Scenario after Entry of New Players, Consolidation &

Mergers in Banking
Introduction:
Indian banking is the lifeline of the nation and its people. Banking has helped in developing the
vital sectors of the economy and usher in a new dawn of progress on the Indian horizon. The
sector has translated the hopes and aspirations of millions of people into reality, it has to control
miles and miles of difficult terrain, suffer the indignities of foreign rule and the pangs of partition.
Today, Indian banks can confidently compete with modern banks of the world. In the Indian
Banking System, Cooperative banks exist side by side with commercial banks and play a
supplementary role in providing need-based finance, especially for agricultural and agriculture-
based operations including farming, cattle, milk, hatchery, personal finance etc. along with some
small Industries and self-employment driven activities.
As the banking institutions expand and become increasingly complex under the impact of
deregulation, innovation and technological up gradation it is crucial to maintain balance between
efficiency and stability. During the last 30 years since nationalization tremendous changes have
taken place in the financial markets as well as in the banking industry due to financial sector
reforms. The banks have shed their traditional functions and have been innovating, improving
and coming out with new types of services to cater emerging needs of their customers. Banks
have been given greater freedom to frame their own policies. Rapid advancement of technology
has contributed to significant reduction in transaction costs, facilitated greater diversification of
portfolio and improvements in credit delivery of banks.

NEED OF NEW (PLAYERS) BANKS IN INDIA
We know that greater financial system depth, stability and soundness contribute to economic
growth. But beyond that, for growth to be truly inclusive requires broadening and deepening the
reach of banking. A wider distribution and access of financial services helps both consumers
and producers raise their welfare and productivity. Such access is especially powerful for the
poor as it provides them opportunities to build savings, make investments, avail credit, and
more important, insure themselves against income shocks and emergencies.

As of March 31, 2009, the Indian banking system comprised 27 public sector banks, 7
new private sector banks, 15 old private sector banks, 31 foreign banks, 86 Regional
Rural Banks (RRBs), 4 Local Area Banks (LABs), 1,721 urban cooperative banks, 31
state co-operative banks and 371 district central co-operative banks.
The average population coverage by a commercial bank branch in urban areas
improved from 12,300 as on June 30, 2005 to 9,400 as on June 30, 2010 and in rural
and semi urban areas from 17,200 as on June 30, 2005 to 15,900 as on June 30, 2010.
The all India weighted average during the same period improved from 15,500 to 13,400.
Though the Indian financial system has made impressive strides in resource
mobilization, geographical and functional reach, financial viability, profitability and
competitiveness, vast segments of the population, especially the underprivileged
sections of the society, have still no access to formal banking services.
The Reserve Bank is therefore considering providing licenses to a limited number of new
banks. A larger number of banks would foster greater competition, and thereby reduce
costs, and improve the quality of service results in financial inclusion, and ultimately
support inclusive economic growth, which is a key focus of public policy.
SUGGESTIONS OF EXPERT COMMITTEES AND MESSAGE FROM
THE GLOBAL CRISIS
High Level Investment Commission:
The February 2006 report of The High Level Investment Commission, constituted by the
Government of India in December 2004 with the objective of enhancing both foreign and
domestic investment levels in India, has, among other things, recommended permitting
ownership in Indian banks of up to 15 percent by Indian corporate, and also to increase limits of
holdings by any one foreign bank up to 15 percent in private banks.
High Level Committee on Fuller Capital Account Convertibility:
The July 2006 report of The High Level Committee on Fuller Capital Account Convertibility,
constituted by the Reserve Bank of India in March 2006 under the chairmanship of Shri S. S.
Tarapore, has recommended that RBI should evolve policies to allow, on a case by case basis,
industrial houses to have a stake in Indian banks or promote new banks. The policy may also
encourage non-banking finance companies to convert into banks. It has also recommended that
after exploring these avenues until 2009, foreign banks may be allowed to enhance their
presence in the banking system.
Committee on Financial Sector Reforms:
The September 2008 report of The High Level Committee on Financial Sector Reforms,
constituted by the Government of India in August 2007 under the Chairmanship of Dr.
Raghuram G. Rajan, has recommended allowing more entry to Private well-governed deposit-
taking small finance banks with stipulation of higher capital adequacy norms, a strict prohibition
on related party transactions, and lower Allowable concentration norms (loans as a share of
capital that can be made to one Party). Such measures would also increase financial inclusion
by reaching out to Poorer households and local small and medium enterprises.
Message from the recent global financial crisis:
The epicenter of the crisis lay in the sub-prime mortgage market in the US, it was transmitted
rapidly throughout the globe, destabilizing financial markets and banking systems. The crisis
eventually impacted the broader macro-economy, affecting economic growth and employment
throughout the world.
The magnitude of this crisis has clearly signaled the need for major overhaul of the global
financial regulatory architecture, the importance and need for improving quality and level of
capital, risk management and governance standards, having strong domestic (indigenous)
banks, avoiding large and complex banking structures as well as strengthening banks
transparency and disclosures.

