Manoj Kumar Agenda Manoj Kumar

‰ Background
Efficiency Gains from Mergers and ‰ Research Question
Acquisitions of Indian Banks: ‰ Literature review
A Data Envelopment Analysis Approach ‰ Methodology
‰ Model Used
‰ Data Sources
‰ Results
‰ Conclusions

Introduction Manoj Kumar

Introduction Manoj Kumar

‰ Till 1991, Indian Banking industry was highly protected and ‰ Consequences of liberalizing and deregulating the banking sector:

only PSBs were operating in the country.

™ Private sector and foreign banks have been permitted to open their offices.

‰ The Indian Banking industry has slowly been liberalized and ™ Increased banking sector mergers due to:
¾ Increased competition: Entry of new private sector and foreign banks
deregulated since 1991

¾ RBI, India’s Central Bank, requires that all Banks operating in India must
compulsorily adopt Basel II framework by 2009.

¾ Indian Government has become supportive of M&A deals happening in the

banking industry.

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 List of Bank mergers in India since 1969 Manoj Kumar Research Question Manoj Kumar

Year Merging Bank Merged With

1969
1970
Bank of Bihar
National Bank of Lahore
State Bank Of India
State Bank Of India
‰ What is the impact of banking sector mergers in the post
1984 Laxmi Commercial Bank Canara Bank
1984
1985
Miraj State Bank
Bank of Cochin
Union Bank of India
State Bank Of India
reform period on the profit efficiency of the merged entities?
1986 Hindustan Commercial Punjab National Bank
1988 Traders Bank Bank of Baroda
1989 United Industrial Bank Allahabad bank
1989 Bank of Tamil Nadu Indian Overseas Bank
1989 Bank of Thanjavur Indian Bank
1989 Karur Central bank Bank of India
1990 Purvanchal Bank Central Bank of India
1993 New Bank of India Punjab National Bank
1993 BCCI State Bank of India
1994 Bank of Karad Bank of India
1995 Kas hinath Seth Bank State Bank Of India
1996 Bari Daab Bank Oriental Bank Of Commerce
1996 Punjab Co-operative Bank Oriental Bank Of Commerce
1999 Bareilly Corporation Bank Bank of Baroda
1999 Sikkim Bank Union Bank of India
1999 Times Bank HDFC Bank
2000 Bank of Madura ICICI Bank
2002 ICICI ICICI Bank
2002 Benaras State Bank Ltd. Bank of Baroda
2002 Nedungadi Bank Ltd. Punjab National Bank
2004 Global Trust Bank Oriental Bank of Commerce
2005 IDBI IDBI Bank
2005 Centurion Bank Bank of Punjab

Significance of Research Question Manoj Kumar Significance of Research Question Manoj Kumar

‰ While theoretically bank mergers should increase the overall
efficiency of merging banks, yet poorly conceived or badly
executed bank mergers can make the merging entities
inefficient, which in turn can present risks to the entire
economy as a stable banking system is a prerequisite for a
healthy economy.
‰ Therefore, effectiveness or otherwise of bank mergers should
necessarily be gauged in context of their influence on the
efficiency of the merging banks.
‰ Most existing studies are in context of developed economies
and present contradictory findings.
‰ Rare studies in context of emerging economies like India
‰ Research on the efficiency gains from banking sector M&As
in India is scarce, largely because M&A deals in the Indian
banking sector is a recent phenomenon.

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 Literature Review Manoj Kumar Literature Review Manoj Kumar

‰ Numerous studies have assessed the ‰ Measuring Efficiency

™ efficiency of banks; and

™ The definition and choice of the inputs and outputs used for measuring the
™ efficiency gains from mergers amongst banks and financial institutions.
efficiency of banks depends on the specific approach used to model the
banking business.
‰ Maximum studies have been conducted in context of US
banks. ™ Various approaches have been used for measuring the bank efficiency

™ Two major approaches are:

¾ Production,
¾ Intermediation,

Literature Review Manoj Kumar Literature Review Manoj Kumar

‰ Production approach: ‰ Intermediation Approach

™ The production approach views banks as producers of various types of
accounts in form of deposits and loans by incurring cost of production
(Berger et al., 1987)
¾ The input is: measured by the cost of production; and excludes the
interest expenses. Cost of production includes the costs of physical
capital and labour.
¾ The output is: measured in terms of number of accounts serviced;
and not measured in terms of the currency value of deposits.
™ This approach considers banks as intermediary of financial services. It
assumes that banks collect funds (deposits and purchased funds) and
transform these into loans and other assets by incurring the cost of
production (Sealey and Lindley, 1977)
¾ Inputs are: the deposits and the cost of production. Costs are
defined to include both interest expense and total costs of
production.
¾ Output are: the volumes of earning assets.

