Important Banking News: Merger Mania 4

MERGER MANIA IV

S.SRINIVASAN

PRESIDENT

NATIONAL UNION OF BANK EMPLOYEES

(NUBE)

The goal of our dissertation in this paper is to enhance the awareness to generate inquiring minds, not only of bank employees, but also to galvanize peoples’ movements, for devising new tools of analysis and action. This is to ensure that global finance capital serves the interests of citizens and democratic states and not the avarice of owners and managers of capital .Our goal is to prepare and merge their hearts and minds to resist & defend the unique &separate identity of Public Sector Banks and defeat the ill advised moves of Consolidation which are pitfalls of a hasty decision without public debate taken by the Government. If the objective on Consolidation Of Public Sector Banks as set out by the Government’s latest moves and policies, it is clear that the entire institutional structures assiduously built up over the past 43 years after Bank Nationlisaton is being subverted to serve the interest of a small section of Indian society in the name of achieving ‘ Global Competiveness’. The entire system is being turned topsy-turvy without any comprehensive study, public debates, debates in news channels and print Medias, except for the reports of committees and foreign rating agencies/ consultants which are tailor made to appease multilateral agencies. While consolidation, mega mergers provide fodder for front line stories in the news papers, electronic channels, a simple fact often ignored is that mergers’ pose new challenges to regulatory authorities in terms of moral hazard. The complexity of big banks makes the task of managing risk more difficult. This becomes more evident as one analysis the consequences of’ myths of consolidation’ objectively without any prejudice which is being sincerely attempted by us in this paper.

Banking sector liberalization is an important component of financial liberalization. While making a strong case in favor of final straw of banking sector liberalization thorough consolidation, its proponents claim global sized bank in the poor and developing world is highly desirable and beneficial. But recent empirical evidence suggests that the entry of big banks could lead to misallocation of credit, which in turn could negatively affect economic growth prospects as bank credit is a vital input for investment and growth. Big global sized banks are not going to lend money to small and medium-sized enterprises (SMEs), small traders, informal sector and farmer as existing well dispersed26 public sector banks. They new global banks will tend to serve less risky businesses such as TNCs and big corporate groups to emerge a first 100 global banks. This has serious consequences for economic growth. In most countries, whether it is India, China, Japan, Germany or US, it is the SMEs (not big business) which are the backbone of economy.

At present, the focus of the global banking industry appears to be on India and China, so it becomes important to analyze some of the recent developments taking place in these countries. Let us begin with India. Instead of liberalization pushing the opening of more bank branches in country, one finds that the trend is opposite. The total number of bank branches has declined, particularly in the rural areas in the post-liberalization period. More importantly, the Indian banking sector has witnessed a secular decline in rural credit. The rural credit went down from 15.7 per cent in 1992 to 11.8 per cent in 2002.4. So the entry of foreign banks has not led to increased rural credit. On the other hand, one finds that there is a growing interest among foreign banks to provide credit for non- essential items such as consumer goods. This situation could be gauged from the fact that car loans come cheaper than agricultural loans in India.

In the post-liberalization period, one also finds that the lending to small and medium enterprises has declined from 15 per cent in 1991 to 11 per cent in 2003.5 SMEs are the engines of India’s economic growth; together they contribute 40 per cent of India’s total production, 34 per cent of exports and are the second largest employer after agriculture. The growing neglect of bank lending to SMEs can have adverse implications on economic growth and employment. Consolidation will add up this mess.

With a view to emerging as global sized banks, the consolidated banks will attempt to make inroads into wealth market by targeting owners of foreign exchange, including local businessmen and expatriates, who have a in liquid assets in Us $ According to banking industry estimates, the total liquid assets held by wealthy Indian households are set to nearly double by2012. No wonder, a number of global banks, new private sector banks have lined up to tap local currency wealth business opportunities in India. Therefore, itseems likely that less credit would be available to small and medium-sized companies in future which, in turn, would have negative repercussions on the economic growth.

As the consumer level, the fewer consolidated banks will emulate foreign banks who have a bias towards providing services to wealthy and affluent customers in the developing world to find list inth global 100. The upmarket retail business will be their primary focus. For instance, consumer retail loans (which are also the riskier) are the fastest growing financial services market in India. The poor and middle class households will not be their attention any more the few consolidated banks big banks banks will attempt cpy their global peers to provide a wide-ranging advisory service to meet the investment and financial planning needs of affluent customers. Some international banks even provide “lifestyle benefits” such as access to exclusive clubs, concierge services and leisure activities to their customers in India.

Not only foreign banks charge higher fees from customers for providing banking services but maintaining a bank account requires substantial financial resources. Take the case of Deutsch Bank which re-entered retail banking operations in seven cities of India in 2005. The Deutsche Bank opens bank accounts for those Indian citizens who could afford a minimum balance of Rs. 200000 (approx. US$5000) in their accounts with the bank. This is a princely sum by the Indian income standards which only affluent customers can afford it. The bias towards affluent customers is evident from the statement issued by Mr. Rainer Neske, a member of the Group Executive Committee of Deutsche Bank. At the launch of retail banking operations in India, Mr. Neske stated, “As the leading retail banking provider in Germany and parts of Europe, we have keenly followed the developments in India - one of the most exciting growth markets in the world. The number of affluent Indian consumers is increasing, the market for consumer goods is expanding and private customers’ demand for excellent advisory services and high quality banking products continues to rise. This is an exciting market that Deutsche Bank seeks to serve by providing advanced value, innovation and convenience to Indian customers.”

So the questions we need to ask: is consolidation going to meet the developmental needs of unbanked regions in India, as there are 391 under-banked districts (out of a total 602 administrative districts) in India? Is it going to augment the reach of the banking system to millions of Indians citizens who do not have bank accounts? Given the fact that the average private banking customer can be ten times more profitable than the average mass-market retail customer, it is highly unlikely that the commercial interests of foreign banks would match with the developmental needs of unbanked regions of both India and China. Also one cannot expect that coonsldted banks who ahvepenchant to emrge as global 100 will would voluntarily open branches in rural and remote regions of India as part of altruistic motives or corporate social responsibility measures. This anomaly could only be addressed by strong regulatory framework, which unfortunately both Indian and Chinese authorities are loosening under the banking liberalization program.

In the US and South Africa, banks have started giving attention to the unbanked market as their “mainstream” already-banked market has become highly saturated.12 In India too, there is a huge untapped market which could be explored by foreign banks. There are 500 million Indians (almost twice the size of US population) who do not enjoy access of banking services. More than altruistic reasons, such a big market size should be attractive to foreign banks. No denying that this market is different from others in the sense that banks need to tailor specific products at a lower costs to serve this population. But the moot point is that it is not the lack of market which is hindering the delivery of banking services by foreign banks but their bias against the rural sector and poor people in general.

In this context, it is also important to stress here that much-touted microcredit programs launched by self-help groups and NGOs are no substitute for the formal banking system in India. With only 15 million clients (the second largest in the world after Bangladesh with 16 million), microcredit programs till date have only reached a fraction of under- banked population in India. Several studies have questioned the developmental impacts of microcredit programs as it has been found that their transaction costs are very high and often much of credit is used for consumption purposes rather than investment in productive activity. At best, microcredit programs can complement, not substitute, the formal banking system to meet the growing credit needs of farmers, rural entrepreneurs, small enterprises and informal sectors of Indian economy. While in the case of China, microcredit programs have yet to emerge on a larger scale.

Consolidation the last nail in the coffin

Having struck the last nail in the coffin of the Public Sector Banks (PSBs), the Government is all set to bury them. Following IMF instructions, the Bill for the privatisation of banks was passed in the winter session of the Lok Sabha. The Banking Companies (Acquisition and Transfer of Undertaking) and Financial Institution Laws (Amendment) Bill 2000, was passed in the Lok Sabha by 209 votes to 159. The Bill provides for the drastic reduction in government equity (shares) in PSBs to a mere 33% from the existing "not less than 51%".

Major foreign banks have been hovering over these PSBs like vultures, waiting to swoop in for the kill. Banks like the HSBC (Hongkong and Shanghai Corp. Bank), Standard Chartered and Citibank have openly expressed their intentions of acquiring Indian banks "when the laws of the land permit." This is quite natural, as these PSBs, with insignificant equity capital, hold gigantic deposits of the public. So, with a small amount of funds, these TNCs can grab control of the huge savings of the Indian public.

The immediate fallout was the government instruction for the removal of over 10% of the employees. It was estimated that by March 31, 2001, roughly 12% of the 9 lakh employees will accept the VRS (Voluntary Retirement Scheme) package and leave — i.e., an employee reduction of 2 lakhs !!

The government’s claim that it will retain control even after dilution of equity to 33%, just because it will retain the power to appoint the CMD (Chairman cum Managing Director), is an outright hoax. In the new establishment out of 15 directors on the board, 10 will be from the private sector. The CMD will therefore remain a mere puppet in the hands of this brute majority. So, after gaining control of these PSBs, with a few crore investment, they will take control of their vast deposits.

Take an example of XYZ nationalized bank Assuming the government at present owns 60% of the equity, if this is to be reduced to 33% through dilution of capital, it would mean an infusion of an additional Rs. 182 crores. So any big business house or TNC by investing barely Rs. 100 to Rs. 150 crore can gain control of the huge deposits of Rs. 51,306 crores. Besides with the market capitalization of these PSBs drops drastically as is the current trend banks can be taken-over at even lower rates.

In the first instance, those that are likely to take control of the PSBs are those big business houses which owe the banks massive debts, euphemistically called non-performing assets (NPAs) who now become directors as per the recent amendments to the banking bills approved by the parliament on 21-12-2012. Once they take-over the banks, with their majority on the board of directors, they can write-off these loans as bad debts. The amount entailed is a gigantic Rs. 1 37lakh crores as could be seen by the pending applications for restructuring official advised by the government in the written reply to Rajya Sabha (after having already restructured Rs 43,334 croresduring January to March 2012 ), of which it is estimated that one-third is owed by 15 big-business houses. Attempts to get the defaulters names public has been so far suppressed by a secrecy clause stipulated in the RBI Act, 1934. If proposed amendment is the adding of Section 20 (6) to B R Act is approved it will enable the RBI to exempt Banks from the present condition which prohibits Bank Directors to be borrowers of that Bank or Bank borrowers to be Directors of that Bank, as a result of this even banks borrowers’ can become directors.

Once these NPAs are written off and the banks ‘restructured’ through big pay-offs in the VRS scheme, they become ideal prey for the TNCs who will gobble them up through so-called "strategic partnerships."

Thereafter The Union Cabinet gave its approval for introduction of a Banking Laws Amendment Bill 2011 in Parliament. The Bill was introduced in the Lok Sabha on 22nd March, 2011, which seeks to amend the Banking Regulation Act, 1949, the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 and the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980. Strengthen the regulatory powers of RBI and also enable the nationalised banks to raise capital through bonus and rights issue and would also enable them to increase or decrease the authorised capital with approval from the Government and RBI without being limited by the ceiling of a maximum of Rs. 3000 crore. The Bill was examined by the Standing Committee on Finance for examination and report thereon. Based on the recommendations of the Committee a draft Cabinet Note along with the Official Amendments Amendments was sent to the Cabinet, which was approved by the Cabinet in its meeting held on 24.04.2012. However, the Bill could not come up for consideration in the Lok Sabha due to adjournment of the House. The basic features of the Bill are

To exempt bank mergers from scrutiny of the Competition Commission of India;
To enable banking companies to issue preference shares subject to regulatory guidelines by the RBI;
To remove the restrictions on voting rights;
To create a Depositor Education and Awareness Fund by utilising the inoperative deposit accounts;
To provide prior approval of RBI for acquisition of 5% or more of shares or voting rights in a banking company by any person and empowering RBI to impose such conditions as it deems fit in this regard;
To empower RBI to collect information and inspect associate enterprises of banking companies;
To empowering RBI to supercede the Board of Directors of banking company and appointment of administrator till alternate arrangements are made;
To provide for primary cooperative societies to carry on the business of banking only after obtaining a license from RBI;
To provide for special audit of cooperative banks at instance of RBI by extending applicability of section 30 to them; and
To enable the nationalised banks to raise capital through "bonus" and "rights" issue and also enable them to increase or decrease the authorised capital with approval from the Government and RBI without being limited by the ceiling of a maximum of Rs. 3000 crore under the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970/1980. .

