Management Integration of the two organizations: The managers at HDFC were recruited with experience of three years but the managers at Times bank had between three to eight years work experience The salaries of Times Bank employees were higher than those of HDFC bank and after merger there were a number (of experienced talent pool) Times Bank Employees who left HDFC bank. These factors contributed to the mass exodus of employees from the bank as a consequence of the merger. The bank was disallowed from offering mortgage lending, a fast growing opportunity in retail banking. This would hamper its aggressive foray into the retail-banking sector.

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Chapter 12 The Journey begins: Key Learnings

A close look at the project report enables us to identify the four major trends that are fundamentally altering the banking industry today and resulting in increased need for mergers and amalgamations. These trends are consolidation of the banks, globalization of operations, development of new technologies and universalisation of banking. Even most of the bank economists term the current row of banking mergers and amalgamations as a long overdue rationalization that will improve and promote diversifications and stability in the Indian banking sector. This study enabled the author to identify some of the main motives for the M&As in the banking sector. Few of them are stated below: Increased Customer Base and improved market coverage. Internationalization of Business Functional / Area wise Specialization Substantial increase in the Capital Base.

Thee author could identify the following key areas that could help in ensuring a smooth and successful merger in the banking industry. Key Areas (Pre-Merger) Banking mergers should not be purely based on the premise that the weaker banks should be taken over by the stronger banks. Instead the mergers should take into account Synergies and Complementariness of merging units and should provide opportunities for pooling of strengths. The merger should be based on a well-defined strategy. In strategic terms, we can distinguish between defensive and offensive financial mergers. Defensive mergers involve efforts to preserve core bank activities in given market areas in the face of heightened external competition. Eliminating workers or closing duplicate offices can cut costs. Defensive mergers may also permit the surviving entity to offload bad debts, declare capital losses, and even become too big to eat. Some gains from geographic diversification may also result. Offensive mergers involve efforts to expand the range of bank activitiesby entering new product markets, capturing new customers within market areas, or entering new geographic markets. Benchmarks in terms of ROA,ROE,NIM,NPA Levels and an operational efficiency should be created in order to achieve cost efficiency in line with international standards.

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Key Areas (Post-Merger) The merged entity should comply with the necessary legal and regulatory framework in order to ensure that the interests of all the stakeholders are aptly looked after. The merged entity should result in an emergence of a stronger bank by the way of increased capital base and with organisational strength. The merger should also keep in mind that Size alone does not matter, but economies of scale do. So the merger should not only aim at increasing the size of the asset holdings but should also emphasise on cutting costs, which would ensure the long term sustainability and growth of the merged entity. The merged entity should take into consideration the need for rationalization of the branch and ATM networks as well as aims at right sizing and re-deployment of surplus staff. The merged entity should be able to evolve a judicious policy so that the divergent credit needs of the clientele of the original banks are effectively taken care of. This will ensure that the original clientele at least continue to get services as was offered by the original banks. The merger should ensure that the balances sheet of the new entity is effectively cleaned up, so that the merged entity does not confront the problems that the original banks faced in terms of bad loans. I.e. The asset quality of the merged entity should evidently be better as compared to the banks in the pre-merged state.