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 Summary of Possible Inputs and Outputs for Manoj Kumar Literature Review Manoj Kumar
Measuring the Relative Efficiency of Banks

‰ Berger and Humphrey (1997)

Inputs Outputs ™ reviewed 130 studies done across 21 countries to estimate
Number of employees (Labour) Processed documents and Transactions
Equity capital (physical capital) Loans the efficiency of financial institutions.
Deposits Other Investments
Other Interest bearing liabilities Net interest income
Non-interest expenses Non-interest income ™ Findings:
Interest expenses Deposits
Interest bearing assets ¾ Financial institutions have an average efficiency of
Off-balance sheet activity
around 77% with a standard deviation of around 13
percentage point.

¾ The standard deviation for within-country studies was

still higher.

Literature Review Manoj Kumar Literature Review Manoj Kumar

‰ Berger and Humphrey (1997) ‰ Huang and Wang (2002)

™ Findings:
™ have provided a comparison of various efficiency
¾ Attributed the high standard deviation to the measurement methods. They have employed a large
methodological differences across studies – number of parametric and nonparametric methods to
estimate efficiencies of a panel of 22 Taiwanese
 Non-Parametric approaches-Data Envelopment Analysis (DEA) and Free
Disposable Hull (FDH) commercial banks.

 Parametric approaches-Stochastic Frontier Analysis SFA, Thick Frontier

Approach – TFA, Distribution Free Approach -DFA ™ They have found out that the two methods yield similar
average efficiency scores.
 All approaches have certain advantages and disadvantages.

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 Literature Review Manoj Kumar
‰ Berger and Mester (1997)
™ used 6000 pieces of commercial bank data for US banks to measure
bank efficiency over the period from 1990 to 1995.
™ They use varied economic efficiency concepts--- cost, profit
efficiencies.
™ They found that efficiency estimates are different among all these
concepts, since each of them involves different information.
™ Their sample of US banks had average
¾ cost efficiency scores of around 86% and
¾ average profit efficiency scores of around 47%.
Literature Review Manoj Kumar
‰ Berger et al. (1999) performed an extensive study of the
existing literature concerning efficiency consequences of the
consolidation of financial institutions and banks in particular.
™ Early studies of efficiency effects of mergers found that there is
no substantial improvement for efficiency after the mergers and
some even found negative relations between bank efficiency and
mergers.
™ On the other side, more recent research found that a substantial
improvement in the efficiency of banks after the merger.
Literature Review Manoj Kumar
‰ Several researchers have assessed the impact of mergers
amongst banks and financial institutions on their efficiency.
‰ Methodologies used:
™ a comparison of pre- and post-merger performance; and/or
™ an event-study type methodology based on prices of specific financial
market assets.
Literature Review Manoj Kumar
‰ Amel et al (2004) make another detailed review of the empirical literature
concerning the efficiency gains from bank mergers in the developed
countries over the past twenty years in order to find common patterns that
transcend national and sector specificities of each country.
‰ Their review suggested that the gains derived from the use of economies of
scale and scope have been less than what is commonly believed.
‰ They found economies of scale gains from M&As mainly for the smaller
banks only, while convincing evidence for economies of scope or gains in
managerial efficiency was not found.
‰ They also noted that it is difficult to see any gains from merger, if the post-
merger period under investigation is short.
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 Literature Review Manoj Kumar Methodology Manoj Kumar

‰ The evidence on the effects of M&As on cost efficiency varies

by country. ‰ Data envelopment analysis (DEA) model was used to measure the relative
bank efficiency.
™ Vennet(1996) found that cost efficiency or operating income following
M&As improves for some European markets (especially between
equals) . ‰ DEA compares relative efficiency of banks by determining the efficient
banks as benchmark and by measuring the inefficiencies in input
combinations in other banks relative to the benchmark.
™ However, Pilloff (1996) found contrary results for the U.S. bank
M&As.
‰ Taking technology and size as given, estimation focuses on how production
factors are combined, by comparing a firm actual costs or profits with the
costs or profits of the best practice institution

Methodology Manoj Kumar Methodology Manoj Kumar

‰ The DEA relative efficiency scores are calculated for all the public and ‰ Model Used
private sector banks operating in India using the Efficiency Measurement
System (EMS) software.
Inputs Outputs
Profit Efficiency Interest expenses Net interest income
Non-interest expenses Non-interest income
‰ A single year data on input and output efficiency parameters for banks in
our sample is fed into the EMS software, which uses DEA to generate that
year’s relative efficiency scores for the banks in our sample.