Indications are that the Banking Regulation Act, 1949, will be amended to prescribe a minimum capital of Rs 1,000 crore for every private sector bank. The current capital requirement is Rs 300 crore. Based on the feedback from a discussion paper issued in August 2010, the RBI has proposed some amendments to the Banking Regulation Act including a change in the minimum capital requirement. The decision, according to the sources, was taken by the Cabinet while approving changes in the proposed the Banking Laws (Amendment) Bill, 2011. It has been decided that the cap on voting rights in the private sectors, which is now at 10 per cent, is raised to 26 per cent in a phased manner. The other proposals in the Bill include increasing voting rights of an entity in a nationalised bank to 10% from the existing 1%. In addition, the Bill provides for taking mergers and acquisitions in banks outside the purview of the Competition Commission of India (CCI). The Bill will also pave the way for issuing new bank licences to private sector entities. In the draft guidelines, which was issued last year, the RBI has specified a wide range of conditions, including a minimum networth of R500 crore, for companies to be eligible setting up banks in India. Under the draft norms companies that have an exposure of 10% or more to real estate and brokerage businesses in terms of revenue or assets are not eligible to seek licences. Another amendment is the adding of Section 20 (6) to B R Act which will enable the RBI to exempt Banks from the present condition which prohibits Bank Directors to be borrowers of that Bank or Bank borrowers to be Directors of that Bank.

Other legislations to push reform in break neck speed includes the State Bank of India (Subsidiary Banks Law) Amendment Act, 2011, to hasten merger of subsidiaries of state bank of India with the State bank of India.

While the government under fire over the CAG report and the Opposition gunning for Prime Minister resignation in the coal block allocations, UPA’s renewed its reform agenda with fervor pushing for FDI in retail sectors, The Banking Laws Amendment Bill to hasten consolidation of Public Sector banks. Banking sector liberalization is an important component of financial liberalization. The three financial sectors reforms laws, Prevention of Money Laundering (Amendment) Bill and Banking Laws (Amendment) Bill, 2012 Was approved by the parlaiament with a brute majority votesand have now become law of the land with President Shri Pranab Mukherjee giving assent to them.

While making a strong case in favor of final straw of banking sector liberalization thorough consolidation, its proponents claim global sized bank in the poor and developing world is highly desirable and beneficial. But recent empirical evidence suggests that the entry of big banks could lead to misallocation of credit, which in turn could negatively affect economic growth prospects as bank credit is a vital input for investment and growth. Big global sized banks are not going to lend money to small and medium-sized enterprises (SMEs), small traders, informal sector and farmer as existing well dispersed26 public sector banks. They new global banks will tend to serve less risky businesses such as TNCs and big corporate groups to emerge a first 100 global banks. This has serious consequences for economic growth. In most countries, whether it is India, China, Japan, Germany or US, it is the SMEs (not big business) which are the backbone of economy.

With a view to emerging as global sized banks, the consolidated banks willa tempt to make inroads into wealth market by targeting owners of foreign exchange, including local businessmen and expatriates, who have a in liquid assets in Us $ According to banking industry estimates, the total liquid assets held by wealthy Indian households are set to nearly double by2012. No wonder, a number of global banks, new private sector banks have lined up to tap local currency wealth business opportunities in India. Therefore, it seems likely that less credit would be available to small and medium-sized companies in future which, in turn, would have negative repercussions on the economic growth.

As the consumer level, the fewer consolidated banks will emulate foreign banks who have a bias towards providing services to wealthy and affluent customers in the developing world to find list in the global 100. The upmarket retail business will be their primary focus. For instance, consumer retail loans (which are also the riskier) are the fastest growing financial services market in India. The poor and middle class households will not be their attention any more the few consolidated banks big banks will attempt copy their global peers to provide a wide-ranging advisory service to meet the investment and financial planning needs of affluent customers. Some international banks even provide “lifestyle benefits” such as access to exclusive clubs, concierge services and leisure activities to their customers in India.

So the questions we need to ask: is consolidation going to meet the developmental needs of unbanked regions in India, as there are 391 under-banked districts (out of a total 602 administrative districts) in India? Is it going to augment the reach of the banking system to millions of Indians citizens who do not have bank accounts? Given the fact that the average private banking customer can be ten times more profitable than the average mass-market retail customer, it is highly unlikely that the commercial interests of foreign banks would match with the developmental needs of unbanked regions of both India and China. Also one cannot expect that consolidated banks who have penchant to emrge as global 100 will would voluntarily open branches in rural and remote regions of India as part of altruistic motives or corporate social responsibility measures. This anomaly could only be addressed by strong regulatory framework, which unfortunately both Indian and Chinese authorities are loosening under the banking liberalization program.

Indian banking system has still not provided loans to company and farmers as an estimate India’s Bank loan to GDP ratio (around 37%) is far lower than that of China where according to IMF it has 136% loans to GDP ratios. Going by the comparative figures that are available of US even as of 2005, if we add up today figure of Nationalized Banks India with US even merger of 19 nationalized banks is not going to create a new entity of international status.

Even SBI is not even one-tenth the size of the tenth largest bank in the world. But this also means that no amount of consolidation will give Indian banks a global size in the foreseeable future. The argument Bigger size is needed for scale economies as being advanced by the Finance Ministry fall on four legs as scale economies are useful but beyond a certain size, the benefits of scale taper off and tend to be offset by growing complexity. Internationally, studies have shown that a size of around $ 20 billion is optimal. India’s top ten banks meet this size requirement.

One outcome of the present global crisis is that large banking monsters have come to be feared.The world's largest banking group viewed under many parameters including profitability is the Citigroup. An outstanding example of a financial services group that grew through M&As, the bank has been asked by the Federal Reserve Board to desist from further acquisitions until it refined its systems and procedures. If a bank such as the CITI, which has been a global force, could be faulted on its basics, there is clearly a message for Indian PSBs to be far more circumspect than what the Government would recommend. Some of the world’s biggest banks, the Citigroup notably, which relied heavily on mergers and acquisitions to grow phenomenally, have been rapped on the knuckles by the regulators and are realising that such stupendous inorganic growth has come at a price. But In India, there is a revival of the clamour for bank consolidation disregarding these adverse trends

Besides, universal banking itself seems to be going out of fashion. In India it is unlikely that banks will be able to impress all their customers across a variety of products. A deficiency in one area, not necessarily its main business, can affect its image disproportionately. Even more damaging is the fact that M&As can bring in disparate cultures that cannot be harmonised simply because of common ownership. . India needs expansion of banking and not consolidation of banks.

The access to finance in developing countries has been considered as a necessity just like safe water or primary education. But in India 41 per cent of adult populations do not have access to banking services. So the questions we need to ask: is consolidation going to meet the developmental needs of unbanked regions in India, as there are 391 under-banked districts (out of a total 602 administrative districts) in India? Is it going to augment the reach of the banking system to millions of Indians citizens who do not have bank accounts? Given the fact that the average private banking customer can be ten times more profitable than the average mass-market retail customer, it is highly unlikely that the commercial interests of consolidation would match with the developmental needs of unbanked regions of both India. What is needed is branch expansion and not consolidation retaining the ethnic, federal structure and identity of existing nationalized banks.

But a systematic and deliberate attempt of calumny, untruths is unleashed ,orchestrated by the corridors in the Ministry of Finance in India through their spokesmen , Ministers which includes FM and their sponsored appointed CEO’s in Public Sector Banks ,chorused through thier accordions , paraded in the daily electronic and print media that Indian banks can emerge stronger only through consolidation of Public Sector Banks to suit their political expediencies in the wake of Election 2014 . Such unwarranted moves in our opinion is a gigantic betrayal of the national interests, taking Indian banking a full circle, putting it back into the direct hands of the imperialists. The ‘Imperial Bank’ of the colonial era will return, with changed names and faces, in a new form. Not only will such moves further will infringe on the sovereignty of the country, but will have a disastrous impact on the lives of the people. But the rulers of our country, acting as the most vile agents of the foreign powers, are pushing through this ‘reform’ at break-neck speed. They will get bouquets from the likes of IMF, WB, and global rating agencies who have vested interests, and multinationals, but brickbats from the masses of India..Hence it has become imperative for us to educate not only our rank file but also the citizens of this great country , by objectively presenting the truths ,exploding their myths with a view of to building a strong movement against such ill advised moves of the government by integrating bank employees movement with wide sections of society through this article.

Consolidation Fragilities:

“The chief function of banks is to act as middlemen in the making of payment – to recycle deposits as loans. Through this, they transform inactive money capital into active money capital; that is to say; capital yielding profit. “As banking develops and becomes concentrated in a small number of establishments, the banks grow from modest middlemen into powerful monopolies having at their commend almost the whole money capital of all the capitalists and small businessmen and also the larger part of the means of production and sources of raw materials in any one country and a number of countries. The transformation of numerous modest middlemen into a handful of monopolists is one of the fundamental processes in the growth of capitalism into capitalist imperialism”

As self respecting and free “nations” decided to develop according to their own priorities and requirements and therefore nationalized the “Banks” – Imperialism developed alternative financial basis for there world wide conquest. A variety of non-banking financial institutions were developed which undermined nationalized banks wherever necessary. Let us, first, look at the non-nationalized global banking.

Today the size of banking monopolies is multiplied a hundred fold, due to mega-mergers taking place in the global banking industry, a trillion dollar bank has now become a reality. In 1998, 505 merger and acquisition deals transferred $285 billion in market value and $1.22 trillion of assets, including megamergers of Citicorp – Travelers and National Bank – Bank of America.

Taking a global view, at the end of 1990, 15 of the largest banks in the world had assets totaling $5 trillion, an amount three times larger than that possessed by the 100 largest banks worldwide in 1976, and far higher than the value of entire world trade in 1990. The extent of concentration in banking can also be seen from the fact that the 31 banks in the Top 200 (corporation) have combined assets of $10.4 trillion and sales of more then $800 billion.

On a country wise basis, we find Japan has risen as the dominant financial power in the world (their Banks though, have been the worst hit by the present slump in the economy). Yet, historically if we look at the development of banking, we find that in 1976, of the six largest banks worldwide, three was US, two French and one German – by far the largest being Bank of America and Citi Bank (both US). The Japanese were then absent from this club of superbankers. Ten years later, in 1986, five of the six biggest banks were Japanese, with Citibank occupying sixth place. A year later, all six were Japanese – and owned assets worth $2.4 trillion. This was the situation in 1997 back. The gigantic bank mergers in America and Europe in 1997 year would have somewhat altered the rankings. Yet Japan continues to be the biggest financial power. Japan has accumulated some $12 trillion in savings….it now supplies roughly half the net savings used by the world’s borrowers, of which $270 billion was funneled into US treasuries (Newsweek February 2, 1998).

Such gigantic monopolies have served to concentrate enormous funds in their hands. For example, US pension funds, which exceed $4 trillion,in 1998 and accounted for a third of all corporate equities and 40% of corporate bonds in 1998 , are mainly managed by the trust departments of these giant banks, thus giving them unprecedented financial power.

But besides commercial banks there are two more exceedingly powerful financial institutions. These are the insurance companies and investment (or merchant) banks. These too are dominated by giant monopolies.

The investment banks are dominated by American Giants. Often they are mere arms of the main Banks, who have fund-management wings. For example, Deutche Bank has Deutche Morgan Grenfell (DMG), Britain’s Nat West Bank has Nat West Markets (NWM) as its investment bank. These investment banks ‘manage’ huge funds and by reason of their stragically placed shareholdings, are powerful forces in a large number of enterprises. It is they who stride the market of speculative capital, organize mergers and acquisitions, trade in bonds and currency markets and reap in huge profits. For example, Merrill Lynch, the largest investment bank in the world, earned a 28% return on capital in 1996/97. Here too it is the top 10 investment banks that dominate this sector. With a spate of mergers and acquisitions, the monopolies are growing larger and larger. In 1990 the top 10 accounted for 52% of the business of the 25 largest investment banks, by 1996 this had increased to 62%. Of the top ten, eight are American.

The complexity of big banks makes the task of managing risk more difficult. This became evident in 1998 when UBS suffered huge losses on account of bad deals in financial derivatives and lending to a hedge fund, LTCM. Then the BIS had come out with a critical study which found that mergers have failed to boost profits. Further, job cuts are an imminent fallout of every merger deal. Deutsche Bank’s merger in 1997, for instance, with Bankers Trust was accompanied by a staggering downsizing of 5500 jobs.

With emergence of universal banking, the trillion dollar banks, would provide a range of financial services including stock brokerage, insurance, mutual funds and internet banking. Megamergers of banks, in fact, have been facilitated by financial deregulation and therefore should be seen as an integral part of a bigger phenomenon. Largely because of increased competition and low margins in retail banking, banks have expanded their business in the last tow decades. As a result, the distinction between the operations of commercial banks and non-banking financial institutions in getting blurred with the emergence of investment banking and universalbanking. Similarly, many non-banking institutions have now ventured into banking services. For instance,in 1998 itself building societies in the UK now offer cheque accounts. Likewise, the launching of financial and banking services by several business corporations (e.g. the General Electric of US and Tesco, a chain of departmental stores in the UK) has further intensified this trend.

With massive financial deregulation, the original separation between commercial and investment banking has been drastically eroded in the recent years as banks now take up discount brokerage operations, sell mutual funds and provide underwriting and other investment services. Rapid changes in the financial sector (e.g. emergence of financial derivatives) have also facilitated the diversification of banks into various non-fund businesses. Some banks have even diversified into the insurance service through mergers and acquisitions. In Germany, for instance, a new type of banking called Allfinanz has emerged which offers like insurance, pension schemes and traditional bank deposits. The list of universal banks includes Citigroup, Deutsche Bank, Dresdner Bank, Commerz bank and HSBC.

