Mergers of Public sector Banks.

Mergers of Public sector Banks and its implications

Introduction

Banks are the nerve centers of trade, commerce and business in a country. Banking plays a very important part in the economic development of all the nations of the world. Industrial revolution that took place in the 18^th and 19^th centuries would not have taken place without the evolution of good banking system. In fact, banking is the life-blood of modern commerce. As a tree is known by its fruits, a bank is known by its functions[1].

This financial institutions have defined in many ways some of which are presented here:-

Bank is an establishment which makes to individual such advances of money as may be required and safely made and to which individuals entrust money which required by them for use.[2]                                                                                                        _ KINGSLEY.

The term ˜Bank™ generally applies to an institution, which receives deposits of money before it and which seeks profits through the extension and sale of its own deposits[3].

_ E.E. AGGER

A banker is one who in the ordinary course of his business, honors cheques drawn upon by him by persons and for whom he receives money[4].                                              _Dr. H.L.Hart.

All these definitions actually mention fundamental functioning of Banks.

A country™s economic well being is understood by the development of her banking industry. Therefore often banking industry relies on merging to develop its banking industry as merger generates synergies between the target and the synergies in turn.

 

Public sector banking in India emerged with the establishment of the State Bank of India in July 1955 that followed the takeover of the strongest private bank that existed then, the Imperial Bank of India, by the Reserve Bank of India. Over the years, State Bank of India has grown in spread and volume of business and today it is the largest bank in India[5].

India banking definitely has a history of consolidation of several banking institutions right from the British era. Several small co-operative banks have also been swallowed up in the process of mergers and amalgamations by some of the leading public sector banks in the country. The first attempt towards merger and amalgamation within the line up of the public sector banks was made by the merger of New Bank of India with Punjab National Bank in the year 1993[6].

Till the mid-1990s, mergers and acquisitions have not been common in developing countries. But, hopefully in future we will find mergers and acquisitions in the Indian banking industry will be the order of the day[7].

The project is focusing on the mergers of Public Sector Banks. While explaining mergers the researcher is going through the meaning of mergers, reasons of bank merging, PSBs merging in as per Indian  Scenario and a chart is also prepared to show the list of Indian Banking that have merged. Three Committees were made by Government Narshimhan Committee, Khan Committee and Verma Committee; reports of these three committees are also focused. The main objective of this project is to focus on the issues and implications that may arise during bank mergers and the procedure that the bank must follow during merging under the Banking Regulation Act, 1949.

Objectives

The objective of the research paper is to focus on the:-

1)      To find the reasons of the merging of the public sector banking in India.

2)      To find if merging of PSBs in India will enable India to compete globally.

3)      To find will the employees of the Banks will able to work in harmony after the banks are being merged[8].

Hypothesis

Banking mergers have enhanced quality of banking services and outreach of banking services to the priority sectors for lending purposes.

Research questions.

The following are considered relevant research questions in the course of study:-

1)      Do Banking mergers & Acquisitions improve the services rendered by Indian Banks?

2)      Do mergers and Acquisitions of Public Sector Banks facilitate economic growth and stability in India?

3)      Do banking mergers enable India to compete globally?

Scope and Limitations

The researcher would work on the mergers and acquisition of the PSBs and their effects on the Banks™ performance. The researcher would highlight the need for restructuring of banks, the impact of merging in India and shall also mention the ground for mergers. The researcher would consider mergers and Acquisitions as a key factor to economic development.

Chapterization.

Chapter-I

Introduction to the Indian Banking system

India has an extensive banking network, in both urban and rural areas. All large Indian banks

nationalized and all Indian financial institutions are in the public sector. The Reserve

Bank of India is the central banking institution. It is the sole authority for issuing bank notes

And the supervisory body for banking operations in India.[9]The Banking Regulation Act, 1949, defines banking company as a company which transacts the business of banking in any state of India. The word banking has been defined under the same Act as the accepting for the purpose of lending or investment, or deposits of money from the public repayable on demand or otherwise and withdraw able by cheque, draft order or otherwise[10].Banks attract savings from the people and thus encourage the investment in industrialization trade and commerce[11].

The banking system has three tiers. These are the scheduled commercial banks; the regional

Rural banks which operate in rural areas not covered by the scheduled banks and Cooperative and special purpose rural banks. Commercial banks are categorized as scheduled

And non-scheduled banks, but for the purpose of assessment of performance of banks, the

Reserve Bank of India categories them as public sector banks, old private sector banks, new

Private sector banks and foreign banks[12].

