In the recent times, there have been numerous reports in the media on the Indian

Banking Industr y Repor ts have been on a variety of topics. The topics have be
en ranging from issues such as user friendliness of Indian banks, preparedness o
f banks to meet the fast approaching Basel II deadline, increasing foray of Indi
an banks in the overseas markets targeting inorganic growth. Repor ts from the w
estern markets of increased M&A activity have also aroused a deep sense of keenn
ess in the authors to compare the various aspects of M&A in the Banking sector i
n India and the international arena. M e r g e r is defined as the combination c
omparable organizations into one. T YPES OF MERGER ‘H o r i z o n t a l ’ : be
tween enterprises in the same product market and at the same level of the produc
tion or distribution cycle. ‘V e r t i c a l ’: between enterprises that opera
te at dif ferent levels of the production or distribution cycle. ‘C o n g l o
m e r a t e ’: between enterprises operating in dif ferent markets. F o r w a
r d – Merger of target into the acquirer R e v e r s e – Merger of acquirer in
to the target Tr i a n g u l a r – U s e o f a n S P V f o r u n d e r t a k i
n g F o r w a r d o r Reverse merger D e m e r g e r – Hive-of f of an undert
aking into a separate company A c q u i s i t i o n is the take-over of a smalle
r company by a larger one. Whilst in both cases the two companies merge voluntar
ily on the basis of a contract, there are also cases of so-called hostile t a k
e o v e r, i n w h i c h t h e m e r g e r t a k e s p l a c e s o t h a t t h e
l a r g e r company acquires a controlling interest in a weaker bank or other w
ise wins over the bank’s majority shareholders against the will of the managemen
t. While the legal personality of the o r i g i n a l e n t i t i e s u s u a l
l y e n d s i n a m e r g e r, i t i s u s u a l l y maintained in the case of a
n acquisition. of two relatively
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Multiple reasons force us to believe that M&A in the Indian Banking Sector is an
imperative. We list them down below: Stability: Fr a g m e n t a t i o n p o s
e s i n c r e a s i n g r i s k i n t h e I n d i a n B a n k i n g S e c t o r.
D u r i n g t h e f i n a n c i a l p e r i o d 2 0 01 - 2 0 0 5 , o n l y f o
u r b a n k s have been able to cross the market capitalization of Rs. 50 billio
n included Bank of Baroda, HDFC Bank, ICICI Bank, and State Bank of India. Consi
derable fragmentation exists in the Banking sector for banks with market capital
ization of less than Rs. 50 billion. Moreover the created value is moving away f
rom the top 5 banks thus indicating fragmentation indeed has increased over the
period of last five years. Shown below are the deposit shares of the Banks opera
ting in India over the period 2000-2004. Data was drawn from around 45 banks whi
ch included state-controlled public sector banks, private sector banks and even
foreign banks operating in India. It is obser ved that the share of the top 5 pl
ayers has eroded and been consumed by the next fif teen players. Considering tha
t the base of total deposits has been consistently increasing, consequently the
value in deposits gained by the next 15 banks has been tremendous (see table bel
ow).
Ye a r 2 0 0 0 2 0 0 4 Similar trends are obser ved in profit af ter tax, borrow
ings and interest and non interest incomes of the banks, thereby hinting at incr
eased levels of fragmentation in the top 20 banks. Though this could be the sign
of a competitive bank market with healthy banks remaining in the market the goa
l of globally competent banks would be missed. In other words, while a fragmente
d Indian banking structure may ver y well be beneficial to the customers (given
increased competition due to lower market power of existing players), at the sam
e time this also creates the problem of no player having the critical mass to pl
ay the game at the global banking industr y level. This has to be looked at sign
ificantly from the state’s long- term strategic per spective.
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Fu r t h e r m o r e , i t i s o b s e r v e d t h a t i n a n i n c r e a s i n
g c o m p e t i t i v e arena the smaller fragmented banks with no economies of
scale, low capabilities to manage risks and poor market power at times end up t
aking excessive risks resulting in irreparable loss to their depositors. This al
so results in af fecting the state and its r e g u l a t o r ’ s i . e . , c e n
t r a l b a n k n e g a t i v e l y. Ta k e t h e f o l l o w i n g c a s e s o
f trouble in the recent past: a . G l o b a l Tr u s t B a n k : S i g n i f i c
a n t e x p o s u r e t o h i g h r i s k m i d s i z e corporates and an exces
sive exposure to capital market operations. b. Madhavpura Mercantile Co-operativ
e Bank: Nineteen customers had unsecured loans of more than Rs. 10 billion . c .