On the other hand, investment banks (e.g. Morgan Stanely Dean Witter and Co., Merrill Lynch, Goldman Sachs and Credit Suisse First Boston) help Corporations to raise funds in financial markets. They also advise their clients on mergers and acquisitions. Much of the income earned by investment banks comes from fees and commissions. As investment banks indulge in heavy risks businesses (such a financial derivatives), their profits are relatively higher.

Notwithstanding the growing trend of commercial banks taking on investment banking services, there are only a few success stories. In fact, several big banks such as Citicorp and Nat West have abandoned their investment banking operations.

Experience, particularly in the context of the Southeast Asian Financial crisis, also raises critical issues about the operation of investment banks. When the crisis broke out, several investment banks were blamed for speculating on Asian currencies and thereby causing the crisis. But curiously, some of them have become advisors to the crisis-ridden countries. Goldman Sachs, for instance, is advising Thailand and Indonesia on bond issues and privatization, while Lehman Brothers is a consultant to the Financial Restructuring Agency of Thailand that is selling off assets of closed finance companies. It is ironical that while advising the thai authorities on restructuring, Goldman Sachs in collaboration with GE Capital (General Electric) was busy bidding to buy up the assets of 56 defunct finance companies. Since these banks have commercial enterprises in Thailand and Indonesia, analysts have pointed out that banks are pursuing their own business interests without any compunction. None other then Thailand’s Finance Minister, Terrain Nimmanahaeminda, has echoed this concern:

“These banks have an advisory side and a wheeler-dealer commercial side… They always say they maintain Chinese wall between them. I rather doubt it. How else would they be proving to their board that they are maximizing profits?”

The Case against Consolidation of Public sector Banks

Banking reforms needs a clear focus. What should be the priority at the moment:
consolidation, lower costs and margins in banking or financial inclusion? Once this is answered, we would know how to go about issuing new licences for banks.

To begin with consolidation we deal with some of the arguments made in its favour .

1. The optimal scale at which banks can operate efficiently (estimated at $10-20 billion, or Rs 50,000-1,00,000 crore) is one that most banks in India already enjoy.
2. There is no reason why any individual bank should be large enough to meet the funding needs of the bigger Indian companies; consortium financing is a better way of managing risk.
3. Merging the weaker public sector banks (PSBs) with the stronger ones can render the latter weak. In terms of managing systemic risk, the less concentrated a banking system, the better. The truly persuasive argument for consolidation would be that the sector is much too fragmented to allow banks to be viable.
4. But this is hardly true of the Indian banking sector. Return on assets for scheduled commercial banks as a whole has been 1% in recent years, which is considered a good figure internationally; that for PSBs is 0.9%.
5. On to the argument about costs and margins. It is said that operational costs in Indian banking are too high. It is hard to postulate an appropriate level of operational costs for a system because these are specific to the banking model. What is crucial is whether these costs are falling or not.
6. In India, operational costs as a percentage of assets have fallen by nearly 100 bps since 1997. The net interest margin has remained at close to 3% of assets for most of the post-reform period. It does not follow, however, that this is on account of lack of competition.
7. One measure of competition is the concentration ratio, defined as the share of the top three banks in total assets. India's concentration ratio of 35% is among the lowest in the world today. Comparable averages are: advanced economies 60%, Asia 40% and Latin America 55%. There are other reasons why margins have remained high in Indian banking, such as the rising share of highyielding retail assets.

Over time, as financial markets emerge as credible competitors to banks, margins are bound to decline. Until then, it is better to allow margins to remain on the higher side in the interest of stability in banking and also in the interest of the third objective mentioned above: financial inclusion.
Financial inclusion will entail substantial costs upfront. However, it also represents a significant opportunity. It will help banks access a large pool of low-cost saving accounts.

It will open up opportunities for high-yielding micro loans and fee income from the sale of financial products. In the long run, financial inclusion and consolidation could well be the key to sustaining profitability in banking.

The argument that the threat to domestic banking arising from an increase in the foreign banking presence should be dealt with through consolidation of domestic banks, which would also serve to strengthen them and make them global players is without logical or empirical basis. While the gains from consolidation are expected along greater economies of scale and scope available to bigger banks, the evidence doesn’t support an automatic association between large size and profitability. On the other hand, bigger banks tend to rely much more on arm’s length transactions and standardised balance sheets and loan accounts, on fees based income that seek to avert credit and interest risk, and on trading risks at the securities market. These tendencies give rise to the phenomenon of financial exclusion (whereby a large segment of the population remains unbanked) at the same time that it engenders financial fragility via a greater exposure to financial markets. To advocate bank mergers as a general policy move and not as a carefully thought-out measure to consolidate the gains of two banks, would be to lend legitimacy to the above outcomes.

Consolidation also amplifies the financial fragility resulting from liberalization in the form of increased exposure of banks to the ‘sensitive’ sectors – commodities, real estate and the capital markets, where speculation is rife and returns volatile. Private banks have increased their exposure to the stock market through acquisition of shares, advances against shares and guarantees to brokers. Once the domestic financial sector is liberalized and then linked to external capital flows through capital account convertibility, the probability of banking crisis, currency crisis and financial crisis increases manifold.

Dealing with these problems requires not merely restraining and even reversing the change in banking policy regime, but a restoration of an important role for an accountable central bank as a regulatory authority. The shift in regime is accompanied by a combination of regulatory forbearance and an emphasis on improved accounting practices, better disclosure and new capital adequacy norms. While these do not always deliver on their regulatory objectives, the capital adequacy norms often result in a contraction of bank lending.

Further, to restrict and reduce the fragility of the financial system it is necessary to: (i) rebuild the Chinese Walls separating the banks and the stock market and drop proposals such as permitting banks to trade in commodities exchanges; and (ii) strongly regulate the access of domestic banks to global resources, which would also help improve monetary management.

However, the evidence seems to run contrary to the above view.

However, the evidence seems to run contrary to the above view. A large number of studies have examined the impact of M&A driven consolidation on bank costs in different contexts. Contrary to popular notion that sees efficiency improving with size, academic studies find no evidence of mergers improving cost efficiency on average. (Berger and Humphrey, 1997; Rhoades, 1993; Peristiani, 1997) As Boyd and Graham (1998, p. 133) conclude after reviewing the literature, research finds “… little evidence that consolidation of the US banking industry has been helpful over any performance dimension.” Evidence from Europe provides similar results. Goldberg and Rai (1996) do not find a robust relationship between concentration and bank efficiency in European banking. Thus, while acquiring banks tend to be more cost efficient than target banks on average (Pilloff and Santomero, 1998; Rhoades, 1998), the evidence does not support the view that there are large cost savings from bank consolidation.

Dymski (2002) in reviewing the literature on mergers quotes several researches which find no evident link between mergers and financial firms’ performance, measured in terms of either profitability or operating efficiency (Berger, Demsetz, and Strahan 1999; Dymski 1999; Rhoades 2000). Efficiency effects are also weak in European bank mergers (OECD 2000). In studies on cross-border mergers, the same conclusion has been reached, for example, Claessens, Demirgüç-Kunt, and Huizinga (1998) and Demirgüç-Kunt and Huizinga (1998) showed that cross-border entry by multinational banks has not increased profit rates in these markets.

Thus mergers automatically need not lead to lower costs, greater efficiency or create stronger banks. On the other hand, it might lead to loss of employment for many and massive adjustments for other staff members who might be relocated to another branch, a different geographic location and into a new line of banking.

The Japanese case is the most telling example of size failing to solve banking problems. Motivated largely by distress, Japan’s large banks have been engaged in a series of defensive mergers, accompanied by government assistance in unloading bad debt. These “bigger are better” mergers did not resolve the problems: gains in microeconomic efficiency were minimal, and these banks’ inability to lend compromised any possible economic recovery. A decade into the post-bubble adjustments, virtually all large Japanese banks have been merged or suggested for merger. The surviving large Japanese banks have gradually cut their links to the large nonfinancial firms with which they were former partners. This continuing crisis at home, exacerbated by the Asian financial crisis, has also prevented Japanese banks from acquiring banking assets abroad. Indeed, Japanese-owned banks’ presence in U.S. markets has been cut, even while U.S. investment banks—Merrill Lynch and Ripplewood Holdings—have successfully penetrated the Japanese market.

In developing countries the problem is all the greater because consolidation often involves foreign takeover. The evidence from Latin America is very important as it reflects on the issue of cross-border mergers. Banking FDI into the major Latin American countries since the mid 1990s was accompanied by a process of consolidation of banking such that the number of banks in these economies have declined by an average of 30 per cent over barely six to seven years. (TableA) Moreover, in economies such as Mexico, all the major banks are foreign owned whereas those under domestic control are much smaller in size. This is true for other regional economies as well, though to a lesser extent. The rising concentration of banking in Latin America has led to concerns about competition in banking. Orthodox economists who would otherwise support mergers on the grounds of efficiency stress the need to balance improvements in efficiency without foregoing the competitive structure. This is easier said than done. Latin America is painfully realizing that once the economy is exposed to the juggernaut of transnational capital, the process becomes irreversible due to the involvement of extremely powerful financial interests that would not brook any argument that makes a case for regulation. Thus, billionaire banking empires assert that competition is inherent to the market system, and the effects on markets may stem from both the actual entry of new competitors, and as a consequence of the increased likelihood of new entries to the industry in pursuit of high profits (i.e. market contestability). It is noteworthy that the recent IMF studies on Latin America reject any decline in competitiveness accompanying bank consolidation. (for example see Gelos and Roldós, 2002; )

Table A: Decline in the number of banks

	1996	2002	Change	%Change
Argentina	117	80	-37	-32%
Brazil	253	177	-76	-30%
Chile	31	25	-6	-18%
Colombia	39	27	-12	-31%
Costa Rica	30	21	-9	-29%
Mexico	40	32	-9	-21%
Peru	22	15	-7	-32%
El Salvador	18	13	-5	-28%

Source: Levy-Yevati and Micco (2003)

On the contrary, a few relatively independent studies throw up enough preliminary evidence that would suggest otherwise. Paula and Alves (2003) find no clear evidence that foreign banks in Brazil have been more efficient than domestic ones both in terms of operational cost and profitability. In fact, foreign banks’ net interest margins have proved larger than those of the domestic private banks. Consolidation has not brought about an improvement in efficiency parameters which one would expect due to cost reduction or product diversification and expansion. In a study of six Latin American banking systems, Wong (2004) finds no efficiency improvement in the way banks fulfilled their intermediation role over 1995-2000. Taking intermediation as the key function of banking he calculates the efficiency of each bank in converting inputs (measured as operating costs, labor costs, interest expenses and total deposits) into outputs (total loans, interest and non-interest incomes). Except Chile where concentration of banking assets has accompanied gains in efficiency of intermediation, in all other countries the situation has worsened with consolidation. Finally, a very revealing interpretation from the study of bank-level balance sheets of eight Latin American countries by Levy-Yevati and Micco (2003) says that the foreign owned banks were much more risky than national banks, due to higher leverage ratios and more variable returns. They were able to reap oligopolistic rents while choosing a riskier profile, whereas national banks were seen as imperfect substitutes of foreign branches or subsidiaries, because of actual differences in their menu of products and the value of the brand name and the perception of an implicit insurance provided by the foreign bank’s parents.

The above evidence dispels the simplistic notion of bigger is better and underlines the downside risks of consolidation of banking. Another set of issues, which is of particular relevance while looking at the pros and cons of consolidation, relates to the relationship between the structure of banking and the nature of bank activities. Large banks are increasingly engaged in harvesting activities, and not in seeding and cultivating activities. (Dymski, 2002) In other words, their role has been that of harvester of fruits of other institutions’ seeding and nurturing activities, and of looking for product lines involving fees for point-of-time services rather than that of durable customer servicing activities.

The economies of scale that make large banks cost-effective depend on the standardisation of products and services. Without standardisation the information sharing that drives mergers would be inefficient at best. And cost savings would be lost if, with each merger, the acquirer added a new set of products or different versions of the same product. This in a way means the end of relationship banking. Relationship banking is based on the premise that the needs of different customers are different and the bank officers dealing with them have to assess both the prospects of the business the prospective borrower is engaged in and the ability of the particular customer to realise the potential of those prospects. Once the credentials were found satisfying, it could develop into a series of contracts between the borrower and the bank. In India, relationship banking has been particularly important in view of the priority given to the small customer. Different types of banks with different kinds of reach over groups of customers and activities were therefore considered a necessity.

As relationship banking gives way to more standardised balance sheets and homogenous loan products convenient for the large banks to service, the anxieties of excluding the small borrower cannot be overstressed. Small banks retain an advantage over large banks in serving these customers, since smaller banks enjoy short lines of communication between lending officers and borrowing company owners and managers. This close communication permits these banks to customise products and employ borrower information in ways that large bank reporting and monitoring systems cannot easily accommodate. As large banks absorb small banks that had so far been the primary source of small- business credit, the small borrower can do nothing but to turn to the curb market.