The commercial banks undertake the banking business with the aim of profit. The deposits are accepted from people, and other resources. The money so collected is provided in the form of short-term loans to customers, i.e., industry, trade and general public. Depending upon the functions performed and services rendered, the banks are known as deposits banks, industrial banks, mixed banks, exchange banks, agriculture banks, etc. However, as such there is no industrial bank in our country. The nationalized banks have started giving loans to industries[13].

The Central Bank of a country is called Central because it is at the apex of the entire banking system of the country were established around the early twentieth century[14]. Central Banks are a relatively recent innovation and most central banks as we know them today. The significance of central bank lies in its function of managing the monetary system of the country. By the nature of its business the Central Bank is intimately connected with the banking system of the country in general interest of the nation. The credit control function is very important as far as economic interests of country are concerned. The commercial banks lend money and create credit. The credit in itself is a very powerful factor and can be utilized for good purposes as well as for evil intentions and that makes it very necessary to exercise full and efficient control on credit operation, so that it cannot be misused. In India Reserve Bank of India is the apex of the entire banking system[15]. It was established under Reserve Bank of India Act 1934. It is managed by the Central Board of Directors of 20members, which consists of Governors, one official from Ministry of Finance, ten directors nominated by the Central Government and four directors nominated to represent for local boards. The R.B.I can be considered as the monarch of the Indian money market centers around the RBI.  Like the Bank of England, India also required Central Bank which would occupy the pivotal position in the monetary and banking structure of the country. The economy needed a leader bank in the money market which supervise, control and regulate the activities of the commercial bank which would supervise, control and regulate the activities of the commercial banks. Hence, the RBI was established as the Central Bank of India[16].

Concept of Banking Mergers

Merger means combination of two or more companies, when one company is completely absorbed by another[17]. A bank merger occurs when banks join to become one. Many people think of bank mergers as something that occurs between two banks, but it may involve more than two in some cases. Even if four or five banks get merged, it will be identified as a single identity. There are two common ways in which a bank merger may be accomplished: one is through a buyout and another is via cooperation with bank shareholders[18].

To understand what a bank merger is, it may be helpful to compare it to marriage. As marriage is joining of two people, bank merging is also combination of two or more people. When banks merge, the separate banks lose their identities and take on a single identity. For example, the merged banks may take on the name of one of the banks involved in the merger or they may create a new name. In many cases, it is preferable to keep one bank’s name for the new identity, as it may have name recognition value[19]

 

 

Banking Regulation Act, 1949 and Emerging trends of banking mergers.

Public sector banking in India emerged with the establishment of the State Bank of India in July 1955 that followed the takeover that existed then, the imperial Bank of India, by the Reserve Bank of India. Over the years, the State Bank of India has grown in spread and the volume of business and today it is the largest bank of India. SBI is also the largest bank in the world by sheer number of branches and also by the number of employees. The Central bank of a country is called Central Bank it is the apex of the entire banking system of the country. In India it is Reserve Bank of India™. RBI regulates the activities of other commercial banks. At the time of SBI™s establishment RBI had 60% stake in it.

The second stage of public sector banking with the takeover of seven princely state banks by the state banks by State bank of India in the year 1959, to expand its rural outreach.

The third phase of public sector banking took place in the late 1960s. The Indira Gandhi Government that was in power then nationalized 14 major Indian commercial banks in the year 1980. In terms of size of assets and capital base, only a few banks rank among the top 500 global banks. These are State Bank of India, Punjab National Bank, Canara bank, Bank of Baroda, ICICI Bank and HDFC BANK. Bank of China is more than four times larger than SBI. Citigroup, the biggest banking conglomerate in the world, has a capital base of about 22times that of the entire Indian banking sector[20].

With the growth in the Indian economy which is expected to remain strong for quite one time, with its strong services sector, the demand for banking services, especially retail banking, mortgages and investment services are growing. Mergers and Acquisitions, takeovers will happen on this front in India.

In the last three years two banks, the State Bank of Saurashtra and the State Bank of Indore, were merged with the SBI.

The merger of State Bank of Bikaner and Jaipur and the State Bank of Travancore are expected to be taken up at a later date[21].

The procedures that a bank must follow while merging is given in the Section-44A. Of the Banking Regulation Act, 1949.

Section 44-A states that No banking companies shall be amalgamated 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 thirds in value of the shareholders of each of the said companies by calling a meeting for that purpose[22].

Notice of every such meeting must given to the shareholder of each of the banking companies concerned in accordance with the articles of association[23].

