MERGER OF

BANKS

BY
JERIN PRADISH
INTRODUCTION: -

The government expects the two relatively strong banks — BoB and Vijaya Bank
— will easily absorb potential shock of amalgamating with a weak one.
The latest move is part of the government’s reform initiatives to create a few but
strong banks with much larger balance sheets to support the rising appetite for
credit of the fast-growing economy and enable optimum utilisation of resources.
The merged entity has a combined business of Rs 14.8 lakh crore, deposits of Rs
8.4 lakh crore, gross advances of Rs 6.4 lakh crore, and 85,675 employees, based
on the position as on June 30. The boards of these three banks are expected to meet
in the next two weeks to consider the proposal and work out modalities.
BoB managing director(MD) PS Jayakumar said the amalgamation process may
take four to six months to complete, although no time frame has been fixed for it.
Vijaya Bank MD RA Sankara Narayanan told a TV channel that the merged entity
will be offered growth capital beyond what is required to meet regulatory needs.
Jaitley said the successful experience of merging State Bank of India (SBI) with
five of its subsidiary banks and Bharatiya Mahila Bank prompted the government
to explore the latest proposal in consultations with the Reserve Bank of India
(RBI). Explaining the context of the proposed amalgamation, Jaitley said many
state-run banks were in a fragile condition due to excessive, “adventurous” lending
in the past (2008-14) and consequent ballooning of stressed assets with them. This
also impaired their lending ability to support economic growth.
The NDA government, through an unprecedented Rs 2.11-lakh-crore infusion plan
for two years through FY19 that was announced last year, sought to capitalise
PSBs to meet regulatory capital requirements and also support lending. “This
amalgamated entity will increase banking operations,” Jaitley added.
The merger will not cause any job loss in any of these banks and, as was in case of
SBI, no employee of the three banks would have service conditions that are
adverse to their present one, he added.
The government currently owns majority stakes in 21 lenders, which account for
over two-thirds of the country’s banking assets. But they also account for an
overwhelmingly large share in total non-performing assets (NPAs) in banking.
Some analysts feel that the merger might hurt the regional character of Vijaya
Bank. It is also not clear what name the combined entity will retain.
Financial services secretary Rajiv Kumar said the merger will help improve
operational efficiency and customer services. The amalgamated bank will be a
strong competitive lender with economies of scale and will have synergies for
network, low-cost deposits and subsidiaries. While the employees’ interest will be
protected, brand equity will be preserved, Kumar added. Capital support to the
merged entity of Dena Bank, Vijaya Bank and BoB would be ensured, he said.
Analysts said the level and management of stressed assets would be an important
characteristics of the commercial considerations for these banks as they weigh
merger. Complementarities and financial burden, mainly stressed assets, were
among the commercial considerations for the amalgamation of PSBs and there was
no one-size-fits-all approach to such mergers, an official source told FE.
Synergies of business portfolios, human resources, systems, reach and cultural fit
will be key factors in the merger consideration. The amalgamation is also aimed at
creating a few strong banks that could cut costs as well as dependence on the
government for capital infusion in the longer term. In the short and the medium
terms, however, the government has made it clear that it would infuse capital, if
required.
The panel, formally called alternative mechanism, mirrors a similar system
adopted for strategic divestment of government assets, where a group of ministers,
headed by Jaitley, has been monitoring the progress. The setting up of this panel
was aimed at expediting the process of consolidation, without the requirement of
Cabinet approval at every stage.
The merger announcement came even as PSBs recovered Rs 36,551 crore in the
June quarter from bad loans, almost half of the entire 2017-18. Their operating
profits rose 11.5% quarter-on-quarter and losses dropped 73.5%, in a sign that the
worst is behind, said Kumar. The 11 of 21 PSBs that are under the prompt
corrective action could be out of it this fiscal, he had said recently.
The RBI in its latest financial stability report said the increase in bad loans is
estimated to be the highest for PSBs. In the base case, the banking regulator
expects the gross NPA ratio for state-owned banks to rise to 16.3% by March 2019
from 15.6% in March 2018. In the worst-case scenario, the bad loan ratio could go
up to 17.3%.

