Consolidation in Indian Banking Sector

Posted in Finance Articles, Total Reads: 1001 , Published on 03 September 2017
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The establishment of the Bank of Bengal in Calcutta in 1786 marked the inception of the commercial banking institutions in India. Over the period of time, numerous reforms were introduced in the banking sector towards building a robust financial system in the nation. The economic reforms of early 1990s helped in the diversification of the economy and strengthening of the operational banking infrastructure. It also enabled competitive financial scenario with the entry of new private sector banks such as HDFC Bank, ICICI Bank, UTI Bank and IDBI Bank. Since then, the banking sector in India has witnessed tremendous growth over the years.


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Consolidation in Banking Sector

The Merger and Acquisitions in Indian banking sector were instigated on the recommendations of Narasimham committee II. These recommendations were based on the idea that whole is greater than sum of its parts (force multiplier effect) and thus merger would enable better economic and commercial growth of the financial institutions and in turn, of the nation. Merger involves series of legal and Administrative measures to add the bank assets of the bidder bank assets and Liabilities to the target banks balance sheet. Over the years, there has been thrust by the Indian government towards the consolidation within public sector banks for the reformation of the banking sector. It is aimed at the reduction of the number of present number of 27 for public sector banks to enable better monitoring and strengthening. In 2015, the merger of the State Bank of India (SBI) with its five associate banks was approved by the cabinet.

Pros of Mergers

The consolidation of the banks would definitely help strengthen the bargaining power of the banks, reduce operational expenditures, improve supervision, enhance capital efficiency, aid in the recovery of bad debts and allow the sharing of technical know-how. It will thus help leverage the advantage of the economies of scale. This is highly crucial given the high capital requirements for the large scale infrastructure projects of the nation.

Issues with Merger

The consolidation of banks could create significant risks in the current scenario of high stressed assets across banks. These risks could deter the banking system from any potential long-term benefits. Further, there is an issue regarding the organizational hierarchy and employee benefit schemes in the consolidated structure. For instance, it is essential to consider the provision of adequate system to define the seniority level of employees of the merging banks in the consolidated system.

Key for Successful Consolidation

One of the crucial factors in order to achieve the anticipated results of consolidation is the rationalization of cost. This would facilitate the reduction in the number of branches of different banks in the same area. This is particularly important in the urban regions due to more density of branches.

• Geographical Location

The key idea here is the promotion of geographical synergies. This would allow the banks to extend their geographical out-reach and customer diversification. There is however a possible issue related to the lack of awareness about the bank in a different geographical location.

• Technology

The other idea is to ensure that there is a technological synergy among the consolidated banks. This is particularly significant in today’s world when the banking system is rapidly adapting to the modern technology. The lack of analogous technical platforms could prove to be a major hindrance to the successful merger.

• Employees

This factor is concerned to the employees of the banks being merged. The employees are apprehensive about a possible loss of organizational identity resulting from merger. There is also a need to provide proper channels for the role identification in the merged structure. The expertise and experience of the employees needs to be properly identified and must be synchronous with the aim of the consolidated organization.

Previous Mergers

• HDFC Bank & Centurion Bank of Punjab (CBoP)

This merger happened in the year 2008. The value of this merger was $2.5 billion. The shareholders of CBoP got one share of HDFC for 29 shares of CBoP. Some of the factors to determine the financial performance of the banks after the merger were analyzed and the results indicate that the positive effects outweigh the negatives and thus an increased performance is observed.

• ICICI Bank & Bank of Rajasthan

This merger happened in the year 2010. The shareholders of Bank of Rajasthan got 25 shares of HDFC for 118 shares of Bank of Rajasthan. The merger provided a strong geographical outreach to both the banks together with a stronger customer base. The analysis of the different financial parameters indicates that there is satisfactory growth observed after the merger for both the banks.

Conclusion

The consolidation of the banks would lead to positive results on many fronts. The merger would enhance the cash balance which is imperative to support the infrastructure growth of the nation. Also, it would enable the banks to feature on the global front and help strengthen the financial institution structure of India. However, it is essential to identify the key issues present and determine a suitable plan to mitigate them. There is a need to develop a comprehensive merger plan while accounting for suitability in terms of geographical location, technology and employee welfare.

This article has been authored by Vidit Mohan from IIM Raipur

References

• Moriarty, S.E. (1994). PR and IMC: The Benefits of Integration, Public Relations Quarterly; 39(3), 35-38.

• Solomon, E. H. (1999). What should regulators do about consolidation and electronic money? Journal of Banking and Finance; 23.

• Ramani V.V., and Mrudula E. (2008). Mergers and Acquisitions in Service Sector: Changing Global Scenario. ICFAI (Hyderabad).

• Beena, P. L. (2004). Towards understanding the merger wave in the Indian corporate sector – a comparative perspective, working paper 355, CDS, Trivandrum, 1-44.

• Loderer, C., and Martin K. (1992). Post-Acquisition Performance of Acquiring Firms. Financial Management; Vol 21, No 3, 69-79.


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