Where a scheme of amalgamation is approved by the majority of the shareholders, it shall be submitted to the Reserve Bank of India. When the scheme of amalgamation is sanctioned by Reserve Bank of India then it can order in writing and also specify the date[24].

Section-45 gives power to Reserve bank of India to apply to Central Government for suspension of business by a banking company and to prepare scheme of restitution of amalgamation[25].

With a view to encourage and facilitates consolidation and emergence of strong entities and providing an avenue for non-disruptive exit of weak/unviable entities in the co-operative banking sector, the Reserve Bank has decided to issue suitable guidelines to facilitate merger/amalgamation in the sector and place them in public domain[26].

Some circumstances are levied, in which R.B.I will consider proposals for mergers and amalgamation in Urban Sectors[27].

Chapter-II

Types of Mergers.

Merger is combination of two or more companies into one company[28]. In India, mergers are called amalgamation, in legal parlance. The acquiring company acquires the assets and the liabilities of the target company. Typically, shareholders of the amalgamating company get shares of the amalgamated company in exchange for their existing shares in the target company. Mergers may involve absorption or consolidation[29].

Horizontal merger– This is the merger of the corporate engaged in the same kind of business[30].

E.g- Merger of bank with another bank.

Vertical merger– When companies that make different elements of a product join[31].. Consolidation through vertical merger would facilitate convergence of commercial banking, insurance and investment banking[32].

Conglomerate merger– A conglomerate merger involves two companies which are among other things engaged in producing or distributing the same competitive products[33].

An example of conglomerate merger is a tea company and a butter company; both are not competitors to each other[34].

Implications of banking mergers.

In theory three motives of mergers is documented. These motives include synergy motive, hubris motive and agency motive.

The synergy motive occurs when the combination of two organization results in economic gains.

The hubris motives is the value of the target is higher than it actual target market value.

The agency motives argue that mergers pursue their own interest to engage in takeover activity at the expense of shareholders[35].

1. Mergers of weak, Practice of mergers of weak banks with the strong banks was going on in order to provide stability to weak banks but Narshimhan committee opposed this practice.

2. Mergers can diversify risk management.

3. Increase in the market competition- Innovation of new products and consolidation of new financial system are the reasons for merger.

4. Markets developed and competition increased and because of this share of all individual reduced so mergers started.

5. Globalization of economy impacted bank mergers.

6. Capability of generating impacted bank mergers.

7. Removal of entry barrier opened the gate for new banks with high technology and old banks can™t compete them, so they decide to merge[36].

Theoretical Justification for mergers of Banks.

A few studies were conducted with regard to the size of a banking unit and its profitability in the past. Ataullah, Cockerill and Le (2004) had done a comparative analysis of evolution in banking efficiency in Indian and Pakistan for the period 1988-98 which was relevant to the onset of financial reforms in these countries[37].

These studies pointed out that in India large banks have performed better than the small ones, especially the public sectors. A small sized-bank would find it difficult to break even in the scenario of dwindling interest spread[38].

In a study conducted by Drake and Hall (2001) with regard to Japanese banks, it was understood that technical inefficiency was one of the main factor for the banking crisis in these banks. The scale of inefficiency was found to be more severe in the case of smaller banks. Even though large sized banks exhibited better efficiency level[39].

There is no static optimum size to guarantee success of a banking Unit. The foreign banks operating in India have better profitability due to their operational characteristics and management strategies and not just for the reason of their greater size. For a bank to work successfully there is need of improved technology and operational characteristics must be of modern methods. It is necessary for a country to develop a full set of sound institutions matching the best practice before embarking on financial integration[40].

After the opening of the Indian financial sector, the Indian PSBs faced cut throat competition from the highly resourceful and the modern multinational banks which could offer products like credit cards, debit cards and other online banking products. The PSBs were heavily burdened with an antiquated system and the manual accounting practices, up gradation of which involved mammoth investment and workload[41].

Some of the Indian PSBs were carrying forward accumulated losses and a massive NPA burden. Government sourcing of funds was neither in the national social and economic interests nor a practical solution to the whole issue.

Banks were required to gear up to international standards with innovative products and services with the accepted level of efficiency.

Many of the PSBs are geographically concentrated and they needed to tie up arrangements with the banks for efficient coverage of other areas beyond their outreach.

A better and optimum size of the organization would help the PSB to offer more and more products and services and help in integrated growth of other sectors[42].

The deciding factors for mergers would be:

• The benefits on mergers.
• The professional standards that can accrue through the means of consolidation.
• The capital adequacy and Structure of an optimum size of the bank. This can be determined by considering the long-term viability aspects.