The announcement of Bank of Baroda, Dena Bank and Vijaya Bank merging into a
single bank is part of the government's strategy to merge public sector lenders and
promote consolidation in the sector marred by loads of non-performing assets
(NPAs).All the 38 listed banks accounted for gross NPAs totalling over Rs 10.17
lakh crore in the quarter ended March 2018. Cleaning of the balance sheet and
minimising NPAs is the objective of the latest merger announced by the
government.The strategy which the government has adopted is merging one weak
bank with its stronger counterparts. In this case, the weaker bank is Mumbai-based
Dena Bank. The lender came under prompt corrective action of the RBI in May
2017 in view of high Net NPA and negative RoA (return on assets) and now faces
restrictions on lending and several other bank operations.On May 12, 2018, the
Reserve Bank of India asked the lender not to issue any fresh loans and hire new
personnel as part of its restrictions under prompt corrective action.A day after the
announcement, the stock hit upper circuit of 19.75% on the BSE.On the other
hand, Bank of Baroda stock closed over 17% lower on the BSE.The reason is
obvious: Bank of Baroda is the largest among the three and will take a hit on its
asset quality post merger with Dena Bank.We explore the financials of the three
lenders in details to find out how the three made ideal candidates for a merger.
The government’s decision to merge three of its banks—Bank of Baroda, Dena
Bank and Vijaya Bank—is expected to reduce the capital it needs to pump into
these lenders and help clean up their balance sheets
How will the bank merger happen?
According to experts, the bank merger process could happen gradually—first with
the consolidation of business, followed by the integration of information
technology structures. For instance, at the time of merger of ING Vysya with
Kotak Mahindra Bank, corporate banking and treasury departments were merged
before retail banking was integrated. Individual boards of each of the three banks
will have to approve of the merger. The merger has to go through parliamentary
approval, which will be a critical factor, considering that general elections are
slated for next year.
What will the merged entity look like?
It will have a total business of ₹ 14.8 trillion, with capital adequacy rating at
12.25%, Tier-1 capital 9.32% and net non-performing assets at 5.71% on the loan
book. The number of branches will be close to 9,500.
What will be the impact of the bank merger on shareholders?
While the merger is positive for shareholders of Dena Bank, it is negative for Bank
of Baroda and Vijaya Bank. The merger will be seen as a bailout of the weak
lender, which has accumulated a net loss of more than ₹ 10,500 crore over the last
two fiscals. Analysts believe that the deal valuation is not going to be cheap.
According to IDFC Bank Securities, while Dena is a weak bank, it still trades at
1.1x price to book value ex-revaluation versus 0.9x for BoB and 0.8x for Vijaya,
based on 1QFY19 numbers.
What will be the challenges?
Financials, process integration, branch rationalization, management bandwidth and
human resources will be the key challenges. Analysts expect a jump in non-
performing loans post the merger, as BoB’s asset quality recognition policies are
stricter than those of other banks. It will put Bank of Baroda’s business strategy at
risk. It had just begun reaping the benefits of the strategy. Analysts say the focus
will shift from growth and clean-up of these banks to employees figuring out what
to do for themselves.
The government has proposed the merger of Bank of Baroda, Dena Bank and
Vijaya Bank to create India’s third-largest lender. This was decided at a meeting of
a ministerial panel called alternative mechanism, as an approval framework for
proposals to merge state-run banks. The rationale is two strong banks will absorb a
weak bank to create a mega bank whose lending ability will be higher and which
will be able to expand operations. While Bank of Baroda and Vijaya Bank have
reported better earnings, Dena Bank is under RBI’s prompt corrective action
framework and has been restrained from further lending.

