M&As in the Indian Banking Sector - Strategic and Financial Implications
Like all business entities, banks want to safeguard against risks, as well as exploit available opportunities indicated by existing and expected trends. M&As in the banking sector have been on the rise in the recent past, both globally and in India. In this backdrop of emerging global and Indian trends in the banking sector, this article illuminates the key issues surrounding M&As in this sector with the focus on India. It seeks to explain the motives behind some M&As that have occurred in India post-2000, analyse the benefits and costs to both parties involved and the consequences for the merged entity. A look at the future of the Indian banking sector, and some key recommendations for banks, follow from this analysis.
The International banking scenario has shown major turmoil in the past few years in terms of mergers and acquisitions. Deregulation has been the main driver, through three major routes - dismantling of interest rate controls, removal of barriers between banks and other financial intermediaries, and lowering of entry barriers. It has lead to disintermediation, investors demanding higher returns, price competition, reduced margins, falling spreads and competition across geographies forcing banks to look for new ways to boost revenues. Consolidation has been a significant strategic tool for this and has become a worldwide phenomenon, driven by apparent advantages of scale-economies, geographical diversification, lower costs through branch and staff rationalization, cross-border expansion and market share concentration. The new Basel II norms have also led banks to consider M&As.
This article looks at some M&As that have happened post-2000 in India to understand the intent (of the targets and the acquirers), resulting synergies (both operational and financial), modalities of the deal, congruence of the process with the vision and goals of the involved banks, and the long term implications of the merger. The article also analyses emerging future trends and recommends steps that banks should consider, given the forecasted scenario.
The Indian Banking Sector
The history of Indian banking can be divided into three main phases 1 :
Phase I (1786- 1969) - Initial phase of banking in India when many small banks were set up
Phase II (1969- 1991) - Nationalisation, regularisation and growth
Phase III (1991 onwards) - Liberalisation and its aftermath
With the reforms in Phase III the Indian banking sector, as it stands today, is mature in supply, product range and reach, with banks having clean, strong and transparent balance sheets. The major growth drivers are increase in retail credit demand, proliferation of ATMs and debit-cards, decreasing NPAs due to Securitisation, improved macroeconomic conditions, diversification, interest rate spreads, and regulatory and policy changes (e.g. amendments to the Banking Regulation Act).
Certain trends like growing competition, product innovation and branding, focus on strengthening risk management systems, emphasis on technology have emerged in the recent past. In addition, the impact of the Basel II norms is going to be expensive for Indian banks, with the need for additional capital requirement and costly database creation and maintenance processes. Larger banks would have a relative advantage with the incorporation of the norms.
Key M&A Deals 2000 onwards: Some Case Studies
The cases chosen for the purpose of this study were selected based on their prominence and recency (all post-2000) to ensure that the motives driving the deals will remain relevant in the current context.
HDFC Bank Acquires Centurion Bank of Punjab (May '08)
For HDFC Bank, this merger provided an opportunity to add scale, geography (northern and southern states) and management bandwidth. In addition, there was a potential of business synergy and cultural fit between the two organizations.
For CBoP, HDFC bank would exploit its underutilized branch network that had the requisite expertise in retail liabilities, transaction banking and third party distribution. The combined entity would improve productivity levels of CBoP branches by leveraging HDFC Bank's brand name.
The deal created an entity with an asset size of Rs 1,09,718 crore (7th largest in India), providing massive scale economies and improved distribution with 1,148 branches and 2,358 ATMs (the largest in terms of branches in the private sector). CBoP's strong SME relationships complemented HDFC Bank's bias towards high-rated corporate entities.
There were significant cross-selling opportunities in the short-term. CBoP management had relevant experience with larger banks (as evident in the Centurion Bank and BoP integration earlier) managing business of the size commensurate with HDFC Bank.
The merged entity will not lend home loans given the conflict of interest with parent HDFC and may even sell down CBoP's home-loan book to it. The retail portfolio of the merged entity will have more by way of unsecured and two-wheeler loans, which have come under pressure recently.