Another strategic shift observed for large banks is a move towards fee-based activity, and away from lending activity. Large non-financial firms, both national and transnational, that operate in the global markets raise most of their external capital needs from the securities markets. Such large firms, however, require underwriting services, clearing services, trading services, advisory and asset management and other fee-yielding activities, which are therefore increasingly taking the place of the core banking activities. Table B compares the loan to asset ratio of the 10 largest banks with that of the other commercial banks in 2000 for seven Latin American economies and the US. Note the very high concentration of banking assets and the low loan to asset ratio of banks in the Latin American economies when compared with the US. Largest banks in all the economies, except Mexico, have systematically lower loans-to-asset ratios than smaller banks.

Table B Financial ratios for Commercial Banks in 2000

	Total Loans as a percentage of assets for:	Assets of the 10 largest banks as % of all Bank Assets 94.9 77 67 72.9 66.8 75.2 49.4
	All Banks	10 Largest Banks	All other Banks 51.7 35.6 25.6 32.2 59.1 45.2 63.7
Mexico Ecuador Brazil Chile Colombia Venezuela USA*	52.2 33.7 21.6 27.1 49.4 42.5 61.2	52.2 33.1 20.3 25.2 44.5 41.6 58.6

* Figures apply to 25-largest and not ten largest banks.

The relationship between large size banks and banking stability, adds an additional dimension to mergers and their effects. Today, banks invest freely in stock markets and also extend credit against bonds and shares, which implies that the different segments of the financial system are well-integrated. Considering themselves `too big to fail’ large banks might undertake high risk investments that may one way or other be linked to the stock markets. If for some reason, a large bank collapses, the concentration of assets and risks could cause massive fall in asset value, which could transmit to the entire financial system in no time. The mighty regulator might be kept completely in the dark, or simply overlook knowing that the other party is too powerful, or seeks compliance, which proves inadequate to prevent a collapse. On the other hand, the regulatory authority seeing the contagion effect on other financial institutions cannot but bailout the failing bank.

ARGUMENTS FOR BANK MERGERS?

Official Push for Bank Mergers

Banks were set up in most countries to mobilize savings and allocate them to productive use. David Hume made one of the classic analyses of the encouragement of thrift and industry through banks and paper credit in his essay, ‘Of Money’ [Hume 1752/1985]. In India, joint-stock banks were founded under colonial rule mostly in order to create a medium through which the government and British businessmen could procure cheap loans. But from the 1840s, some Indian entrepreneurs also began founding joint-stock banks in order to extend credit to Indian traders, who were mostly ignored or shortchanged by the European-controlled banks. After independence, and especially after the nationalisation of the Imperial Bank of India and the subsequent nationalisation of all the major commercial banks, developmental banking came into its own. In the post-nationalisation years, the deposits mobilised and the credit extended by scheduled commercial banks in India have grown at a phenomenal rate. We cite just two figures to illustrate this growth: The aggregate deposits of the scheduled commercial banks grew from Rs 5,906 crore in 1970-71 to Rs 15,04,416 in 2003-04 and the total bank credit outstanding grew from Rs 4,684crore to Rs 8,40,786 crore between those two years [RBI 2004].Between 1969 and 1990, Indian scheduled commercial banks, along with the credit to farmers and small-scale traders and industrialists as well as to big traders and large industrial firms. But with the onset of ‘economic reforms’ from 1991, the structure of the banking system has changed in a fundamental sense. The template for that structural change was provided by the Report of the Committee on the Financial System (chaired by M Narasimham),which, among its other recommendations, envisaged a structure under which three or four large banks would provide global coverage, eight to 10 banks would provide national coverage and the rest would be confined to local operations. Like the major part of the Narasimham Committee recommendations, the idea that mega banks would serve national interests better than the multiplicity of small or medium-sized was based on little empirical evidence bearing on the development of poor economies or indeed on the experience of the advanced market economies. The government of India did not immediately accept all the recommendations of the Narasimham Committee because of political opposition and because of the sheer impracticability of implementing those recommendations under the then existing institutional set-up. In 1997, a second committee was set up under the chairmanship of Narasimham, this time to specifically recommend further measures for banking sector reforms. This second Narasimham Committee, in its report submitted in April1998, reiterated the assertion of the first that a few mega banks would be effective instruments of domestic and international competition. It is remarkable, how despite the ill-effects of many of the institutional changes brought about in the financial system since1991, successive governments at the centre have stuck to the vision that the rich will be continually enriched and the poor will(hopefully) reap the benefits of growth through trickle-down effects. The move to effect mergers of public sector banks is consonant with the vision of the neoliberal reformers, clearly delineated in 1991 and reiterated in numerous policy documents and policy pronouncements since that time.

Successive governments in the neo-liberal era have downplayed the role of the public sector banks (PSBs) as providers of loans to small borrowers, venture capitalists, and small and marginal farmers forced them to downsize their workforce and recapitalized those PSBs whose non-performing assets were large. These methods have succeeded in raising the profitability levels of thePSBs. Some of the benefits of that improvement have been already passed on to the rich by disinvesting substantial fractions of the equity capital of the banks. Now the government wants to make the banks even more rich-and foreign investor-friendly by forcing some of the PSBs to merge. Thereafter government has announced that it will give autonomy to banks. That autonomy will include the right of the bank managements to ‘make domestic and foreign acquisitions, exit nonviable businesses and close down unprofitable branches without the government’s prior approval. The stock market responded gleefully by pushing up the shares of those PSBs – including the State Bank of India, the biggest of them all – which are likely to take up the offer of autonomy and pursue profit at the expense of the small borrower and economically backward regions or lagging sectors. There is little doubt that many bank managements will welcome the move because it will also further push up the salaries and perks of the top managers. In this chapter, we take up the issue of mergers of PSBs and leave on the one side the issue of permitting the PSBs to become purely profit-oriented organisations and ultimately go private altogether. We also leaving aside the question of whether pushing all banks to become so called universal banks and break down all barriers between banks and stock markets is a wise decision, given the increased turbulence created in stock and money markets by the full deregulation of financial markets .Thereafter we shall answer the question is there any compelling reasons for India’s public sector banks rationale for consolidation?

It is the very commercial success of the Indian PSBs, the access of enormous wealth in a few hands and the greed of foreign financial institutions to rich prizes in India that have come together to prompt the central government and the Indian Banks Association (IBA) at this juncture to urge the mergers of various sets of PSBs. The IBA had set up a committee under the chairmanship of V Leeladhar and, assuming that bank mergers were on the anvil any way, in its report submitted inSeptember 2004, had dealt with the legal and regulatory implications of bank mergers. In order to understand the ‘incentive’ driving the ministry of finance and the various interests pushing it, it is useful to distinguish between the activities of banks as seeding-cum-cultivating agents and as harvesters on the one hand, and the activities of modern banks as over-time seekers of interest from customer activities, and their activities as point-of-time earners of fees[Dymski 2002, 2004]. Bank mergers, like many other types of liberalisation directed at increasing the wealth of rich shareholders has been a tsunami originating in the activities of US financial corporations. Their role has been that of a harvester of fruits of other institutions’ seeding and nurturing activities, and of looking for product lines involving fees for point-of-time services rather than of durable customer servicing activities. They generally provide usual banking services only to an elite band of up-market customers with whom they have sought to build close relationships.

Economies of Scale in Banking?

Bank mergers are advocated by many on grounds of economies of scale and scope. Before we look into the empirical evidence bearing on that, it should be made clear that there are no obvious economies of scale in banking. Banking is not like petroleum refining so that a three-tenths law of relation between volume and surface area will automatically generate productivity gains as size increases. Banking is also not like ordinary production activities, so that an increase in the size of the market leads always to better division of labour and hence a reduction in cost. Banking is a highly diversified enterprise, differentiated by the activities the customers engage in, by the different types and degrees of risk they face and by the strategies open to them to tide over unanticipated shocks. In India and in most other counties, banks come in all shapes and sizes, with different bases of depositors and customers for different types of banks. If US mega banks have succeeded in raising their profitability and hence their shareholder value, which is the altar at which all liberalizers worship, they have done so by excluding 20 per cent of the population of that rich country from banking services. Moreover, the gains of US banks have been built on the immensely higher burden of consumer debt in that country– a debt that has so far been financed by the loans to that country by the rest of the world: in 2004, the US current account deficit has climbed to $630 billion [RBI, 2004b:90]. There is no other country that can possibly emulate the US banks’ climb to a mega size even if it were politically desirable to do so. Under exceptional circumstances, two particular banks can decide to merge of their own accord, and the decision is based on a host of considerations, such as complementarity in their business profiles, the commonality of governance structures and cultures, or the objective of improving the management of one bank by inducting the superior managerial style of another bank. But advocacy of bank mergers as a general policy and the use of the argument of economies of scale, really conceal the hidden goal of reaping the economies of exclusion – gains made by denying credit to more venturesome customers or customers who need more attention. Even if the profitability of banks may increase by mergers and acquisitions, the real economy may suffer. Innovations are discouraged, production may decline because of shortage of working and fixed capital and economic growth may slow down. This outcome is being deliberately orchestrated in a context in which jobless growth has been haunting responsible policy planners all over the world.

When it comes to serving small customers, all banking takes the form of relationship banking. The needs of different customers are different. The bank officers dealing with them have to assess both the prospects of the business the prospective borrower is engaged in and the ability of the particular customer to realize the potential of those prospects. Hence it has been considered necessary for a long time in India, going back to the days of British rule, to have different types of banks with different kinds of reach over groups of customers and activities. What was permitted to cooperative banks, for example, was not always permitted toscheduled commercial banks serving a different layer of customers. That a bigger size as such did not make for better banking is clearly indicated by the relative performance of the Bank of Bengal and the Bank of Madras, two of the three banks that merged to become the Imperial Bank of India and eventually the State Bank of India. The Bank of Bengal had more than three times the capital base of the Bank of Madras in the late 19th century. But the growth rate of its deposits and of its advances was much slower than that of the Bank of Madras, especially from the 1900s to 1920. More significantly, the Bank of Madras reached out to Indian customers such as owners of rice mills or leather merchants, and was prepared to advance loans to apex cooperative banks. But the Bank of Bengal confined most of its loans to European customers or big Indian shroffs who acted as the intermediaries between the Presidency Banks and the ordinary Indian moneylenders. The Bank of Bengal simply refused to consider loans to cooperatives as a possible banking option. The merger of banks poses also difficult issues of management. Different banks have different cultures of services to customers, and even branches of banks in different regions have different cultures in this respect. For example, the southern region in India had a higher credit/deposit ratio than the eastern region before the nationalisation of banks in 1969 and that difference has persisted in the post-nationalisation period. But the credit/deposit ratio has gone down drastically invirtually all regions in India, especially in the rural areas, during the period of neo-liberal reforms. If there is any sense among the managers of two banks that there are strong complementarities between the businesses they conduct, and that they and their customers and employees will benefit from regional or product diversification, then they can talk about mergers in a serious way. But that move has to be internally generated and has to be accompanied by a serious exercise setting out all the pros and cons of the move. It is strange that anadministration that professes to minimize government interference in economic affairs and increase the autonomy of PSUs should dream up a move without studying the situation on the ground and cavalierly dictate to banks that they must merge or incur official displeasure.

A Glance at the International and Indian Evidence

The international evidence on most aspects of bank performance after two or more banks have merged does not indicate that M&As in the field of banking have produced beneficial results. After a thorough examination of the issue of bank mergers in the US, Gary Dymski (1999:275) concluded: …bank mergers may have effects contrary to consumer and small non-financial firms’ interests. To a large extent, banking markets remain local; but consolidation increases the opportunities for monopolistic pricing. Consumers earn lower rates of interest on deposits in more concentrated banking markets; and the evidence collected by the Federal Reserve shows that consumers pay higher fees at large banks and at banking institutions owned out-of-state. Banks’ fees for consumer financial services have not fallen in the last few years despite apparent gains in computer technology during this period. Large acquisition-oriented banks in particular have aggressively increased bank fees; so the increased dominance of these banks suggests banking consumers will pay higher average fees.

On the basis of the results of a Probit analysis, carried out with 1995 and 1996 data, Dymski (ibid) also concluded that “access to credit varies inversely with market concentration….The more concentrated are these markets, the lower the probability of loan approval, all else held equal.” From the evidence that is available in India, there is no indication that bigger size confers greater efficiency as understood by the liberalisers that is a consistently higher level of profitability.