ISSUES FOR CONSIDERATION

Many opinion makers have expressed views about the desirability of permitting new banks
(including local area banks), allowing conversion of NBFCs into banks and whether large
industrial and business houses should be allowed to set up banks.
A number of issues, however, bear consideration. These include:
Minimum capital requirements for new banks and promoters contribution.
Minimum and maximum caps on promoter shareholding and other shareholders.
Foreign shareholding in the new banks.
Eligible Promoters:
Whether industrial and business houses could be allowed to promote banks
Should Non-Banking Financial Companies be allowed conversion into banks or
to promote a bank?
Industry scenario of Indian Banking Industry
The growth in the Indian Banking Industry has been more qualitative than quantitative and it is
expected to remain the same in the coming years. Based on the projections made in the "India
Vision 2020" prepared by the Planning Commission and the Draft 10th Plan, the report
forecasts that the pace of expansion in the balance-sheets of banks is likely to decelerate. The
total assets of all scheduled commercial banks by end-March 2010 is estimated at Rs 40,90,000
corers. That will comprise about 65 per cent of GDP at current market prices as compared to 67
per cent in 2002-03. Bank assets are expected to grow at an annual composite rate of 13.4 per
cent during the rest of the decade as against the growth rate of 16.7 per cent that existed
between 1994-95 and 2002-03. It is expected that there will be large additions to the capital
base and reserves on the liability side.
The industry is currently in a transition phase. On the one hand, the PSBs, which are the
mainstay of the Indian Banking system, are in the process of shedding their flab in terms of
excessive manpower, excessive non Performing Assets (NPAs) and excessive governmental
equity, while on the other hand the private sector banks are consolidating themselves through
mergers and acquisitions. PSBs, which currently account for more than 78 percent of total
banking industry assets are saddled with NPAs (a mind-boggling Rs 830 billion in 2000), falling
revenues from traditional sources, lack of modern technology and a massive workforce while
the new private sector banks are forging ahead and rewriting the traditional banking business
model by way of their sheer innovation and service.
The PSBs are of course currently working out challenging strategies even as 20 percent of their
massive employee strength has dwindled in the wake of the successful Voluntary Retirement
Schemes (VRS) schemes.
Management should be accountable for the effective and efficient use of this freedom. There
are two levels of accountability of management to the Board and of the Board to the
Shareholders. The main task is to ensure the continued competence of management, for
without adequate and effective drive, any business is doomed to decline. As stated by
J.Wolfensohn, President, World Bank Corporate governance is about promoting
corporate fairness, transparency and accountability.
Consolidation in Banking
Consolidation can be said to be, the obligation by law, for which two or more companies to
combine form one new company to meet a specific requirement or agreement or whatever.
Bank Consolidation, in general is referred to a merger of banks. When a merger of banks takes
place, significant saving is done by closing down overlapping branches, laying off of
unnecessary staff, selling of not require capital goods. Increase in revenue may result when
various products of the different merged banks are taken up for sale from branches of merged
banks. As banks carry new products into different geographical markets, this diversification is
bound to produce more trade returns. Along with these benefits of Bank Consolidation, there are
many drawbacks in this.
The harsh restructuring that is required after Bank Consolidation to increase the efficiency is
resisted by internal opposition in the merged organization. At the time of merger, differences
among the merger banks in their work culture and ways of communication can be a costly affair.
With merger the managers are subjected to more complicated and vast organization thereby
bringing to fore the inefficiencies and lack of expertise required in their field.
Regarding the change in efficiencies of the two banks that have merged for Bank Consolidation,
if the acquirer bank has a higher efficiency than the acquired bank, there is going to be net
increase in efficiency of the two merged banks.
Also if both acquirer and acquired banks are inefficient then a wake-up alarm for change is the
attitude that produces better efficiency in the Consolidation Bank. The mergers involving
acquired banks with smaller market shares give rise to lower loan rates while in Bank
Consolidation involving in-market mergers lead to higher decrease in loan rates.

As Bank Consolidation has bought multi layered management, the distance between the agent
who collects information about the lender and the agent which has powers to sanction lending to
the customer increases thereby leading to lower efficient relationship lending? So the only one
that really will benefit from Bank consolidations are the banks and not the consumers! Many
banks all over the world do this because for one reason only it benefits the bank with the most
power. With todays economy we have seen many mergers of banks all over the world. Its not
just in the United States that people are suffering from the fallen economy, but it is all over the
world! Im pretty sure that we will be seeing many more banks all over the world be sold and
merged with other banks before the economy gets any better. Or its possible that the United
States will be bailing out even more smaller banks in the near future.
We will see this soon if the economy does not pick up fast! So like always its the smaller
person who always gets screwed!