There is also said to be a synergy between the merging entities arising out of their geographical preference and concentration, regional presence etc. This needs to be probed and studied before merger itself with all its pros and cons that would result in a decision either in favour of or against a mergers decision[43].

Chapter-III

Mergers of Banks in India.

More or less the same characteristics could be spotted in the mergers that took place among the Indian Banks since the shift of the policy regime in the mid-1991, two public sector banks were merged: they were the weak New Bank of India and the relatively strong Punjab National Bank. The former lost its identity with the merger and the assets of the latter increased sharply. But the enlarged PNB could not exploit the scale and scope economies as effectively as it was expected at the time of the merger due to problems of personal integration. The officers and other staff members of the New Bank of India felt that they were treated unfairly when they were given lower positions in the merged bank[44].

On the other hand, there were merger among private Indian banks around the late 1990s, for a variety of reasons such as for enhancing financial strength, for improving the share in the growing retail business and for securing relatively long regional presence. Important examples, mergers were mooted by the merging banks[45].

Mergers also took place among the Indian Banks with the public sector banks in recent years. Prominent examples of this phenomenon were the mergers of Banaras State Bank with the Bank of Baroda in 2002, Nedungadi Bank with the Punjab National Bank in 2003 and the Global trust Bank with the Oriental Bank of Commerce in 2004.All these mergers were initiated by the authorities essentially to preserve stability[46].

Since about the middle of 2004, the Government of India has been seriously hinting at the idea of consolidating Indian banking through mergers for three major reasons. The two familiar reasons are to exploit the economies of scale and scope.  Consolidation of the banking sector into fewer organizational entities has been advocated also for enabling the Indian Banks to compete internationally[47].

Public sector bank (PSB) consolidation was a hot topic in 2008-09. Mooted by the then Finance Minister P Chidambaram, the issue did not get the required thrust after he left the Ministry[48]. The emerging scenario is also turning favorable to the process of consolidation. Mounting pressures to issue new bank licenses, which will induce enhanced competition from foreign banks getting full bank licenses, and entry of a new set of private sector banks, will also precipitate the PSB consolidation[49].

The Reserve Bank (RBI) has already set the process of new licenses in motion by approving the Dutch banking major Rabo Bank™s application for a full banking license[50].

Various committees appointed by the Government of India and The Reserve Bank of India have studied in detail the aspects of consolidation through the process of mergers[51].

Narasimham Committee (1991 and 1998) suggested merger of strong banks both in public sector and even with the development Financial Institutions and non banking financial companies (NBFCs).Mergers are based on the synergies as well as location and business specific complementarities which make sound commercial sense[52].

To be globally competitive, a limited number of top level banks can be chosen to open up branches internationally. These can be designed ˜A™ category banks and christened international banking corporations. At the next level, there can be national level banks, categorized as ˜B™ category, which may be defined for co-operative banks to cater to the specific needs of the region as well as the state concerned[53].

The khan Committee in 1997 stressed the need for harmonization of roles of commercial banks and the financial institutions. The Committee recommended that the management and shareholders of banks along with DFIs be permitted to explore gainful mergers[54].

The Committee recommended mergers-

a)      Between banks,

b)      Between banks and DFIs,

c)      Between the strong and weak of these to become viable entities, and

d)     Between two strong banks and DFIs.

The Verma Committee pointed out that provide for pooling of strengths and lead to overall reduction in cost of operations so as to improve competitive ability, operational efficiency, better positioning with enhanced market share.

According to reports, giants like Bank of India and the Union Bank of India, Bank of Baroda and Dena Bank and now Punjab national bank, Bank of Baroda, Canara Bank are going in for merger[55].

Issues in mergers.

Human Resources- People often fear mergers because it creates uncertainty for both the companies. Human resource in both the Banks help smooth out this problem by answering as how merge will help each employee of the banking company[56]. Various laws under which the banking institutions are constituted contain provisions about mergers as also continuation of the existing employees of the transferor bank. In the case of New Bank of India vs. Union of India[57] the Supreme Court held that the Central Government had the powers to frame such a scheme and the Court would be entitled to interfere with such a scheme only if it comes to the conclusion that either the scheme is arbitrary or irrational or based on extraneous considerations. In all cases of mergers, the Central Government will have to formulate a suitable scheme for continuation and other service conditions, applicable to the employees of the transferor bank consequent upon merger[58].