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Chapter 13 The Road ahead: Small aint beautiful no longer for the Indian
Banking Industry
In this era of globalization, Indian banks will have to be competitive and aggressive in order to survive the onslaught of the mighty players from overseas. With the deadline for the implementation of the Basel II norms fast approaching, the RBI has ushered in a host of prudential norms and measures that commercial banks are to follow. Basel II necessitates enhanced IT infrastructure and capital, historical databases and skilled manpower, a wish list most banks especially the smaller players would find difficult to fulfill. Added to this signs like the decline in banking treasury profits prove it is high time that Indian banks go global and find alternative ways to increase their sources of income. In this context, the recently organized National Bankers Conference called for reducing the number of Indian banks by way of mergers and strategic alliances to create 5-6 big banks. These would then, be in a position to open more branches abroad and compete with multinational banks. Moreover the smaller players would benefit by meeting additional capital requirements and savings in cost and labour. Recently the finance ministry also permitted the presence of four full-time directors in the banks, if required, to accommodate all the existing executive directors in the post-merger entity. It has also allowed the PSUs a free hand to undertake business policy decisions without government interference. Common business policies and approaches amongst the Public sector banks would make the process of integration easier for them. The sheer size of the merged entity would enable it to participate in a range of financial activities, thereby generating profits from a range of operations - from the call money market to the stock market. Therefore, the optimism shared by industry leaders towards consolidation also seems to be the line of thinking of the regulatory bodies. Broadly two basic banking structures could emerge. The first involving a big bank taking over a smaller group and the second structure could a merger of group of mid sized players to from a larger institution. Under the first alternative, it is envisaged that a private sector bank like HDFC bank or ICICI bank (with strong fundamentals) could play a dominant role and absorb 4-5 old private sector players, to become a large organization. It would be difficult for banks having a market share of less than 1% to sustain over the long run and these would then be susceptible to takeover. Under the second structure, there could be consolidation amongst the SBI group or within the nationalized banks. The combined entity of the SBI group currently enjoys close to 1/3 rd market share and it is important that it does not lose its market share. A cluster

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approach could emerge in the case of nationalized banks, wherein 5 banks with a size Rs 80,000 crores, could absorb a bank of a size of Rs25,000-80,000 crores. To conclude, the emerging scenario could look as follows: SBI & associates forming a single entity in the next few years. Nationalized banks consolidating into 4-5 banks in the medium term. Private sector banks consolidating to not more than 5 over the next 5-7 years.

Finally, the overall consolidation could result in the 49 banks (other than foreign) getting reduced to less than 12 banks in the medium to long term. Another section of analysts believe that promoting mergers as the only means to allow banks to compete with the big boys on the global stage is misplaced. Mergers should be considered only when all means of organic growth have been exhausted and moreover the possibility of Indian banks attaining the might to compete with the foreign banks on their own terrain is remote. They would also require stringent regulatory systems considering the fact that they are important social and financial tools for economic development. The most serious problem with mergers in Indian banking could be because of the higher levels of concentration. Fewer banks, less competition, and greater pressure to generate quicker profits could well result in an escalation in the cost of credit and this could adversely impact small borrowers. Service quality could be impaired and fees could escalate. A gradual step-by-step approach considering the impact of various parameters and the general direction of the industry is the way forward. The government should not force the issue. M&As can bring benefits if banks can close down uneconomic branches, redeploys or retrench staff, make lateral recruitments, offer market-related salaries, reward performance, and penalize non-performance. Without managerial autonomy, bank consolidation may end up adding more fat than muscledefeating the very purpose of the exercise.

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Bibliography
Websites: www.Blonnet.com www.insight.asiacerc.com www.banknetindia.com www.economictimes.com www.investopedia.com www.quickmba.com

Annual Reports/Books Annual reports-HDFC Bank, Timesbank-March 2000 Shareholders Notice-Of Merger Annual Reports-ICICI Bank- March2001, March 2002 Indian Bank Association- Annual Publication

Corporate Mergers Amalgamations & Takeovers- Dr Verma J.C. (SEBI-Substantial Acquisition of shares & Takeovers Regulations, 1997) 3rd Edition-(Chapters 2,5,8,9,13,14)

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Authors Profile
The author is a B.com (Hons.) graduate from Sydenham College of Commerce & Economics, University of Mumbai. She is currently pursuing her Masters of Business Administration (MBA) from Narsee Monjee Institute of Management Studies (Deemed University), Mumbai and is specializing in the field of Finance. Name: Manasi Lad Nature of Work: Banking & Finance Name of the organization: Narsee Monjee Institute of Management Studies, Mumbai Email: manasilad@yahoo.com

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