Dena Bank
Dena Bank's net loss for the fiscal ending March 2018 widened to Rs 1,923.15
crore compared to a loss of Rs 863.62 crore for the fiscal ending March 2017.In
fact, during the last three fiscals, the bank posted net loss amounting to Rs
3,722.09 crore.However, for the fiscal ending March 2015, the bank posted a net
profit of Rs 265.48 crore down from Rs 551.66 crore for the fiscal ending March
2014.The fall in net profit of the bank can be attributed to a rise in NPAs over the
years.Gross NPAs of the bank rose from Rs 2,616.03 crore for the fiscal ending
March 2014 to Rs 16,361.44 crore for the fiscal ending March 2018.Similarly, net
NPAs of the bank rose from Rs 1,818.92 crore in the fiscal ending March 2014 to
Rs 7,838.78 crore crore for fiscal ending March 2018. Bank deposits fell from Rs
1,17,430.96 crore for the fiscal ending March 2016 to Rs 1,06,130.14 crore in the
fiscal ending March 2018.Similarly, advances for the fiscal ending March 2018 fell
to Rs 65,581.51 crore compared to Rs 82,328 crore for the fiscal ending March
2016.The above figures throw light on the deteriorating financial condition in the
state-run lender over the last few years after which RBI had to intervene and bring
the lender under preventive corrective action.
Vijaya Bank
The Bangalore-based lender is on a better financial footing than its weaker
counterpart Dena Bank.Net profit for the fiscal ending March 2018 fell to Rs
727.02 crore compared to a net profit of Rs 750.48 crore for the fiscal ending
March 2017. However, net profit rose to Rs 750.48 crore from Rs 381.80 crore for
the fiscal ending March 2016.In fact, Vijaya Bank is the only lender among the
three to post net profit in last fiscal.During the last three fiscals, the bank posted
net profit amounting to Rs 1,859.3 crore compared to Dena Bank's net loss of Rs
3,722.09 crore for the same period.Gross NPAs of the bank rose from Rs 1,985.86
crore for the fiscal ending March 2014 to Rs 7,526.09 crore for the fiscal ending
March 2018.Similarly, net NPAs rose from Rs 1,262.37 crore in the fiscal ending
March 2014 to Rs 5,021.24 crore for fiscal ending March 2018.However, on the
deposits front, the bank seems to have clocked a healthy growth during the last five
fiscals. Deposits rose from Rs 1,24,296.16 crore for the fiscal ending March 2014
to Rs 157,287. 54 crore for the fiscal ending March 2018 depicting a 26.54 percent
rise over five years.On the other hand, advances for the fiscal ending March 2018
rose to Rs 116,165.44 crore compared to Rs 81,504.03 crore for the fiscal ending
March 2014, depicting a 42.52% growth over five years.
Bank of Baroda
The Vadodara-based lender is the largest lender among the three banks.It did not
perform well in the March 2018 fiscal as the bank posted a net loss of Rs 2,431.81
crore amid rise in provisions and contingencies and NPAs compared to net profit
of Rs 1,383.13 crore for the fiscal ending March 2017.In last five years, the bank
reported the highest net profit of Rs 4,541.08 crore for the fiscal ending March
2014 and the highest loss of Rs 5,395.55 crore for the fiscal ended March 2016.In
fact, the lender posted a net loss of Rs 6,444.23 crore during the last three
fiscals.Gross NPAs of the bank rose from Rs 11,875.90 crore for the fiscal ending
March 2014 to Rs 56,480.39 crore for the fiscal ending March 2018.Similarly, net
NPAs rose from Rs 6034.76 crore in the fiscal ending March 2014 to Rs 23,482.65
crore for fiscal ending March 2018.However, on the deposits front, the bank
logged a zigzag pattern of growth during the last five fiscals. Deposits rose from
Rs 5,68,894.39 crore for the fiscal ending March 2014 to Rs 5,91,314.82 crore for
the fiscal ending March 2018. Deposits crossed the Rs 6 lakh crore mark twice for
fiscals ended March 2017 and March 2015 but could not sustain the
momentum.On the other hand, advances for the fiscal ending March 2018 rose to
Rs 4,27,431.83 crore compared to Rs 3,97,005.81 crore for the fiscal ending March
2014, depicting a 7.66% growth over five years.