S o u t h I n d i a n C o - o p e r a t i v e B a n k : N o n P e r f o r m i n
g A s s e t s ( N PA s ) from excessive lending to small group of clients d. Ne
dungadi Bank: This bank based in Southern part of India had significant exposure
to plantation industr y and had weak credit risk management systems and process
es. Fu r t h e r r e c e n t c a s e s ( i n 2 0 0 5 - 0 6 ) o f t w o b a n k s
i n I n d i a n a m e l y United Western Bank and Sangli Bank became attractive
targets for acquisition by private sector banks because of their risk profile.
The merger with these larger banks is expected to i m p r o v e t h e a s s e t
p r o f i l e , N PA m a n a g e m e n t a n d p r o t e c t t h e depositors at
the same time of fer the acquiring private sector banks further reach in terms
of branches and customer base.
How Would Consolidation Help Indian Banks?
A bigger player can af ford to invest in requisite technology and play globally
to take advantage of global oppor tunities Because for going global a bank needs
to upgrade its t e c h n o l o g y, M I S , “ s y s t e m s & p r o c e s s e s
” a n d s t r a t e g i e s , . t o c o m p e t e e f f e c t i v e l y a n d “
M & A” c o u l d f a c i l i t a t e t h i s . The confidence of international
investors in Indian banks has increased manifold in recent times and this offers
our banking sector a good opportunity to restructure itself
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A small analysis of per formance of the bank sector and the equity market benchm
ark index in India and USA showed the following results:
India United States of America (USA) The above table clearly indicates that the
banking portfolio in US is as risky as the composite portfolio which is not the
case in India. Though the returns are more in India the risk is also higher as s
hown by the standard deviation. A report as early as August 1 9 91 r e c o g n i
z e d t h e t r e n d i n s h a r e h o l d e r r e t u r n s i n t h e U S a n
d hence was one of the reasons for the bank M&A wave in the USA Benefits to the
customers: Benefits to customers can be seen in a number of ways. One such way
being lowering in the intermediation costs. A 10 year trend i n t h e i n t e r
m e d i a t i o n c o s t s a s a p e r c e n t a g e o f To t a l a s s e t s i
n Indian Banks shows that the Indian private sector banks have the least interm
ediation costs as a percentage of total assets (see graph below). During this ti
me frame, a significant decreasing trend can also be obser ved in the Private Se
ctor banks of India in the decade. Being non fragmented they could claim greater
ef ficiency and hence lower intermediation costs.
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Adhering to the International CAR norms and Supporting Regulator y Framework: Su
pporting institutional and regulator y framework in India is vital for domestic
banks aspiring for global operations. The Central Bank i.e., the Reser ve Bank o
f India (RBI) has suitably c hanged the countr y’s regulator y framework from ti
me to time to support Indian financial institutions to withstand the competitive
pressures placed on them by increasing globalization. Proper steps have been ta
ken to guide the banking sector to see that the banks pass through this transiti
on phase by and large s u c c e s s f u l l y. W i t h t h e R B I r e g u l a t
i n g t h e C a p i t a l t o R i s k Weighted Asset Ratio (CRAR) at 9%, a perc
ent above the Basel II CRAR, going for ward many banks would not be able to meet
these requirements and may have to go through restructuring in order t o m e e
t t h e r e g u l a t o r y r e q u i r e m e n t s . Fu r t h e r m o r e t h e
r e a r e a number of banks in India whose growth is restricted due to unavaila
bility of capital. These banks have a significant depositor base but the market
perception does not enable them to raise further funds. Hence such banks also be
come potential targets of acquisition.