Taxation: Under section 72A (1) of the Income Tax Act where there has been an amalgamation of a banking company with a specified bank, the accumulated loss and the unabsorbed depreciation of the amalgamating company shall be deemed to be the loss and the provisions of the Income Tax Act relating to set-off and carry forward of loss and allowance for depreciation shall apply accordingly[59]. The effect of this provision is that benefit of carry forward loss and unabsorbed depreciation is available only in case where a banking company is merged with SBI or subsidiary of SBI or a corresponding new bank[60].

Accounting: The system of maintaining accounts and accounting practices, are standardized and uniform in banks. Standards in regard to income recognition, classification of accounts and provisioning have also been standardized by RBI directives. Section 29 of the Banking Regulation Act, 1949 requires every bank to prepare a balance-sheet and profit and loss account in the forms set out in the Third Schedule to the Ac[61]t. Sub-section (3) of section 29 further provides that provisions of the Companies Act, 1956 relating to balance-sheet and profit and loss account shall apply to banking companies to the extent they are not inconsistent with the Banking Regulation Act. Hence, in view of such standardization, merger may not pose problems in relation to accounting practices except the need to fine-tune any divergent practices, in respect of specific heads of accounting[62].

IT integration : One critical area that would need careful consideration is integration of different technology platforms and software which not only have process and control implications but may involve substantial costs in terms of money and time and retraining of personnel. Integration of products and services[63]: In regard to actual banking operations, each bank has different nomenclatures for deposit schemes and loan products. Similarly, in internal working and inter-branch transactions, banks have different nomenclatures for debit and credit vouchers. On any merger, such variations in the schemes and products and other practices need to be integrated[64].

Swap Ratio: As regards the shareholders’ interest, the swap ratio could be decided mutually at the time of merger and normally does not pose much problem. Mergers abroad: Across the globe, the mergers have taken place in recent months[65]. For instance during August 2004, Japan™s Supreme Court ruling cleared the way for World™s largest bank by way of full takeover of UFJ by Mitsubishi Tokyo Financial Group. Similarly during June 2004, the Federal Reserve US approved the merger of JP Morgan Chase and Bank One Corp to form US 2nd largest banks with more than $ 1 trillion in assets[66].

Mergers of Public Sector Banks and Its Ramifications: Indian Perspective

Mergers in Indian banking sector have initiated through the recommendations of Narshimhan committee II. The committee recommended that the mergers between strong banks would make for greater commercial sense[67].

It has been widely reported that banks should not fear consolidation because India is in need of couple of global-sized banks[68]. The biggest whale in the Indian Banking waters, State Bank of India, is considered to be small fry in the global banking ocean[69].

Even cornering about 25 percent of the banking business in the country, SBI is ranked 60^th in the list of Top 1000 Banks in the world by the Banker in 2012[70]. Ideally, India should have 4 or 5 global-scale banks. Recently the Government is said to have SBI to do a detailed cost-benefit analysis of its mergers with its five associate banks. The bank not facing any tangible problem in merging two of its subsidiaries earlier might have worked as a trigger[71].

Actually bigger banks would be in a position to take the advantage of efficiencies of scale, scarce talent could be utilized more fruitfully than in a smaller bank, better exploitation of broad equity and capital utilization[72]. By experience one can say that larger the balance sheets you working on, more is the ability to weather economic ups and downs[73].

Suggestions and Conclusions

Banks are the important part of a country™s economy. In fact Bank works as a country™s back bone on which economic development depends[74]. It is not necessary to have banks more in number but to have banks large in size to operate efficiently. Large Banks can operate globally[75]. Large Banks would be in a position to take advantage of efficiencies of scale than in smaller Banks. Banks are the life-blood of the modern economy, so there is need to develop the Banking system of a country[76]. To have larger banks, there is need to have merger of Banks. To say suppose there are three banks in country Bank A, B and C. Bank A uses modern technology and Bank B has more skilled employees. If these two banks get merged these two will work more efficiently than Bank C. As said above State Bank of India after being merged is now ranked among 60^th of the world in the list of 1000 banks, so if many other banks are merged they can also be able to rank among world™s top banks[77].

Mergers of banks are seeking attention now days because there is need to reduce costs, need for global sized-business. Merger is not new concept in India, the mergers in 60s had taken place under the direction of R.B.I and as result the 566 banks in India in the year 1951 came down to 85 in the year 1969[78].

The Govt. wants Indian Banks to look and behave like global banks[79]. The Finance ministry has indicated that it will encourage merger of banks to create strong entities so it can compete with the world class banks[80].

The research paper is concluded by stating that merger of Public sector banks will improve the services rendered by them as weak bank will be equipped with new technologies after being merged.  As after being merged the banks would be in a position to take advantage of efficiencies of scale and capital utilization is possible it will help in economic growth in India.