Synergy:
The merger of Bank of Baroda (BoB), Vijaya Bank (Vijaya) and Dena Bank
(Dena) will result in several benefits to the merged entity in terms of cost
efficiency and ease of operation. On a cumulative basis, the adjusted capital (book
value minus net non-performing assets or NPAs) of the amalgamated bank will be
strengthened, increasing its lending capacity.
The government’s decision to merge Bank of Baroda, Dena Bank and Vijaya Bank
will yield the desired results only if these lenders rationalised their branches,
looked to reduce costs and handled people issues well, analysts said.
All three banks combined would have a total loan book of Rs 6.40 lakh crore and
total deposits of Rs 8.41 lakh crore, making it the third-largest bank in India. Total
branches will increase to 9,489. But many of these branches could be overlapping,
which means they may have to cut branches that are near to each other. A
government statement said the merger will lead to synergies of a shared network,
low cost deposits and subsidiaries. The merged bank will have a current and saving
account ratio of 34.06% and capital adequacy of 12.25%.

Reason and research:

Three years ago, the government picked Bank of Baroda, country's fifth largest
bank, for a turnaround experiment. It appointed high-profile outside professionals
to overhaul the scheme of things at BoB. Ravi Venkatesan, former chairman of
Microsoft India and ex- independent director of Infosys, joined the bank as its
chairman. P S Jayakumar, an ex-citibanker, took over as MD& CEO. In fact, a lot
of professionals joined laterally to work with them to transform the bank. The idea
behind inducting professionals was to create a fresh template for public sector
banks (PSBs) for them to stay competitive in the market.
In the last three years, the duo managed to create some building blocks for a
complete transformation of business. In fact, a lot of work was left to be done.
Strangely, Venkatesan declined the offer for a second term. Jayakumar's tenure is
also coming to an end next month. There is no news of his extension. But the
merger announcement with Vijaya Bank and Dena Bank hit headlines just before
his extension.

Problem faced after the merger:

The merger of Dena Bank and Vijaya Bank with Bank of Baroda will create
following new challenges for BoB:
1) Does size matter?
The merged entity will emerge as the second largest bank after State Bank of India
with balance sheet size of close to Rs 10 lakh crore. The SBI's balance sheet stood
at over Rs 27 lakh crore as of March 2017. The next two after BoB will be HDFC
Bank and ICICI Bank. But the question is; size for what? Amid fast-changing
digital banking world, the banks should focus on faster processing of loans, risk
management and cost and also on lucrative return for the shareholders.
2) New geographies
With Vijaya Bank, there will be new geographies in the South, but Bank of Baroda
also has a national presence. There is likely to be some duplication of branches.
The three banks actually mirror each other in terms of portfolio of assets and also
the quality of portfolio. Dena Bank is in a bad shape with higher NPAs, higher cost
to income and falling profitability. Dena Bank's numbers will pull down some of
the profitability numbers of the merged entity.
3) Technology integration
The technology integration will be a big issue. The bank of Baroda recently
upgraded its core banking technology from Finacle 7 to Finacle 10. It was a huge
exercise lasting for months. In fact, the BoB was targeting on the up-gradation of
its core banking of foreign offices from the older version. They will now have a
huge task at hand to put all the three banks in the same platform.
4) Workforce troubles
The BoB had hired a lot of outside professionals at the level three after executive
directors and MD&CEO. The merged entity will have lot of senior people coming
from Vijaya and Dena Bank. The new capabilities that the BoB was building in
loan processing at Gift City and two new IT subsidiaries require completely
different set of people with new skills. These people from new banks have to be
trained to put them in new areas like relationship managers, marketing and sales
work etc.
The BoB insiders say the building blocks created by the new management,
especially share services -- an independent processing subsidiary based in Gujarat's
Gift city for retail loans -- is a good template for the new merged entity. They just
have to shift the branch processing work of Dena and Vijaya to this newly created
subsidiary. Similarly, the focus on relationship manager in the corporate banking
will be expanded in the new entities merging with it.
New entity profile:
“This is not a big-bang merger, rather the government has decided to go via a step-
by-step approach. It will lead to operational synergies but how they handle the
human resources will be a challenge,” said Karthik Srinivasan, vice-president at
ICRA. “The visible impact of this move will take time to fructify but the ultimate
test will be how they scale up business and fasten credit growth, which has been an
issue with banks.”

Sur said the merger’s success will also depend on how quickly these corporate-
focused banks use their network and tilt toward retail. “Bank of Baroda was trying
to shift toward retail lately but both Dena and Vijaya were predominantly
corporate-focused banks,” Sur said, adding, “They can use their network to expand
on the retail front. Clients of Dena and Vijaya will also benefit from Baroda’s
branch network abroad.”