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Average Capital Adequacy Ratio of Banks in India The reforms initiated in the ba
nking sector have now reached a crucial stage. Government’s stake in many Public
Sector Banks (PSBs) has gone down and as a consequence other shareholders equit
y ownership in these PSBs has gone up. This leads to greater responsibility on t
he bank managements since the level of accountability has increased. Pressures o
f performance and profitability will keep the PSBs on their toes all the time as
the public shareholders expect good financial performance along w i t h g o o d
r e t u r n s o n t h e i r e q u i t y. M a n y P S B s h a v e a l r e a d y
star ted the exercise of cleaning up of their balance sheets by s h e d d i n g
t h e e x c e s s b a g g a g e . T h e Vo l u n t a r y R e t i r e m e n t S c
h e m e (VRS) in the recent past in some of the banks was aimed not only at dow
nsizing the manpower but also at cutting down the future staf f costs and increa
sing the per formance levels of the staf f in the long run. Some of these PSB ba
nks are able to run the show to a cer tain extent by low cost funds that are ava
ilable thanks to the branch network spread over the length and breadth of the c
o u n t r y. M & A a c t i v i t y w i l l f u r t h e r b o o s t t h i s p r o
c e s s f o r m a n y other banks that cannot go through this exercise individu
ally and need larger par tners to execute them in terms of processes and resourc
es. Managing Bankruptcy Risks Recent studies have established that if merger and
acquisitions in banks if allowed in a controlled manner would significantly r e
d u c e t h e b a n k r u p t c y r i s k o f t h e m e r g e d e n t i t y. O
b v i o u s l y, mergers would also provide these benefits to banks in India red
ucing their bankruptcy concerns.
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Bottom Line Growth: Mergers and Acquisitions or Restructuring may also help bank
s improve in three other areas as listed below: 1. E c o n o m i e s of Scale: A
n acquirer would capabilities to improve the collections, ser vice distribution,
infrastructure and IT of the target bank have the processes,
2. E c o n o m i e s o f S c o p e : An ability to grow products and segments an
d an opportunity to cross sell would enhance revenue. This could also result in
more geographic growth could also be obtained. 3 . S y n e r g y B e n e f i t s
: Tr e a s u r y p e r f o r m a n c e w o u l d b e i m p r o v e d as the cos
t of funds would reduce (hence, improve spread) as it would have a better credit
rating. A bank would also be able to leverage scale and improve its trading inc
ome.
Tw o p r i m e r e a s o n s f o r c e u s t o b e l i e v e t h a t M & A i n t
h e I n d i a n B a n k i n g S e c t o r i s a n o p p o r t u n i t y. Creati
on Bank: of a Financial Super Market or a Universal
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A recent trend is to promote the concept of a financial super market chain, maki
ng available all types of credit and non-fund facilities under one roof under on
e umbrella organization (or through specialized subsidiaries). An example of suc
h a financial supermarket would be the reverse merger of ICICI and ICICI Bank .
ICICI Bank today stands as India’s second largest bank of fering its clients bot
h in India and overseas a product range as varied us retail banking products to
e x o t i c i n v e s t m e n t b a n k i n g a n d t r e a s u r y s o l u t i
o n s . S i m i l a r l y, I D B I and IDBI Bank treaded the same route. Though
one has to state that consolidated accounting and super visor y techniques would
have to evolve and appropriate fire walls built to address the risks underlying
such large organizations and banking conglomerates. Tec h n ol og ic a l Ex p e
r t is e: New entrants in the banking sector are armed with technological exper
tise while older players are well equipped with experience in practices. Merger
s would thus help both parties gain an exper tise in areas in which they lack .
In India, the retail banking market biased towards the urban markets is growing
at a C o m p o u n d e d A n n u a l G r o w t h R a t e ( C AG R ) o f a l m o
s t 1 8 - 2 0 % w h i l e the rural market is yet to be fully tapped. Keeping in
focus the population profile, technology would be a major enabler for banking i
n the future. A number of state owned banks in India are adopting sophisticated
core banking solutions and these are just the larger ones. For smaller banks to
adopt technology platforms the expenditure may not be sustainable and hence this
may be one more reason for M&A . Growing integration of economies and the marke
ts around the world is making global b a n k i n g a r e a l i t y. T h e s u r
g e i n g l o b a l i z a t i o n o f f i n a n c e h a s a l s o gained momentu
m with the technological advancements which have ef fectively overcome the natio
nal borders in the financial ser vices business. Widespread use of internet bank
ing, mobile banking, and other modern technologies (such as SWIFT) has widened f
rontiers of global banking, and it is now possible to market financial products
and services on a global basis. In the coming years globalization would spread f
ur ther on account of the likely opening up of financial ser vices under W TO. I
ndia is one of the signatories of Financial Ser vices A greement ( F S A ) o f 1
9 97. T h i s g i v e s I n d i a ’ s f i n a n c i a l s e c t o r i n c l u d
i n g b a n k s an opportunity to expand their business on a quid pro quo basis
. An easy way for this is thus to go through adequate reconstruction to acquire
the necessar y technology and get an early mover advantage in globalizing the In
dian Banks.