Let us take the State Bank group for example. Within that group, the State Bank of India (SBI) is a giant: of the total operating profit of the State Bank group amounting to Rs 14,363.52 crore in 2003-04, the SBI accounted for Rs 9,553.46 crore. But over the years from 1998-99 to 2003-04, the net profit as a percentage of total assets of the SBI has been lower than for the group as a whole. If we move to the 19 nationalised banks, again, it is hard to detect a discernible positive relation between size and profitability over the same years. The talk is that there is a move to merge the Bank of India and the Union Bank of India. The Union Bank of India has been more profitable than the average nationalised bank during the period 1998-2004. The Bank of India has also been more profitable than the average nationalised bank from 2000-01. Has a study been carried out to find if the merger will in fact improve profitability and will not do so at the cost of excluding large chunks of their current customers, and without drastically retrenching employees? Suppose that it is claimed that government regulation suppresses scale effects in case of PSBs. Let us look at the performance of ‘new’ private sector banks. (We are ignoring ‘old’ private sector banks (PRSBs) because they are supposed to have been plagued by some of the same problems as the PSBs, besides being constrained by their size limitation, although in fact, they have on an average been more profitable than the new PRSBs.) Again there seems to be no clear monotonic relation between size and profitability. There is also the stark fact that the average net profit/total assets ratio of PRSBs has been distinctly lower than that of the PSBs in all the years from 1998-99 to 2003-04 (RBI 2004a, Appendix Tables III15(C) and III16(C)). The SBI Commercial and International Bank, which was hived off as a private sector bank has had a particularly luck-lustre performance, with widely fluctuating returns between 1998-99 and2003-04 and a negative average profitability over those years.

The policy-makers who advocate disinvestments of government shares as a way of improving the performance of PSBs have to put up a strong defence for their irresponsible advice in view of this accumulating evidence.

The policy-makers in the Ministry of Finance since 1991 have not shown much interest in the issue of whether credit-deposit ratios (CDRs) are affected by size and therefore by mergers. But they are of vital interest to small and medium-scale enterprises in all areas of economic activity. An inspection of the CDRs in Indian banks fails to reveal any clear pattern of variation with size. But CDRs are distinctly lower for those banks which are regionally concentrated in the eastern region: the CDR for the United Bank of India was 0.51 per cent in 1991, went down to 0.26 per cent in 1999 and inched up to 0.35 in 2004; the CDR for the UCO Bank was 0.64 in 1991, went down to 0.38 in 1999and crawled up to 0.53 in 2004. It is obvious that the increased profitability of many PSBs has been attained partly at the cost of a severe contraction of credit relatively to the actual economic activity in an economy that had been subjected to a deflationary pressure by other official policies.

One of the hidden items of agenda of the privatisers (fully supported by the recommendations of the two Narasimham Committees) is to clean up the balance sheets of the PSBs and make them ready for a takeover. Mergers would make them more attractive for the sharks roaming around the global financial seas.

Some of the liberalisers might argue that we need to infuse the blood of dynamic foreign banks into the Indian banking industry.

One of the first acquisitions of an Indian bank by a foreign bank occurred when the ING Bank of the Netherlands took over the Vysya Bank. The ING Bank has acquired other banks in Latin America and so it is an old hand at the game. The ING VysyaBank is now classed as an ‘old’ PRSB by the Reserve Bank of India. Its profitability record since 1998-99 has been consistently and considerably worse than that of the average ‘old’ PRSB, and a fortiori worse than that of the PSBs. So the magic of infusion of foreign capital has done little to improve the performance of the Indian joint-stock banks.

However, banks continued to be favoured areas of investment by foreign financial institutions (FIIs) until recently. The government obviously welcomes such investment since it has taken steps recently to disallow some curbs that the RBI had imposed on inflows of foreign hot money. There is no justification for that step. Research at the World Bank itself, not an enemy of global capital movements, has confirmed that not only does free capital movements increase the risks of financial crises but the entry of foreign firms and foreign banks may lead to the misallocation of resources. Small businesses are typically rationed out by foreign firms and only easily monitorable loans made to customers with high-value collateral find favour with them. There are other threats posed by the entry of firms controlled from abroad that any student of Indian banking history should know. In the case of three of the biggest bank failures in Indian history, namely, the Agra and United Services Bank in the 1860s, Arbuthnot and Co in 1906 and the Alliance Bank of Simla in 1921-22, the main factor leading to losses was speculation or unwise investment by the dominant managers abroad, mostly in foreign shares or property. Let us not also forget that the Harshad Mehta scam was primarily instigated by big foreign banks. Indian PSBs lost somewhere around Rs 5,000-6,000 crore in that scam (which also ruined hundreds of small investors) and the government has recovered little of that money. The east Asian financial crisis of 1997-98 was also precipitated by the herd behaviour of foreign fund managers. It is not an accidentthat the People’s Republic of China and the Taiwan Province of China escaped largely unscathed because they had strictly regulated the entry of foreign funds and banks into their economies. But, of course, the big foreign banks and their agents are not bothered about the misallocation of resources in a particular country and may be angling precisely for a financial crisis that will allow them to buy up domestic firms at bargain basement prices. According to the Capital Markets Report (2000) of the International Monetary Fund, the presence of foreign-owned banks increased dramatically during the 1990s. In central Europe, the proportion of assets controlled by such banks increased from 8 to 56 per cent between 1994 and 1999; in Argentina, not only did the proportion increase dramatically but after the economic meltdown of 2001, the foreign banks which had earlier bought up Argentine domestic banks were trying to pressurise the Argentine government to bail them out again. Some governments of Mediterranean countries in which these banks were domiciled were playing an active role in these pressure tactics. Denationalisers wanted national action by a government they had deliberately bankrupted!

Arguments Based on Supposed Advantage in International Competition

Given this national and international background, why is the Indian Finance Ministry pushing bank mergers (and capital account convertibility as the larger goal)? One argument could be that we need big banks as national champions. But what will they do that a consortium of big PSBs can’t do? Do we want them to bankroll, say, $30 billion takeovers? When they can do hat, they will no longer be national champions but simply another set of multinational banks treating India on the same plane as, say, Croatia. What Indian firms might need is loan guarantees for export projects backed by large foreign exchange reserves, and keeping a tight hold of the foreign exchange kitty in the hands of monetary authorities is probably the best way of doing it. We might learn something about how to do it from the policies of the South Korean government until they gave in to the pressure for capital account convertibility and got caught up in the Asian crisis. Let us not delude ourselves that with killer whales such as Citibank, Bank America or Chase roaming the waters of global finance, a mere Indian bank can create or retain a sheltered space for its own hunting: it is much more likely to be swallowed up as a mouthful by one of them. Finally, with all the talk about prudential regulation lulling neo-liberal policy-makers to sleep, in the case of massive external shocks or sudden loss of confidence and herd behaviour on the part of FIIs, no country outside the G7 bloc can protect itself against a balance of payments crisis, a currency crisis, and an economic crisis if it has been unwise enough to introduce full capital account convertibility. If the officially initiated move for merging banks is a further step towards full capital account convertibility that it appears to be, then it should be resisted with all the political will of the people caring for the welfare of the many rather than the wealth of the few. But even without that design, the move seems to be based on bad reasoning and poor empirical evidence.

IS THERE ANY COMPELLING RATIONALE FOR CONSOLIDATION?

Consolidation of banks, especially of public sector banks (PSBs), seems to have become a priority for the Indian government. Pronouncements made by finance minister P Chidambaram as well as by some senior bankers suggest that they see this as something of an imperative for the banking industry, although the reasons put forward vary.

Some see consolidation as essential for the survival for some of the PSBs in a context where foreign banks may be planning to enhance their presence in India. Others think getting bigger would make Indian banks more efficient, implying there are benefits to be had from greater size, and enable them to compete in the international marketplace. Yet others have indicated that many PSBs are so similar in characteristics that there is little point in two or more of such banks existing in the same areas – in other words, there are synergies to be realised through merger, such as the elimination of overlapping branches. Underlying many pronouncements is a sense that consolidation, like globalization or privatisation, is the wave of the future. Mergers have happened elsewhere; ergo they must have happen here as well.

This NUBE document in this chapter examines the case for consolidation of Indian banks in light of the vast literature that has developed on the subject. The rest of the document is as follows: Section II reviews the trends in consolidation in banking in recent years the world over. Section III examines the motivations and causes underlying mergers. In Section IV, we review the evidence on the relationship between size and scope and efficiency. Next, in Section V, we summarise the evidence on bank mergers and shareholder value.

We do not attempt comprehensive surveys in Sections IV and V as these already exist. Instead, we highlight the main findings in three survey papers: Berger et al (1999), the Group of 10 report (2001) and D Amel et al (2004). Section VI examines the case for bank consolidation in India in light of the evidence presented in the preceding sections. Section VII spells out the pre-conditions to be satisfied before mergers are attempted in India. Section VIII concludes.

Trends in Bank Consolidation

Bank mergers, like mergers in other industries, have been growing at a frenetic pace. In 1990-95, there were a total of 3,363 bank mergers valued at $340 bn, with the main industrial countries accounting for 78 per cent of the number and 87 per cent of the value. In 1996-2001, the number had shot up to 4781, with a total value of 1495 bn, the major industrial countries accounting for 66.6 per cent of the number and 88.1 per cent of the value (Table 1).

As Table 1 shows, merger activity was most pronounced in the US. The wave of mergers resulted in the total number of banks falling by about 30 per cent between 1988 and 1997 (although the total numbers for both the years were impacted by entries and exits of banks as well). The US banking industry saw a spate of ‘megamergers’, th mergers of banks with assets of more than $ 1billion. More recently, it has also seen ‘supermegamergers’ involving banks with assets of more than $100 billion. Four out of the nine biggest mergers ever in any industry in the US took place in the US banking industry in 1998 [Berger et al 1999].

Table 1: Mergers and Acquisitions in the Main Industrial Countriesa

1990-1995	1996-2001
Banks	Banks
	Number	Per Cent to Total	Total Value ($ Billion)	Per Cent to Total	Number	Per Cent to Total	Total Value ($ Billion)	Per Cent to Total
US	1691	50.3	156.6	46.0	1796	0.3756536	754.9	50.5
Total main industrial countries	2631	78.2	295.1	86.7	3183	0.6657603	1316.6	88.1
World	3363	100.0	340.3	100.0	4781	1	1494.9	100.0

Notes:

Mergers and acquisitions involving majority interests.
Includes: commercial banks, bank holding companies, saving and loans, mutual savings banks, credit institutions, real estate; mortgage bankers and brokers.
G10 countries, Australia and Spain.

Source: D Amel et al (2004).

The Group of 10 report (2001), which examined financial consolidation in the period 1990-99, notes that 1995 was a landmark year for bank mergers when the average value of merger quadrupled over the previous two years. Almost, most of the merger activity in the broader financial sector (comprising banks, insurance companies, securities firms and others) involved firms in the same country and the same industry. The average value of transactions was greater in the second half of the 1990s compared to that in the first half. In the emerging markets, consolidation was relatively muted in comparison in 1990-96 but there was a sharp upsurge in 1997-99 partly as a sequel to the east Asian crisis (Table 2).

Table 2: Bank Mergers and Acquisitions in Emerging Markets

	Number	Value (US $ bn)
	1990-96	1997-99	1990-96	1997-99
India	0	2	0	-
Hong Kong	0	0	0	0
Singapore	1	5	18	146
Indonesia	14	15	-	-
Korea	0	11	0	323
Malaysia	2	21	1	17
Philippines	14	6	NA	7
Thailand	1	2	0	39
Brazil	8	38	1	84
Chile	6	6		1
Colombia	3	11	1	4
Mexico	5	7	7	22
Peru	5	8	0	1
Czech Republic	1	6	0	0
Hungary	3	4	4	3
Poland	124	580	-	-
Saudi Arabia	0	2	0	7
memo:
Europe	799	427	95	231
US	1,607	970	190	507

Note: 1 Mainly between cooperative banks.

Source: BIS (2001).

Consolidation: Motivations and Causes

Consolidation has been driven by a variety of objectives: – maximising shareholder value by increasing their efficiency, given the perception that there are economies of scale to be had by becoming bigger- gaining market power which too would help maximise shareholder value could also be realised through gaining market power and this is something that regulators need to be alert to.

– gains that might result from greater diversification. This reduces the risk for a given level of return, which would translate into a lower requirement of economic capital and hence a higher return on equity.

– becoming ‘too big to fail’ – meaning the government is sure to bail you out – for that could translate into lower funding costs and hence an increase in shareholder value.

However, mergers could be motivated by reasons other than the pursuit of shareholder value – for instance, the pursuit of managerial self-interest. Bank managers may engage in empire building either as an end in itself or because managerial compensation does bear a relationship to the size of the firm. Mergers could sometimes also be driven by governments seeking to address financial crises or distressed financial institutions. While consolidation could thus have a range of motivations, it is rendered possible or necessary by certain forces at work in the environment, namely, deregulation, technology, globalisation and distress or bankruptcy in the banking system.