Standard Chartered Acquires ANZ Grindlays Bank (November '00)
Standard Chartered wanted to capitalise on the high growth forecast for the Indian economy. It aimed at becoming the world's leading emerging markets bank and it thought that acquiring Grindlays would give it a well-established foothold in India and add strength to its management resources. For ANZ, the deal provided immediate returns to its shareholders and allowed it to focus on the Australian market. Grindlays had been a poor performer and the Securities Scam involvement had made ANZ willing to wind up.
Standard Chartered became the largest foreign bank in India with over 56 branches and more than 36% share in the credit card market. It also leveraged the infrastructure of ANZ Grindlays to service its overseas clients. 2
For ANZ, the deal, at a premium of US $700 million over book value, funded its share buy-back in Australia (a defence against possible hostile takeover). The merger also greatly reduced the risk profile of ANZ by reducing its exposure to default prone markets. 3
The post merger organisational restructuring evoked widespread criticism due to unfair treatment of former Grindlays employees. 4
There were also rumours of the resulting organisation becoming too large an entity to manage efficiently, especially in the fast changing financial sector.
Bank of Baroda Acquires South Gujarat Local Area Bank Ltd (June '04)
According to the RBI, South Gujarat Local Area Bank had suffered net losses in consecutive years and witnessed a significant decline in its capital and reserves5. To tackle this, RBI first passed a moratorium under Section 45 of the Banking Regulation Act 1949 and then, after extending the moratorium for the maximum permissible limit of six months6, decided that all seven branches of SGLAB function as branches of Bank of Baroda. The final decision about the merger was of the Government of India in consultation with the RBI. Bank of Baroda was against the merger, and protested against the forced deal7.
The clients of SGLAB were effectively transferred to Bank of Baroda, deriving the advantage of dealing with a more secure and bigger bank. SGLAB did not benefit much, except that it was able to merge with a bigger bank and able to retain its branches and customers, albeit under a different name. Since BoB was a large entity (total assets of Rs. 793.2 billion at the time of merger), addition of a small liability did not affect it much. Albeit minor, it obtained seven more branches and the existing customers of SGLAB. This further strengthened its position in rural Gujarat.
There was no widespread criticism or any apparent drawback of the merger since the financials involved were not very high.
ICICI Bank Ltd. Acquires Bank of Madura (March '01)
ICICI Bank Ltd wanted to spread its network, without acquiring RBI's permission for branch expansion. BoM was a plausible target since its cash management business was among the top five in terms of volumes. In addition, there was a possibility of reorienting its asset profile to enable better spreads and create a more robust micro-credit system post merger. 8
BoM wanted a (financially and technologically) strong private sector bank to add shareholder value, enhance career opportunities for its employees and provide first rate, technology-based, modern banking services to its customers.
The branch network of the merged entity increased from 97 to 378, including 97 branches in the rural sector.9 The Net Interest Margin increased from 2.46% to 3.55 %. The Core fee income of ICICI almost doubled from Rs 87 crores to Rs 171 crores. IBL gained an additional 1.2 million customer accounts, besides making an entry into the small and medium segment. It possessed the largest customer base in the country, thus enabling the ICICI group to cross-sell different products and services.
Since BoM had comparatively more NPAs than IBL, the Capital Adequacy Ratio of the merged entity was lower (from 19% to about 17%). The two banks also had a cultural misfit with BoM having a trade-union system and IBL workers being young and upwardly mobile, unlike those for BoM. There were technological issues as well as IBL used Banks 2000 software, which was very different from BoM's ISBS software. With the manual interpretations and procedures and the lack of awareness of the technology utilisation in BoM, there were hindrances in the merged entity.
Oriental Bank of Commerce Acquires Global Trust Bank Ltd (August '04)
For Oriental Bank of Commerce there was an apparent synergy post merger as the weakness of Global Trust Bank had been bad assets and the strength of OBC lay in recovery.10 In addition, GTB being a south-based bank would give OBC the much-needed edge in the region apart from tax relief because of the merger. GTB had no choice as the merger was forced on it, by an RBI ruling, following its bankruptcy.