Integration process:

The potential merger of Bank of Baroda, Dena Bank and Vijaya Bank is a bold
move by the government ahead of the general elections next year, but it comes
with its own challenges on business integration, technology, culture and people
management including a possible opposition by trade unions.
Alka Anbarasu, Vice President, Financial Institutions Group, Moody’s Investors
Service, said the plan will be credit positive "as it will provide efficiencies of scale
and help improve the quality of corporate governance for the banks."
Bank of Baroda is strong in western and northern India while Dena Bank has a
larger base in Gujarat and Maharashtra and Mangalore-based Vijaya Bank has a
presence in south India.

On Sept. 17, the Narendra Modi government announced plans to merge three
public sector banks: Mumbai-based Dena Bank, Bengaluru’s Vijaya Bank, and
Bank of Baroda (BoB) that has its head office in Vadodara, Gujarat. The merged
entity, with total assets of over Rs14 lakh crore ($190 billion), will be India’s third-
largest lender behind the State Bank of India and HDFC Bank.

“The government had announced in the budget (for the financial year 2019) that
consolidating banks was on our agenda and the first step has been announced,”
finance minister Arun Jaitley said in New Delhi.
With this, the government has thrown a lifeline to Dena Bank, whose gross non-
performing assets (NPA) ratio in the quarter ended June 30, 2018, stood at 22%,
among the industry’s highest. It is already under the Reserve Bank of India’s (RBI)
supervision; in May it was barred from lending any further or recruiting new
employees.
Vijaya Bank and BoB are in better shape. In the April-June quarter of financial
year 2019, Vijaya Bank posted a net profit of Rs144 crore, while BoB’s figure
stood at Rs528 crore. In this period, Dena Bank posted a net loss of Rs721 crore.

One of the reasons for choosing these three banks was that the two stronger ones
will be able to absorb the weaker entity, explained Jaitley.

“It (the merged bank) will be a strong competitive bank with economies of scale,
network synergies, low-cost deposits and subsidiaries, and the possibility of greater
outreach and expansion,” said Rajiv Kumar, the government’s financial services
secretary.
The merger proposal will first have to be approved by the board of directors of the
three banks. Then the government will prepare a plan to be vetted by the union
cabinet and both houses of parliament. The process can take up to a year, said
Asutosh Kumar Mishra, a banking analyst with Reliance Securities.
While the government has assured there will be no job losses, bank unions are up
in arms. Several of them are set to demonstrate across the country against the
merger plan. Even BoB and Vijaya Bank shareholders are unlikely to be happy
since their assets could get diluted by Dena Bank’s absorption.
“These banks will have to compensate for the bad asset quality of Dena Bank and
it is likely they will be very unhappy with the move and this may also lead to some
hiccups in the merger process,” said Mishra of Reliance Securities.

Legal Formalities in merging:

Section 44A of Banking Regulation Act 1949

Section 44A of the Banking Regulation Act, 1949 Lays Down the Norms for
Voluntary Mergers.

Section 44A: Procedure for Amalgamation of Banking Companies

No banking company under the force of any law, shall be amalgamated with
another banking company, unless a scheme containing the terms of such
 amalgamation has been placed in draft before the shareholders of each of the
banking companies concerned separately, and approved by a resolution passed
by a two-thirds majority of the shareholders of each of the said companies.

Forced Mergers are Done under Section 45 of the Banking Regulation Act.

 The Reserve Bank can apply to the Central Government for an order of
moratorium for a banking company.

 The Central Government, after considering the application made by the Reserve
Bank may make an order of moratorium staying the commencement or
continuance of all actions and proceedings against the company for a fixed
period of time on such terms and conditions as it finds proper and may from time
to time extend the period on condition that the total period of moratorium shall
not exceed six months.