Deregulation has been a big factor propelling consolidation especially in the market that has dominated bank mergers, the US. Deregulation induces consolidation in many ways: by exposing existing players to greater competition through new entry, by freeing interest and deposit rates and hence with assured spreads in banking, by allowing banks to move into geographical areas and products from which they had been barred, etc. The last has been a potent factor in the US. Historical restrictions on interstate and intrastate banking were progressively dismantled in the 1980s and early 1990s, culminating in the Riegle-Neale Interstate Banking and Branching Efficiency Act of 1994 that substantially liberalised interstate banking. The removal of restrictions on interstate and intrastate banking came close on the heels of the gradual dismantling of regulation Q starting in 1980, under which interest rate ceilings on small time and savings deposits had been stipulated.

The removal of these ceilings put pressure on bank spreads and the opportunities for consolidation that came with the removal of branching restrictions thus proved most timely (and indeed were intended to help banks cope with the pressure on spreads). The sequence is worth underlining: there is pressure on bank spreads, banks feel the need to grow volumes, consolidation facilitates growth in volumes and offsets the impact of declining bank spreads. Growth in volumes was not the only outcome possible by the removal of branching restrictions in the US. When banks were confined to state boundaries, that limited the potential for diversification of the loan portfolio. Sometimes, a bank would be inordinately exposed to one asset that happened to be the dominant business activity in a state – say, oil or real estate. Spreading across states helped diversify loan portfolios and increase shareholder value by lowering the risk for a given return.

The removal of restrictions on the scope of banks’ activities (put in place by the Glass-Steagall Act of 1933) also paved the wave of mergers between banks and non-bank financial companies. Here again, there was an important economic rationale for mergers. Banks were losing depositors and borrowers to the capital markets, so mergers with securities firms and investment banks was a way of ‘following clients to the market’.

Technology can confer economies of the scale in various operations (such as custody, cash management, back office operations), in the production of derivatives and various risk management products and it can also render possible a scaling up of products such as credit cards. This again could motivate mergers of firms operating at uneconomical scales.

However, an important change in recent years is that technology is available in a modular form, which permits scaling up as volumes increase. In other words, changes in technology mitigate the need for going in for large scale at the very outset. Also, as Berger et al (1999) note, it is increasingly possible for small financial institutions to access scale at low cost through correspondent banking, franchising, outsourcing, shared ownership of payments networks, etc. It must not be presumed, therefore, that bigger size or merger is the only route to accessing scale economies.

Globalisation renders consolidation necessary as goods and financial markets get integrated. With markets being opened up to the entry of foreign firms and governments allowing domestic firms to be acquired by foreign ones, consolidation has become feasible.

Financial distress or bankruptcy has been an important driving consolidation in any industry, with weak or inefficient firms being taken over by stronger ones, whether domestic or foreign firms. Much of the consolidation seen in emerging markets in recent years has been a sequel to such distress within the system and, importantly, have been government-driven rather than marketdriven. The most notable, of course, have been the east Asian economies following the crisis of 1997-98.

As BIS (2001) notes, in Malaysia, the government selected 10 ‘anchor’ banks to lead the consolidation of some 54 financial groups into large, viable groups. In Korea, the government pushed consolidation through capital support to private banks and by buying out non-performing loans of banks. In Indonesia, four out of the seven state banks that existed before the crisis were merged into a new state bank that came to control a quarter of commercial bank deposits. In Philippines, the government promoted mergers through provision of incentives. Much the same phenomenon had been seen earlier in Latin America. In both Mexico and Venezuela, consolidation was a sequel to banking crises. In Argentina, consolidation happened in the wake of financial liberalisation and the consequent decline in fortunes of several banks. Central Europe has seen a mix of market-led and government-led consolidation but lack of viability and financial distress have been factors driving consolidation.

In short, whether in the US or (to a lesser extent in Europe) or in emerging markets, there has been a clear economic rationale for mergers. Firms have responded to falling margins that followed deregulation or to inefficiencies created by regulation or to distress that followed banking crises. To say that mergers have taken place elsewhere and, therefore, we in India should follow suit is thus not the most persuasive argument to put forward – it betrays no more than a herd mentality.

Size, Scope and Efficiency

Much of the impetus towards consolidation comes from the belief that there is a linear relationship between size and efficiency, arising partly or wholly from economies of scale. So the bigger you get, the more competitive you become. Indian banks are much smaller than international banks. If they wish to become more competitive, they must get bigger. Table 3 provides data on the relationship between size and certain performance parameters of banks in Europe, North America and Japan. In Europe and North America, costs as a proportion of gross income decrease as size increases, reach their lowest for banks with a size of $20-50 bn and then rise again when assets are greater than $50 bn. Japan is different in that it is banks with assets greater than $50 bn that have the lowest cost to income ratio. In Europe as well as US, however, it is banks with size greater than $50 bn that have the highest return on equity.

However, return on equity does not increase uniformly with size: in Europe banks in the range $5-20 bn are more profitable than those with assets in the range $20-50 bn; in the US, the two categories have the same return on equity. In Table 3, return on equity is influenced not just by costs, but also by non-interest income. If we are measuring efficiency using costs, then a U-shaped relationship is in evidence; if we use return on equity as the measure, a clear relationship is not discernible.

The academic literature on the subject, summarised in Berger et al (1999) supports the impressionistic evidence provided by Table 3 about the relationship between size and costs, although recent research indicates that the optimal size may be higher today than was the case earlier. Studies in the late 1980s and early 1990s found the scale-efficient point to be located somewhere between $100 million and $10 billion in assets – a disconcertingly wide range from the standpoint of policy-makers. Even if they differ in respect of the optimal size, the studies agreed on one thing: there were no significant scale economies to be gained from mergers of large banks.

More recent research places the optimal point between $10bn- $25 bn. It is possible that technological progress as well as deregulation have resulted in a higher size being optimal than before. Berger and Mester (1997) suggest that the increase in optimal size reflects the lower open-market interest rates of the 1990s, given that a greater proportion of large banks’ liabilities tends to be sensitive to open-market rates. This last point is important for it indicates that we cannot generalise as to what constitutes an optimal size – much depends on the cost structure in a given context.

Consolidation may also be about scope and product-mix efficiency. Banks may merge in order to produce a broader set of outputs than what each bank produces individually or to jointly achieve a product-mix at lower cost than before. There have been studies that looked at this aspect [e g Berger et al 1987] and have concluded that cost savings from consolidation were negligible. Consolidation could lead to efficiency gains not because of scale or scope economies but because of superior diversification. Diversification could reduce risk for a given level of return or increase return for a given level of risk. Studies have found evidence of both effects.

Hughes et al (1996) found that the largest US banks also had the lowest ratios of equity to assets, which suggested that they were reaping the benefits of lower risk through diversification. Demsetz and Strahan (1997) found that large organisations, while more diversified, are as risky as smaller ones, which would mean that they used diversification to enhance return rather than lower risk. There is evidence that the diversification benefit has to do

Table 3: Size and Performance of Commercial Banks

		< USD 5bn	USD 5-20bn	USD 20-50bn	> USD 50bn
Area	Variables	No	Average	No	Average	No	Average	No	Average
Europe	Non-int income (per cent of gross income) Operating costs (per cent of gross income) Return on equity	539 543 559	19.2 63.1 7.1	169 183 185	24.6 61.6 7.4	50 55 48	20.2 55.6 7.2	64 63 58	30.8 65.5 8.2
North America	Non-int income (per cent of gross income) Operating costs (per cent of gross income) Return on equity	266 266 266	21.5 60.9 11.2	97 96 97	29.2 59.8 13.5	29 29 29	28.2 55.4 13.5	19 19 19	53.4 67.8 14.1
Japan	Non-int income (per cent of gross income) Operating costs (per cent of gross income) Return on equity	15 17 17	0.4 76.9 1.3	63 63 63	9.2 69.5 0.1	29 29 29	8.9 67.9 0.5	26 26 26	30.0 60.4 3.2

Source: Group of 10 report (2001).

with geographic diversification made possible by the removal of restrictions on interstate banking. An inference that one could derive from this is that, where firms are sufficiently diversified by industry or by geography, the benefits from consolidation might be expected to be negligible.

Another set of studies has investigated the effects of mergers on managerial or X-efficiency, defined as the distance of a firm from the optimal point on the efficient frontier. These studies are country-specific, meaning the efficient frontier relates to firms in a given country and cannot be said to constitute an international benchmark. The case for mergers as a means of improving Xefficiency rests on the fact that many firms are seen to operate at a considerable distance from the efficient frontier – costs are higher by 20 per cent and profits lower by as much as 50 per cent.

D Amel et al (2004) cite studies on American and Australian banks that show little improvement in cost efficiency consequent to bank mergers, while, in Europe, there is some evidence of improvement. On the other hand, Akhavein et al (1997) found improvement in profit efficiency in US bank M&As in the 1980s and early 1990s. This improvement appears to arise from the diversification effect mentioned earlier: after merger, banks took on more loans in place of government securities and improved their returns, thanks to the benefits of diversification. This, again, had to with the fact that mergers were taking place in banks across states.

Mergers and Shareholder Value

A third category of studies measures efficiency gains by looking at the stock market performance of merging banks. Such studies, also known as event studies, examine share prices around the time that a merger is announced, the share price of the bidder as well as that of the target. In the majority of mergers, it is found that while the target firm gains in value, the bidding firm loses value. The gains and losses offset each other; sometimes, there is a net loss in value; net gains in value are less frequent. Thus, mergers seem to lead to a transfer of wealth from the bidding firm to the target firm.

Amongst banking studies, Hannan and Wolken (1989) and Houston and Ryngaert (1994 and 1997) fall in the category of merger studies that do no find increases in shareholder value. There is one study [Cornett and Tehranian 1992] that found positive overall returns. De Long (2001) found that mergers that were focused in terms of geography or product did create value. Rhoades (1994) provides a summary of event studies involving banks.

One study on bank mergers [Rhoades 1997] is worth citing at length because it involved nine mergers that were chosen for analysis because they appeared to have a good chance of reaping efficiency gains. In all instances, acquirers were committed to cost cutting and all acquirers were more efficient than the targets. Moreover, there was considerable branch overlap in all cases. The study found that cost-cutting objectives were achieved in all the nine cases; four mergers showed clear efficiency gains relative to peers; seven mergers showed an improvement in return on assets relative to peers; and the wealth effect was positive in five cases. The author concludes:

…not all of these mergers unambiguously yielded efficiency and profitability improvements despite the favourable characteristics and the significant reduction in non-interest costs achieved in all these mergers Consequently, it is not especially surprising that studies using large cross sections of bank mergers rather than mergers selected for their favourable attributes generally have not found efficiency gains from mergers.

Moreover, in spite of having chosen a sample that was conducive to capturing efficiency gains, the author was unable to define attributes that could be expected to produce such gains in a merger. While a commitment to cost-cutting and a relatively efficient acquiring firm ‘probably’ contribute to efficiency gains, they are neither necessary nor sufficient conditions. The conclusion is worth underlining given the presumption in popular discourse that the potential for cutting costs or a determination to cut costs or the superior performance of an acquiring bank can be counted upon to result in a successful merger.

We conclude this brief survey with a quote from the G-10 report (2001) on mergers in banking:

…M&As do not significantly improve cost and profit efficiency and, on average, do not generate significant shareholder value. There is evidence in favour of exploiting scale economies in retail banking up to a certain size (well below that of the most recent very large deals). Economies of scope are harder to pin down; there is no clear-cut evidence of their existence.

Bank Consolidation in India

This section focuses on the issue of bank consolidation in India insofar as it relates to public sector banks (PSBs). We do not believe that mergers between domestic private banks or between domestic private banks and foreign banks are a big issue. Some of the material in this section draws on Ram Mohan (2004).

At the very least, our summary of some of the central findings of the literature on bank mergers should induce a measure of caution in those making claims about the benefits to be had from bank consolidation in India. There is nothing in the literature that provides a basis for any presumption that mergers must automatically lead to gains or even that there is a high probability of this happening. So, in addressing the question of bank consolidation in India, we need to find answers to basic questions:

– At the aggregate level, what forces render consolidation essential?

– What can we say about size and performance in the Indian context?

– Is there a case for mergers based on synergies? What concerns do mergers raise?

Rationale for Mergers at the Aggregate Level

We have seen that elsewhere mergers were a response to a variety of forces: deregulation, globalisation, financial distress, technology. How do these forces bear on the merger issue in India? Deregulation everywhere has the effect of putting pressure on margins; indeed, this is the rationale for deregulation, that greater competition would benefit the customer. In the case of banks, we would want deregulation to result in lower spreads so that the borrower gets the benefit of a lower interest rate.

Contrary to experience elsewhere, this has not happened in India. If we compare spreads at PSBs with that in the initial period of reforms (1993-95), we find that spreads have been higher in all but two years (Table 4).

Table 4: Net Interest Income (Spread) to Total Assets

Year (average) Spread

1992-95 2.72

1996-97 3.16

1997-98 2.91

1998-99 2.80

1999-2000 2.70

2000-01 2.86

2001-02 2.73

2002-03 2.91

2003-04 2.97

Source: Report on Currency and Finance (2001-02), Report on Trend and

Progress in Banking (2003-04).