Mergers Of Banks

Globally mergers and acquisitions have become a major way of corporate restructuring and the
financial services industry has also experienced merger waves leading to the emergence of very
large banks and financial institutions. The key driving force for merger activity is severe
competition among firms of the same industry which puts focus on economies of scale, cost
efficiency, and profitability. The other factor behind bank mergers is the too big to fail principle
followed by the authorities. In some countries like Germany, weak banks were forcefully merged
to avoid the problem of financial distress arising out of bad loans and erosion of capital funds.
Several academic studies for an excellent literature review) examine merger related gains in
banking and these studies have adopted one of the two following competing approaches
A merger is expected to generate improved performance if the change in accounting-based
performance is superior to the changes in the performance of comparable banks that were not
involved in merger activity. An alternative approach is to analyze the merger gains in stock price
performance of the bidder and the target firms around the announcement event. Here a merger
is assumed to create value if the combined value of the bidder and target banks increases on
the announcement of the merger and the consequent stock prices reflect potential net present
value of acquiring banks.

Bank Mergers in India
Period Number of
Mergers
Pre-nationalization of banks (1961-1968) 46
Nationalization period (1969-1992) 13
Post-reform period (1993-2006)
Forced Mergers 13
Voluntary Mergers 5
Convergence of Financial Institutions in to
Banks 2
Other Regulatory Compulsions 1
21
Total number of mergers 80

The objective here is to present a panoramic view of merger trends in India, to ascertain the
perceptions of two important stake-holders viz. shareholders and managers and to discuss
dilemmas and other issues on this contemporary topic of Indian banking. The currently available
merger cases do not form a sufficient data set to analyze the performance of mergers based on
corporate finance theory because almost all the mergers are through regulatory interventions
and market driven mergers are very few. The impact of bank mergers on market value of equity
of both bidder and target banks. The perception of bank managers is ascertained through a
questionnaire based survey that brings out several critical issues on bank mergers with insights
and directions for the future.
Why Indian banks should go for mergers? These arguments are also applicable to other Asian
countries which have bank consolidation on their agenda. Adopting standard event study
methodology, the impact of both forced and voluntary mergers on shareholders wealth
analyzes some critical issues in mergers based on the perception of banks by reviewing results.


The two important issues examined by several academic studies relating to bank mergers are:
First, the impact of mergers on operating performance and efficiency of banks and second,
analysis of the impact of mergers on market value of equity of both bidder and target banks.
Berger et.al (1999) provides an excellent literature review on both these issues. Hence in what
follows we restrict the discussion to reviewing some of the important studies.

Important pre-merger issues



Second the study of post merger accounting profits, operating expenses, and efficiency ratios
relative to the pre-merger performance of the banks. Here the merger is assumed to improve
performance in terms of profitability by reducing costs or by increasing revenues.





Important post-merger issues
.
Some studies have also examined the potential benefits and scale economies of mergers.
They explore potential diversification benefits to be had from banks merging with non banking
financial service firms. Simulated mergers between US banks and non-bank financial service
firms show that diversification of banks into insurance business and securities brokerage are
optimal for reducing the probability of bankruptcy for bank holding companies. Berger and
Humphrey (1994) concluded that the consensus view of the recent scale economy literature is
that the average cost curve has a relatively flat U-shape with only small banks having the
potential for scale efficiency gains and usually the measured economies are relatively small.
Studies on scope economies found no evidence of these economies.

Conclusion
Bank mergers result into stronger market power due to Bank Consolidation. Attaining stronger
market power will bring along prices change that is against the benefits of the consumers. It has
been found from studies that stronger market power of the bank is used against the interest of
the customer; exploiting the customer for extracting higher prices.
The ability to gauge the risks and take appropriate position will be the key to success. It can be
said that risk takers will survive, effective risk managers will prosper and risk averse are likely to
perish.
One of the concerns is quality of bank lending. Most significant challenge before banks is the
maintenance of rigorous credit standards, especially in an environment of increased competition
for new and existing clients.
Experience has shown us that the worst loans are often made in the best of times.
By implementing the bank marketing mix and strategies we can fulfill the national socio-
economic requirements and make the banking more reliable and efficient.
TOGETHER WE CAN TOGETHER WE WILL
Total words = 2794, Pages = 6, Name = ISHAN CHAUDHARY (SWO-A)
Branch Name = DHARAMSHALA (HIMACHAL PRADESH), PF NO 311035