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Cross Border M&A in Banks One more reason for M&A which has sprung up in the rec
ent years is Indian Banks seeking international presence. In the last two decade
s, there has been a jump in the Indian diaspora working abroad. A new recent tre
nd is the increase in the interest of foreign expats to work in India. Both thes
e communities seek banking products in remittances and other cross border retail
p r o d u c t s . Fu r t h e r f i r m s a r e l o o k i n g f o r f u n d s o
v e r s e a s f o r v a r i o u s purposes ranging from capital expenditure to l
everaged M&A financing. Hence, Indian banks are setting up branches and subsidia
ries overseas and foreign banks are expanding their operations in India. These b
ank branches (set up abroad) further target the local population to be profitabl
e and hence target l o c a l a c q u i s i t i o n s . E v i d e n t l y, t h i
s r e s u l t s i n a n M & A o p p o r t u n i t y for Foreign Banks to acquire
an Indian Bank and also Indian Banks to acquire foreign banks. For example, ICI
CI Bank has made an acquisition of a bank in Europe in 2006 to establish itself
in a geographical area.
The Indian M&A environment is a strongly regulated by the following major pieces
of legislation/bodies: − − − The The The Act, Companies Act, 1956 Ta k e o v e
r s C o d e , 1 9 97 M o n o p o l i e s a n d R e s t r i c t i v e Tr a d e P
r a c t i c e s 1969 9
− The − The − The − The • • •
Foreign Exchange Management Act, 1999 Foreign Investment Promotion Board (FIPB)
Reser ve Bank of India I n c o m e Ta x A c t , 1 9 61
Mergers, amalgamations, de mergers, acquisitions of business units or divisions,
are all governed by The Companies Act for all registered companies Acquisition
of shares in listed Indian companies is g o v e r n e d b y T h e Ta k e o v e r
C o d e , 1 9 97.
M E R G E R O F S TAT E B A N K O F I N D I A A N D S TAT E B A N K OF SAURASHTR
A
SBS is the smallest of the seven associates. The other associates a r e S t a t
e B a n k o f Tr a v a n c o r e , S t a t e B a n k o f M y s o r e , S t a t e
B a n k o f B i k a n e r a n d J a i p u r, S t a t e B a n k o f H y d e r a
b a d , S t a t e B a n k o f Indore and State Bank of Patiala. SBS has 460 bran
ches and the merger would help eliminate duplication of branches in the same are
a. Its net profit rose 45 p e r c e n t t o R s 8 7. 4 c r o r e i n 2 0 0 6 0
7. T h e b a n k h a s p a i d u p e q u i t y
10
c a p i t a l o f R s 31 4 c r o r e . T h e t o t a l d e p o s i t s s t o o d
a t R s 1 5 , 8 0 4 crore while total advances were at Rs 11 ,081 crore. The me
rger would help SBI consolidate its position as the countr y's biggest bank and
widen the gap with nearest rival ICICI B a n k . W i t h 9 , 57 9 b r a n c h e
s , S B I h a s t o t a l a s s e t s o f R s 5 , 6 6 , 5 6 5 c r o r e a n d p
o s t e d a n e t p r o f i t o f R s 4 , 5 41 c r o r e a s o n M a r c h 31 ,
2 0 07. I C I C I B a n k h a d a s s e t s o f R s 3 , 4 4 , 6 5 8 c r o r e a
n d p o s t e d a net profit of Rs 3,110 crore in 2 0 0 6 07. The merger comes
at time when the bank has decided to go in for big expansion. The bank is also
looking at freeing up capital by setting up a holding company for its life insur
ance and asset management businesses. SBI’s move to merge its arms could p a v e
t h e w a y f o r f u r t h e r c o n s o l i d a t i o n i n t h e i n d u s t
r y, w h i c h faces imminent competition from foreign banks from 2009. Merger
of State Bank of Saurashtra with SBI would enable it to up-scale in terms of foo
tprint, manpower and other resources. It would also enable it to face competitio
n arising from g l o b a l i z a t i o n o f t h e e c o n o m y, a p a r t f r
o m a u g m e n t i n g e f f i c i e n c y and enabling better management of ri
sk. State Bank of Saurashtra is the smallest of its associate banks and operates
in regions where SBI does not have a large presence.