Lending rates have been declining but not as much as deposit rates. Thus, in the period 1999-2004, the interest income as a proportion of assets declined by 1.57 percentage points while interest expense declined by 1.74 percentage points, resulting in a widening of the spread.

The widening of the spread reflects two factors: lack of disintermediation, with neither depositors nor borrowers deserting the banking system in favour of the capital market; and banks’ increased appetite for government securities relative to loans at a time of declining interest rates. Banks’ increased appetite for government securities has contributed to an improvement in banks’ bottom lines in other ways as well. It has resulted in greater treasury profits and it has lowered non-performing assets as a proportion of total assets.

The combination of wider spreads, lower NPAs and treasury profits has seen banks’ profitability soar to new heights in the post-reform era. As a result, the Indian banking system, dominated by the PSBs, was the second most profitable system in the world after the US in 2003 (Table 5).

Table 5: Profitability of Banking Systems

Pre-Tax Profits/Total Assets

Country 2002 2003

US (11)                                                        1.7                            2.0
Canada (5)                                                   0.6                            1.0
Japan (11)                                                   -0.5                            0.1
UK (5)                                                         1.1                            1.2
Sweden (4)                                                  0.7                            0.8
Germany (4)                                                0.1                           -0.2
France (3)                                                    0.5                            0.6
Italy (5)                                                       0.5                             0.8
Spain (3)                                                     1.1                             1.3
India *                                                         0.8                            1.0

* Pertain to 97 scheduled commercial banks in 2002 and 93 for 2003. Financial year is

April - March.

The profit figure refers to net profits.

Note: Figures in brackets indicate number of major banks included.

Source: Report on Trend and Progress of Banking in India (2003-04).

Note that the table gives pre-tax profitability for other banking systems and post tax profitability for India. As the figures given in the table for other countries are based on a limited sample (presumably, the top banks in those countries), the table probably understates the relative performance of the Indian banking system.

Within the PSBs as a group, the improvement has been secular, with almost all banks showing a steady improvement in performance and being very successful in raising funds from the stock market on the strength of improved performance. The stock prices of listed banks have shown phenomenal appreciate since listing, with the result that stocks of PSBs, a class said to be lacking in commercial orientation, have become the darlings of the stock market (Table 6 ).

Table 6: Change in Market Capitalisation of Selected PSBs

Market Capitalisation (Rs Crore)

June 4, 1998 March 3, 2005 Per Cent
Change

Bank of Baroda 2562 6601 158

Bank of India 2604 4842 86

Corporation Bank 1294 5441 321

Dena Bank 459 1020 122

Oriental Bank of Commerce 1099 6291 472

State Bank of Bikaner and Jaipur 205 1266 517

State Bank of India 11047 37757 242

State Bank of Mysore 135 794 488

State Bank of Travancore 230 1021 344

Source: Prowess database, CMIE

The point has been made that since profitability has been driven by treasury profit, the figures for profitability for 2002-04 may not be sustainable and hence cannot be used as a basis for deriving inferences about the health of the banking system. How true is this contention? The Report on Trend and Progress in Banking (2002-03) states that trading profit accounted for Rs 13,245 crore out of total operating profit of Rs 17,077 crore of all scheduled commercial banks in 2002-03. Even if trading profit were to be halved, that would take away approximately Rs 4,000 crore in post-tax terms. If we subtract this from the net profit figure of Rs 17,077 crore for 2002-03, the net profit to total assets ratio works out to 0.76 – still perfectly respectable by international standards.

Thus, at the aggregate level, the Indian banking system has defied the conventional pattern of deregulation leading to a squeeze on banking margins (a factor that had led to collapses in banking systems elsewhere) and hence necessitating mergers as a means of sustaining profitability. It could well be that further down the road, the capital markets become a credible competitor for savings and firms’ funding requirements. When that point is reached, a rationale for consolidation might exist. It should be remembered that when the first Narasimham committee recommended consolidation, the financial viability of the Indian banking system was in question. That is emphatically not the case today, so the mere invocation of the Narasimham committee’s prescription on the subject does not make sense.

Size and Performance

Turn now to the obsession with size as a means of improving the competitiveness of Indian banks. While presenting the budget for 2005-06, the finance minister lamented the fact that SBI was a mere 82nd in the list of the world’s largest banks, implying that this pointed to an inadequacy in Indian banking that needed to be rectified. The minister’s attention might have been drawn to the fact that the world’s largest bank in terms of assets, Mizuho Financial Group, ranks 638th in terms of return on assets. Surely, we would like Indian banks to do better than that! Those clamouring for consolidation seem to be making two points: at the present size, Indian banks are not competitive; two, they would somehow become competitive if they became bigger. Several points can be made about the contention that Indian banks are not competitive at their present sizes. First, the profitability comparison made in Table 5 above refutes the notion that the Indian banking system is not competitive. Secondly, on an impressionistic basis, there is no correlation between size and performance among Indian banks (Table 7).

Table 7: Asset Size and profitability in Top indian Banks

For the Year 2003-04 Total Assets Ratio Profitability

Banks (Prof to Assets) Rank

(Rs Crore) in Per Cent

State Bank of India 407815 0.90 28

ICICI Bank 125229 1.31 11

Punjab National Bank                            102332                1.08                              20
Canara Bank                                            99539                1.34                                 9
Bank of Baroda                                       85109                1.14                               18
Bank of India                                          84860                 1.19                               17
Central Bank of India                             63345                 0.98                               24
Union Bank of India                               58317                 1.22                              14
Indian Overseas Bank                             47322                 1.08                             19
Syndicate Bank                                       47223                 0.92                             27
UCO Bank                                              43798                 0.99                              23
HDFC Bank                                            42307                 1.20                              16
Oriental Bank of Commerce                   41007                 1.67                               5
Indian Bank                                             39154                 1.04                             21
Allahabad Bank                                      34704                  1.34                             10
Bank of Maharashtra                              32213                  0.95                             25
State Bank of Hyderabad                       30646                  1.24                             13
Corporation Bank                                   29154                  1.73                              2
Andhra Bank                                          27009                   1.72                              3
State Bank of Patiala                              26897                  1.60                              6
United Bank of India                              25843                  1.22                             15
Vijaya Bank                                            24071                  1.71                              4
State Bank of Travancore                       24003                  1.02                             22
Dena Bank                                              22160                  0.92                             26
State Bank of Bikaner and Jaipur           20256                  1.49                               7
Punjab and Sind Bank                             15011                 0.06                             29
State Bank of Mysore                             13758                  1.28                             12
State Bank of Indore                               13044                  1.73                               1

State Bank of Saurashtra 12837 1.38 8

Source: Database on the Indian Economy, RBI.

India’s largest bank, ranks 28th among the top 29 domestic banks (public and private) in terms of assets. Many of SBI’s subsidiaries are more profitable than the parent – State Bank of Indore tops the ranking in terms of profitability while being the 28th in terms of size. The second largest bank, ICICI Bank, ranks 11th in terms of profitability. Thirdly, if it is suggested that there is an optimal size in the Indian context, then this needs to be substantiated through rigorous research. Even if we were to blindly accept the optimal size figure for US banks of $10 bn (which itself is on the higher side of estimates), that puts at least nine PSBs in Table 7 out of contention as candidates for consolidation.

Fourthly, as our survey of the literature shows, gains from growing bigger come not so much for scale or scope economies but from diversification. India’s PSBs, for the most part, are considerably diversified, whether by geography or by borrower, as their borrowers are spread over several states and industries. If there are particular banks that could gain through geographic diversification, then these banks would need to be identified. However, judging by newspaper reports, the focus of policy-makers seems to be on banks within the same region on the ground that the cultural or ethnic dis-similarities would not be too acute in such cases. There would thus appear to be a trade-off in the Indian context between the diversification benefits to be had from mergers and the costs of bringing together banks with disparate cultures.

Fourthly, it is suggested that Indian banks would not be able to compete with foreign banks once the latter decide to scale up their operations. As (Table 8)

Table 8: Top Foreign Banks by Asset Size

Bank Assets (Rs Crore)

Standard Chartered Bank                                                         34563
HSBC                                                                                       25357
ING Vysya Bank                                                                      13232
ABN-Amro Bank NV                                                              10667
Deutsche Bank                                                                           8603
Bank of America National Trust and Savings Association       5132
American Express Bank                                                            3406

Source: Prowess Database, CMIE.

makes clear, most foreign banks have a long way to go before catching up with PSBs. Indeed, the whole notion that PSBs will not be able to stand up to global giants in India is hard to stomach because, in the post-reform era, PSBs have lost market share, not to foreign banks, but to domestic private banks much smaller than themselves (Table 9).

Table 9: Share of Total Banking Assets

(Per cent)

1996-97 2003-04

Public sector banks                    82.66                             74.50
Old private sector                         6.61                               6.11
New private sector                       2.40                             12.49
Foreign banks                              8.33                               6.90

Source: Report on Trends and Progress of Banking in India, RBI.

It is suggested that Indian banks need size, not so much to compete in the domestic market where they are safe, as in the international arena. If this proposition is accepted, then no amount of merger is going to be enough. If the top 10 PSBs were combined into one entity, we would still not be in the top 50 in the world (Table 10).

Table 10: Top 10 Banks by Asset Size

($billion)

Rank International Banks Size of Indian Banks Size of
Assets Assets

1              Mizuho Financal Group        1,285       State Bank of India                       91
2              Citigroup                               1,264       ICICI Bank                                   28
3              UBS                                       1,121       Punjab National Bank                  23
4              Credit Agricole Groupe        1,105        Canara Bank                                22
5              HSBC Holdings                    1,034        Bank of Baroda                           19
6              Deutsche Bank                      1,015       Bank of India                               19
7              BNP Paribas                            989        Central Bank of India                  14
8              Mitsubishi Tokyo Financial     975       Union Bank of India                    13
               Group
9              Sumitomo Mitsui Financial     950        Indian Overseas Bank                  11
                    Group
10            Royal Bank of Scotland           806       Syndicate Bank                             10
57            San Paolo IMI                          255

Source: Banker; Prowess Database, CMIE.

It is a sobering thought, when we talk of the global aspirations of Indian banks, that many of the Indian banks that operate abroad are not even able to garner adequate deposits from the nonresident Indian population overseas and have to rely substantially on inter-bank borrowings to fund themselves. There is merit in some banks venturing abroad to capture business related to the international operations of Indian businesses or even in quest of NRI deposits. But it is sheer delusion to suppose that Indian banks can, in the near future, take on the global majors.

It is useful at this point to step back and reflect on how banks have achieved global stature. Banks are said to be a play on the national economy. The strengths of banks will reflect the strengths of the economy (an exception, perhaps, being Swiss banks). American banks and Japanese banks became global players on the strengths of their underlying economies. HSBC rode from insignificance to global status on the back of the Hong Kong growth miracle. So also, as the Indian economy powers along for the next two decades, Indian banks will emerge as international players. It is futile to try to short-circuit the route to international status through merger.

Mergers and Synergies

It is said that PSBs need to merge because there are obvious synergies to be had from doing so. PSBs are often clones of each other – there is no fundamental difference between a Union Bank of India and a Bank of India that requires the two banks to have branches in the same areas. By eliminating overlapping branches, there are huge cost savings to be had. This proposition can be addressed in several ways.

First, even if intended presumed cost savings materialise, the literature on mergers in general warns us not to expect overall shareholder value to be enhanced. Secondly, mergers have failed to add value even in contexts where people can be easily dispensed with. In India, we have assurances that bank staff, who account for a big chunk of branch costs, will not be affected which means that the potential for savings is far less than in mergers elsewhere. Thirdly, not being able to prune staff also means that the clash of cultures that has undermined efficiency in many a merger will be far more intense. But the notion that PSBs need to merge in order to save costs must seem odd to anybody acquainted with these banks. Problem-ridden banks such as Indian Bank and Dena Bank have improved their performance thanks to substantial cost economies through means such as closing and merging uneconomical branches. There is considerable scope for streamlining operations and reducing costs at other PSBs as well. The potential for increasing revenues and reducing costs on a stand-alone basis is so large that to undertake this exercise under the aegis of a merger, with all the complexities it brings, seems utterly uncalled for.