Management conflicts:

A bank employee unions' federation has called upon bank unions to hold
demonstrations on Tuesday to protest against the merger of three state-run lenders
--Bank of Baroda, Vijaya Bank and Dena Bank, a union leader said on
Monday."The sit-in will take place after office hours on Tuesday. All our unions
are requested to hold protest demonstrations in all state capitals and in all other
towns on 9 October," C H Venkatachalam, General Secretary of All India Bank
Employees' Association said.

The demonstrations are against the government's proposal to merge Bank of

Baroda, Vijaya Bank and Dena Bank, he added.

AIBEA in a statement said that it has learnt that the board of these three banks
have approved the agenda and hence they may proceed further.
"The issue as discussed in the UFBU meeting held on 29 September, 2018, and it
has been decided to call upon all our unions to hold protest demonstrations," it
said.

AIBEA said that the issue will be further discussed in the ensuing UFBU meeting
to be held on 12 October in Mumbai and the further course of action will be
decided upon.

Separately, the National Organisation of Bank Workers (an industrial federation of

Bhartiya Mazdoor Sangh), in a statement said that it will hold demonstrations
across the country tomorrow to protest against government's decision to merge the
three banks.

It said the union do not agree with the government's stance of creating six-seven
large banks by merging existing banks.

Consolidation by way of merger will not solve the problem of non-performing

assets in the banking system, it added.

The boards of three state-run banks Dena Bank, Bank of Baroda, and Vijaya Bank
have approved the proposed merger.

The amalgamation of these three banks will create country's second-largest PSU
lender by assets and branches.

CONCLUSION

Having said that, from a reform-perspective, consolidation among State-run banks

gives the industry certain benefits. It helps to create large-sized banks that can then
work to build enough muscle mass to compete in a global banking industry
presently dominated by large-sized lenders. With a Rs 10 lakh crore asset size, the
post-merger Bank of Baroda-Vijaya Bank-Dena Bank entity will still not be a
match for the top global banks (even SBI is not big enough to be among the top
banks on the global list), but India is slowly creating large-sized banks. Through a
series of mergers, perhaps the country will have five or six large banks that can be
groomed to compete in the global market. This makes sense now also because RBI
has now started giving permits to a number of small banks that can focus on
expanding small-scale banking activities in rural areas.

In any case, it did not make sense to control the ownership of so many banks in an
ambitious economy. There has been no progress on the privatisation of State-run
banks which would have been the ideal case to bring in private talent and money.
The IDBI Bank-LIC deal can be hardly called a privatisation move, since LIC is
technically a government-run entity.

Thus, with not enough political will and scope for privatisation of these banks,
consolidation seems to be the only way to keep the momentum going for banking
sector reforms.

But there is an important question the government will need to answer when it
goes ahead with the PSB consolidation drive: Does the merger solve the NPA
problem of State-run banks and the insatiable capital hunger of these banks,
especially the weaker ones?

Take the Bank of Baroda, Dena Bank and Vijaya Bank merger for example. The
combined entity will have a total gross NPAs of Rs 79,320 crore, which as a
percentage of total advances stand at around 13 percent. How will the merger help
in addressing this problem? What is happening here is only the process of bundling
of a few small problems into a bigger one. The work culture and management
inefficiencies that led these banks to the present situation, and the onus on the
government to feed capital to these banks all remain the same. Had it been a sell-
off instead of a merger among PSBs, fresh private money would have come in and
more efficient management which would have been accountable for efficient use of
that money.

This is something former RBI governor Raghuram Rajan had pointed out in 2015 .
Rajan's main points were that the merger of two (or more) unhealthy banks in the
financial system will create an unhealthy entity that would lead to the creation of a
bigger problem in the economy. Secondly, even in the case of the merger of an
unhealthy bank with a large healthy bank, the merger would bring problems to the
acquiring bank. Thirdly, in the event of a merger of a weak bank with a strong
bank, the acquirer will have to deal with the cultural problems that arise out of the
merger, besides dealing with the primary challenge — the bad loan pile in the
weak bank, thereby creating difficulties for the strong bank.

The point is that if consolidation is the way ahead for the government, it will have
to invest equally in a management revamp and out-of the-box solutions to address
the NPA problem, beyond the Insolvency and Bankruptcy Code resolution. If the
fundamental problems are not addressed, consolidation will end up as
unannounced bailout packages for banks