‰ Following the above procedure, the relative efficiency scores are calculated
separately for all the years in the post reform period starting from 1991 till
2006.

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 Methodology Manoj Kumar Data Source and Sample Manoj Kumar

‰ The changes in the relative efficiency score of the merging banks in the post merger would
indicate that bank mergers have influenced the efficiency of the merged entities. ‰ The banks specific inputs and outputs data required for the
DEA model was taken from
‰ Year-wise average efficiency score of all banks is calculated.
™ CMIE’s Prowess database.
‰ Excess efficiency score is calculated for all the merging banks by deducting the average ™ RBI
relative efficiency score of the entire industry from the relative efficiency score of the bank.
™ Capitaline
‰ The yearly excess efficiency scores for the merged banks are calculated for three years
starting from one year period before the year of bank merger being analyzed.

‰ The directional trends in the yearly excess efficiency scores for each of the merged entities
are observed.

Results
List of Bank Mergers Analyzed Manoj Kumar Trends in the yearly excess efficiency scores for the Manoj Kumar
merged entities

Year Merger Table shows the year-wise excess efficiency scores for the merged entities starting from one year
1993 State Bank Of India and BCCI before the merger (shown as Y(-1) ) to one year after the merger (shown as Y(+1) ). The year of merger is
1994 Bank Of India and Bank of Karad shown as Y(+1). Table also shows directional trend in excess efficiency scores for each of the merged
banks. The increasing,
1995 State Bank Of India and Kashinath Seth Bank
decreasing and unsteady trends in excess efficiency scores are, respectively, shown by +, - and ± symbols.
1996 Oriental Bank Of Commerce and Punjab Co-operative Bank Merger Y(-1) Y(0) Y(+1) Trend
1996 Oriental Bank Of Commerce and Bari Daab Bank State Bank of India and BCCI 1.99% -1.47% -1.83% -
1999 Bank Of Baroda and Bareilly Corporation Bank Bank of India and Bank of Karad -14.97% -7.09% -2.02% +
1999 H D F C Bank Ltd.and Times Bank State Bank of India and Kashinath Seth Bank -1.83% 8.57% 12.43% +
Oriental Bank of Commerce and Punjab Co-operative Bank 7.09% 18.32% 15.45% +
1999 Union Bank Of India and Sikkim Bank
Oriental Bank of Commerce and Bari Daab Bank 7.09% 18.32% 15.45% +
2000 I C I C I Bank Ltd. and Bank of Madura Bank of Baroda and Bareilly Corporation Bank -4.02% 4.07% 8.68% +
2002 ICICI and I C I C I Bank Ltd. H D F C Bank Ltd.and Times Bank 16.14% 7.74% 10.48% ±
2002 Benaras State Bank Ltd. & Bank Of Baroda Union Bank of India and Sikkim Bank 10.73% 1.36% -3.91% -
I C I C I Bank Ltd. and Bank of Madura -1.23% 6.61% -1.63% ±
2002 Nedungadi Bank Ltd. & Punjab National Bank
ICICI and I C I C I Bank Ltd. -1.63% -3.09% 0.93% +
2004 Oriental Bank Of Commerce and Global Trust Bank Benaras State Bank Ltd. & Bank of Baroda 2.94% 13.17% 14.97% +
2005 IDBI and I D B I Bank Ltd. Nedungadi Bank Ltd. & Punjab National Bank 3.56% 14.96% 11.80% +
2005 Bank of Punjab Ltd. and Centurion Bank Oriental Bank of Commerce and Global Trust Bank 15.34% 8.63% 0.85% -
IDBI and I D B I Bank Ltd. 1.44% 4.39% #N/A +
Bank of Punjab Ltd. and Centurion Bank -26.64% -0.87% #N/A +
Average Excess Efficiency of Merged Entities 1.06% 6.24% 6.28% +
#N/A: As of the date of analysis, year-specific inputs and outputs data for the bank was not yet
available from any of the data sources used in this study.

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 Results Manoj Kumar Conclusions Manoj Kumar

‰ Fifteen mergers were analyzed: ‰ Bank mergers in India, at large, has positively influenced the
™ In ten mergers, the excess efficiency scores have been positively efficiency of the merged entities.
influenced the merged entity.

‰ However it must be noted that the DEA only tells about

™ In three mergers, the excess efficiency scores have been negatively
influenced the merged entity. existence of positive or negative excess efficiency gains and
thus can not comment upon the reasons for the same.
™ Remaining two mergers showed unsteady trends in the excess
efficiency scores of the merged entities.
‰ Each merger is unique and needs to be studied individually to
identify the relevant reasons.