It is also contended that there are too many banks chasing too little business in India, that we are an ‘overbanked’ country. The data in Table 11

Table 11: Efficiency of the Banking System, 1999

DTIs Branches

DTIs Per DTIs Branches DTI Assets Number of

Million Per Million (‘000 US$ DTI Staff

Persons Persons Per Person) Per Branch

India                           0.3                   68                                 0.3                             161
Hong Kong                 42                  261                                129                              44
Singapore                   69                  160                                219                             261
Indonesia                    48                   76                                  0.6                              10
Korea                          80                  215                               19.7                              12
Malaysia                     65                  127                               30.7                              34
Philippines                 14                    90                                    1                               …
Thailand                     80                    76                                    4                               26
Argentina                     3                  119                                 3.5                               24
Brazil                           9                     11                                2.9                               28
Chile                            2                     92                                3.3                               30
Colombia                     2                     93                                   1                               21
Mexico                      0.4                    84                                1.7                               16
Peru                              2                    10                                0.9                               94
Czech Republic            4                  208                                6.8                               25
Hungary                   256                  118                                3.1                                23
Poland                        22                  312                                2.3                               14
Israel                             8                 177                              27.8                               32
Saudi Arabia               0.5                  60                                5.3                               18
South Africa               1.4                  60                                2.8                                50
Memo:
Australia                     18                 321                                                                     52
Euro area                    23                 557                                                                     13
Japan                            5                 180                                                                      23
Switzerland                56                 471                                                                      32
UK                                9                242                                                                      25

US 79 288 26

Notes: DTIs: Deposit-taking institutions; 1 1991.

Source: BIS (2001).

should effectively rebut this notion. By a wide variety of measures, India appears underbanked not only in relation to the industrial countries but also many emerging markets.

Concerns About Mergers

We need to be wary of mergers not only because their effect on efficiency is uncertain. Mergers can lead to concentration in the banking system, which, in turn, could result in the exercise of market power. The efficiency benefits of mergers must be weighed against the adverse impact on competition.

One measure used for judging how competitive a banking structure is the share of top five banks in assets. Table 12

Table 12: Share of Five Largest Banks

(Per cent to total)

Countries Deposits Assets

Brazil                                             63                                   54
Chile                                              62                                   61
France                                            70                                   60
Germany                                        21                                   20
India                                               41                                   44
Japan                                              46                                   46
Malaysia                                        57                                   56
Mexico                                           80                                   80
Philippines                                     46                                   43
United Kingdom                            24                                   23

United States 29 30

Source: Report on Trend and Progress of Banking in India, (RBI), 2003-04.

gives the comparative data for India and some other banking systems. The Indian banking system is not as competitive as that of the US or the UK but it compares favourably with France, Japan and many emerging markets. Moreover, competitiveness in the system has been improving in the post-reform period as indicated by the declining share in assets, deposits and profits of the top five banks (Table 13).

Table 13: Share of Top Five Banks – Assets, Deposits

and Profits

(Per cent)

Parameter 1991-92 1995-96 1998-99 2000-01 2001-02

(1) (2) (3) (4) (5)

Assets 51.7 45.9 44.7 43.9 43.5
Deposits 49 45 44.4 43.9 43.3

Profits 54.5 190.7* 49.1 44.8 41.4

Note: *Owing to presence of loss-making banks.

Source: Report on Currency and Finance (2001-02), RBI

It is not clear that this process needs to be expedited. But, if at all this is attempted, consolidation must not involve the top five banks, it must involve the rest, so that the merged entities from among the smaller banks pose effective competition for the ones at the top. The broader point one could be make is that consolidation is best effected in the Indian system through a bottom-up process whereby the weaker players are combined into viable entities. If this is accepted as the guiding principle for consolidation, then mergers should be attempted first among the private sector banks and the cooperative banks, whose weaknesses pose risks to the system, rather than among the stronger players such as PSBs.

Another concern relates to the impact of mergers on small business lending. Berger et al (1999), after surveying the evidence, conclude:

The most common findings are that consolidations of large banking organisations tend to reduce small business lending, whereas consolidations involving small organisations tend to increase small business lending, although there are exceptions. Given that largebank M&As account for most of the assets involved in M&As, the overall effect on small business lending by consolidating institutions is generally negative.

Banks’ reluctance to lend to small businesses has been pronounced in the post-reform era. The preferred portfolio of banks is corporates with superior ratings and government securities. With greater size, the ability to cater to the requirements of the better rated corporates will be stronger and the incentives to lend to small businesses weaker. Again, with banks that have a local character, absorption into larger banks based elsewhere might diminish incentives for local lending. We are yet to evolve into a situation where disintermediation makes it necessary for banks to make a success of small business lending. Until such time as this happens, consolidation will tend to create a bias against small business and local lending rather than in favour of these. It would be unwise to ignore these concerns especially in light of the commitments to increase credit flows to sectors such as small business and agriculture.

Conditions for Merger

We have argued that, at the aggregate level, the rationale for mergers among PSBs is rather weak at the present stage of the Indian banking system. However, there could be particular instances where a case for merger exists. Before allowing the merger to proceed, it must be ensured that certain conditions are satisfied so that mergers work out to the benefit of all concerned.

One, as no distress exists amongst PSBs, mergers must be market-driven, not driven by government. A basic requirement for this is that the banks in question must be listed. This will enable analysts and academics to track the announcement effect of mergers as well as the gains from merger over the long run.

Two, bank management must quantify the synergies, including cost savings, from merger and place these before the board so that all board members, including officer and worker representatives, understand the potential gains from merger. Such quantification would also enable the board to assess whether the market shares management’s perceptions as to the gains from merger and whether these gains accrue over time. An analysis of this sort would also serve as a basis for evaluating other merger proposals made down the road.

Three, bank management must present to the board a clear plan for integration of the workforce and systems of the banks in question and must also outline the time frame over which such integration is expected to be achieved.

Four, the RBI must monitor the effects of the merger in terms of the impact on the quality of services to customers, prices of deposits and loans, and the impact on small business and local lending. This would facilitate an assessment of the effects of merger on competition and again provide a basis for evaluating future merger proposals.

Unless these conditions are satisfied, there is every danger of mergers degenerating into a mania and derailing the steady improvement in the health of the Indian banking system that has taken place consequent to banking sector reforms.

Concluding Remarks

Banking the world over has been in the throes of consolidation among firms for nearly two decades now. Consolidation is premised on gains to shareholders that could result from greater efficiency, diversification, market power or the perception that the merged entity would be ‘too big to fail’. However, consolidation could also be driven by non-value maximising motives, such as empirebuilding by corporate executives, or by government’s objective to make the banking system more stable.

Consolidation has been driven by a variety of forces: deregulation, technology, globalisation and financial distress. In the US, whose banking system accounts for the highest proportion of mergers, deregulation has been an important force. The removal of restrictions on interstate and intra-state banking enabled banks across states to combine and eliminate the inefficiencies inherent in the earlier restrictions. Similarly, banks were able to venture into investment banking in order to cope with the threat posed by disintermediation.

In many of the emerging markets, financial distress meant that banking systems needed infusions of capital. Merger among domestic firms was a way of rescuing distressed firms. Globalisation and the opening up of domestic markets to foreign entry made it possible for foreign firms to inject capital in many instances.

The extensive literature on mergers has documented that the quest for scale and scope economies, which drives mergers, is likely to go unrewarded because such economies tend to be negligible. There is an optimal size beyond which scale does not confer benefits and this optimal point seems to be around $10 bn for US firms. However, it is not possible to generalise this finding to other economies. Mergers also do not seem to result in improvements in cost efficiency; some studies have found evidence of a favourable impact on profit efficiency. Not least, mergers do not, in general, enhance shareholder value: the target firm benefits but not the acquiring firm, resulting in a zero or negative sum game.

When we view the Indian situation against this backdrop, we are faced with several issues. At the aggregate level, India’s public sector banks lack a compelling rationale for consolidation. Contrary to the experience elsewhere, spreads at PSBs have not declined consequent to deregulation and profitability has improved sharply, making the Indian banking system the second most profitable in the world. The performance of PSBs, measured by the appreciation in stock values, has also been very impressive. It is hard to argue, against this background of improving performance, that greater size is the key to further performance improvement. At the very least, such a contention needs to be backed by rigorous research as to what constitutes the optimal size of assets in the Indian context.

The argument that Indian banks need size in order to compete with international majors is not tenable either. Size is not an impediment to Indian banks competing with foreign banks in India; no amount of merger will enable PSBs to compete in the international marketplace in the foreseeable future. Besides, there seems to be no obvious correlation between the sizes of PSBs and their performance. Often, mergers result in gains not because of enhanced size but because of diversification benefits. As PSBs are, for the most part, have diversified portfolios, additional gains from merger may not be significant.

Mergers as a means of effecting cost savings is not a strong argument either, given that there is enormous scope for cutting costs even on a stand-alone basis. In short, mergers are a response to faltering earnings growth. Where there is sufficient scope for growth on an organic basis, it would be unwise to saddle firms with the complexities – in terms of meshing workforces and systems – that merger brings. If indeed scaling up as a means of achieving efficiency is required, it is among the private sector and cooperative banks, categories that pose a systemic risk today. Among PSBs, if mergers are sought, certain conditions must be satisfied. Mergers must be market-driven, which means the banks in question must be listed, so that the post-merger performance can be tracked. Synergies claimed must be quantified, the time frame for integration must be spelt out and the merger proposal must be approved by the boards concerned. The effects of merger on competition, retail customers, small businesses and local lending must be monitored by the RBI.

Some Indian evidence

There is already evidence in India as well of the futility and even the dangers of consolidation. First, in the last few years, the Indian public sector banks have been able to raise their profitability substantially. While the real costs of these apparent gains in terms of the real economy’s needs are what this report seeks to underline, it cannot be denied that PSBs when judged by corporate performance parameters have recorded substantial improvement. Both profitability and market capitalisation at PSBs have grown consequent to deregulation with a particularly impressive performance in the last three years. Between 1998-99 and 2003-04, profitability at PSBs rose from 0.42 to 1.12 per cent. Note that a return on assets of 1 per cent is considered outstanding internationally. Between September 2000 and September 2004, the market capitalisation of nine listed PSBs has soared from Rs 156 billion to Rs 447 billion – or a rise of 186 per cent. In the present circumstances, where the banks are able to book profits normally and an increasing proportion of the banks are tapping the capital markets to strengthen their equity base, most observers find it difficult to comprehend the need for PSB mergers. (See Ram Mohan, 2004) There are absolutely no domestic compulsions for consolidation of public sector banks.

Even today The profitability ratios of scheduled commercial banks highlighted comparitively improved over previous year (i.e., 2009-10) of banks for Return on Assets (ROA) and Return on Equity (ROE) from 1 percent and 13.3 percent to 1.1 percent and 13.7 percent for the year 2010-11. These ratios of public sector banks slightly decreased in the year 2010-11 to 0.9 percent and 15.4 percent compared to 1 percent and 16.2 percent in 2009-10. Even there was improvement in Interest spread from 2.7 percent to 3.1 percent. In future due to factors such as hike in the savings account interest rate, increasing interest rates, and changes in provisioning requirements for NPAs and also provisions for pension liabilities may have direct effect on profitability of banks (Reserve bank of India,2012).

From last decade Banks in India has shown tremendous performance in the form of Growth and Profitability. According to Boston Consulting Group, 2010: Financial Metrics of Banking sector indicated drastic improvements as bad debts have considerably fell down. Comparing 10 percent in the year 2000, the gross Non-Performing Asset (NPA) ratio is 3 percent currently. The cost to income ratio has decreased from 60 percent in year 2000, to 45 percent currently. Net Interest Margins (NIM) was approximately 3% with small changes from previous two years. Thus, embarking all this significant facts Indian banking sector looks forward for next decade with lots of opportunities.

Second, the Indian evidence of the post-liberalization era doesn’t uphold that bigger size.Within the State Bank group, State Bank of India (SBI) is a giant. Of the total operating profit of the State Bank group amounting to Rs 14363.52 crore in 2003-4, the SBI accounted for Rs. 9553.46 crore. But over the years from 1998-9 to 2003-4, the net profit as a percentage of total assets of the SBI has been lower than for the group as a whole. Similarly, smaller banks like Oriental Bank of Commerce and Corporation Bank have shown remarkable consistency in different parameters of growth. In the private sector the old generation Federal Bank and Karnataka Bank have turned out to be more efficient than the ICICI Bank. Even the new generation HDFC Bank, very small compared to ICICI Bank has shown up commendable performance over the years.

The relationship of profitability of banks (defined as net profits to asset ratio) with their total asset size has been estimated for scheduled commercial banks for the period 1991-2 to 2003-4 by a study indicates that the coefficient of asset size is negative insignificant even at 10 per cent level, which leads to the conclusion that total asset size had no systematic impact on the profitability ratios of the Indian scheduled commercial banks.

One of the aspects of mergers that is often underplayed when expecting a cost efficiency improvement is the problem of compatibility of the cultures and systems and people of the merged entity. As it were, these are going to be real problems, even if the employed workforce can be slashed heavily, a probability not unforeseen for Indian PSBs. The RBI deputy governor sounded a cautionary note in this regard: “As we have seen in the past, in any merger integrating the manpower and culture of the taken over bank with manpower and culture of the host bank proves to be a great challenge. It is only when integration in these aspects is achieved successfully that the merged entities will be able to capitalize on the synergies. ……it will be necessary to ensure that mergers are successful in all respects, including manpower and cultural aspects which are unique in the Indian context.”

To be continued …….

Important Banking News

Wednesday, February 13, 2013

Merger Mania 4

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