Buyer Wells Fargo & Company is a financial holding company and a b a n k h o l d
i n g c o m p a n y. I t i s a d i v e r s i f i e d f i n a n c i a l s e r v
i c e s c o m p a n y. I t p r o v i d e s r e t a i l , c o m m e r c i a l a n
d c o r p o r a t e b a n k i n g ser vices through banking stores located in 2
3 states: Alaska, Arizona, California, Colorado, Idaho, Illinois, Indiana, Iowa,
Michigan, Minnesota, Montana, Nebraska, Nevada, New Mexico, N o r t h D a k o t
a , O h i o , O r e g o n , S o u t h D a k o t a , Te x a s , U t a h , Washin
gton, Wisconsin and Wyoming. It provides other financial ser vices through subsi
diaries engaged in various businesses, principally wholesale banking, mortgage b
anking, consumer finance, equipment leasing, agricultural finance, commercial -
11 -
finance, securities brokerage and investment banking, insurance agency and broke
rage ser vices, computer and data processing ser vices, trust ser vices, investm
ent advisor y ser vices and venture capital investment. It operates in three seg
ments: Community Banking, Wholesale Banking and Wells Fargo Financial. Ta r g e
t Wac hovia Corporation (Wac hovia) is a financial holding company a n d a b a n
k h o l d i n g c o m p a n y. I t p r o v i d e s c o m m e r c i a l a n d r
e t a i l banking, and trust services through fullservice banking offices in Ala
bama, Arizona, California, Colorado, Connecticut, Delaware, Florida, Georgia, Il
linois, Kansas, Mar yland, Mississippi, Nevada, N e w J e r s e y, N e w Yo r k
, N o r t h C a r o l i n a , P e n n s y l v a n i a , S o u t h C a r o l i n
a , Te n n e s s e e , Te x a s , V i r g i n i a a n d Wa s h i n g t o n , D .
C . I t a l s o provides various other financial ser vices, including mor tgage
b a n k i n g , i n v e s t m e n t b a n k i n g , i n v e s t m e n t a d v i
s o r y, h o m e e q u i t y lending, asset-based lending, leasing, insurance,
international and securities brokerage ser vices, through other subsidiaries. Th
e Company?s retail securities brokerage business is conducted through Wac hovia
Securities, LLC, and operates in 49 states. In O c t o b e r 2 0 07 , W a c h o
v i a c o m p l e t e d t h e a c q u i s i t i o n o f A . G . E d w a r d s ,
I n c . I n F e b r u a r y 2 0 07 , t h e C o m p a n y a c q u i r e d a m a j
o r i t y interest in European Credit Management Ltd.
Wells Fargo to buy Wachovia for $15.1bn Wells fargo & co the biggest US bank on
the west coast, agreed to buy of Wac hov ia corp for about $1 5.1 bn in stoc k ,
trumping C i t i g r o u p ’ s o f f e r f o r e m b a t t l e d N o r t h C a
r o l i n a l e n d e r. T h i s d e a l w o u l d b e e x e c u t e d e n t i r
e l y b y We l l s Fa r g o w i t h o u t h e l p of US unlike citigroup’s of f
er which relied on financial backing from the Federal Deposit Insurance Corp. R
AT E O F R E T U R N W e l l Fa r g o s a i d i t w i l l a c q u i r e a l l o
f Wa c h o v i a ’ s b u s i n e s s e s preferred equity and banking deposits.
Bank claimed that the acquisition will add to earnings per share by the third ye
ar af ter completion and should produce internal rate of return of at least 15 %
.
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Buying Wac hov ia is a detour from the strategy was outlined by W e l l s F a r
g o . A f t e r a c q u i r i n g W a c h o v i a W e l l s Fa r g o w o u l d h
a v e $ 1 . 4 2 t r i l l i o n i n a s s e t s , $ 7 8 7 b i l l i o n i n d e
p o s i t s a n d 1 076 1 branches.
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