OBC gained from the 104 branches and 276 ATMs of GTB, a workforce of 1400 employees and one million customers. Both banks also had a common IT platform. The merger also filled up OBC's lacunae - computerisation and high-end technology. OBC's presence in southern states increased along with the modern infrastructure of GTB.
The merger resulted in a low CAR for OBC, which was detrimental to solvency. The bank also had a lower business growth (5% vis-a-vis 15% of peers). A capital adequacy ratio of less than 11 per cent could also constrain dividend declaration, given the applicable RBI regulations.
Motives Behind Consolidation
Based on the cases, we can narrow down the motives behind M&As to the following :
Growth - Organic growth takes time and dynamic firms prefer acquisitions to grow quickly in size and geographical reach.
Synergy - The merged entity, in most cases, has better ability in terms of both revenue enhancement and cost reduction.
Managerial efficiency - Acquirer can better manage the resources of the target whose value, in turn, rises after the acquisition.
Strategic motives - Two banks with complementary business interests can strengthen their positions in the market through merger.
Market entry -
Cash rich firms use the acquisition route to buyout an established player in a new market and then build upon the existing platform.
Tax shields and financial safeguards -
Tax concessions act as a catalyst for a strong bank to acquire distressed banks that have accumulated losses and unclaimed depreciation benefits in their books.
Regulatory intervention -
To protect depositors, and prevent the de-stabilisation of the financial services sector, the RBI steps in to force the merger of a distressed bank.
Future of M&A in Indian Banking
In 2009, further opening up of the Indian banking sector is forecast to occur due to the changing regulatory environment (proposal for upto 74% ownership by Foreign banks in Indian banks). This will be an opportunity for foreign banks to enter the Indian market as with their huge capital reserves, cutting-edge technology, best international practices and skilled personnel they have a clear competitive advantage over Indian banks. Likely targets of takeover bids will be Yes Bank, Bank of Rajasthan, and IndusInd Bank. However, excessive valuations may act as a deterrent, especially in the post-sub-prime era.
Persistent growth in Indian corporate sector and other segments provide further motives for M&As. Banks need to keep pace with the growing industrial and agricultural sectors to serve them effectively. A bigger player can afford to invest in required technology. Consolidation with global players can give the benefit of global opportunities in funds' mobilisation, credit disbursal, investments and rendering of financial services. Consolidation can also lower intermediation cost and increase reach to underserved segments.
The Narasimhan Committee (II) recommendations are also an important indicator of the future shape of the sector. There would be a movement towards a 3-tier structure in the Indian banking industry: 2-3 large international banks; 8-10 national banks; and a few large local area banks. In addition, M&As in the future are likely to be more market-driven, instead of government-driven. 11
Based on the trends in the banking sector and the insights from the cases highlighted in this study, one can list some steps for the future which banks should consider, both in terms of consolidation and general business. Firstly, banks can work towards a synergy-based merger plan that could take shape latest by 2009 end with minimisation of technology-related expenditure as a goal. There is also a need to note that merger or large size is just a facilitator, but no guarantee for improved profitability on a sustained basis. Hence, the thrust should be on improving risk management capabilities, corporate governance and strategic business planning. In the short run, attempt options like outsourcing, strategic alliances, etc. can be considered. Banks need to take advantage of this fast changing environment, where product life cycles are short, time to market is critical and first mover advantage could be a decisive factor in deciding who wins in future. Post-M&A, the resulting larger size should not affect agility. The aim should be to create a nimble giant, rather than a clumsy dinosaur. At the same time, lack of size should not be taken to imply irrelevance as specialised players can still seek to provide niche and boutique services.
is an Associate Professor in the Corporate Strategy and Policy Area at IIM Bangalore. He is a Fellow of Indian Institute of Management, Ahmedabad. (1998) and did his Post Graduation in Forestry Management (PGDFM) from Indian Institute of Forest Management (IIFM), Bhopal (1993). He can be reached at
(PGP 2007-09) holds a Petroleum Engineering Degree from Indian School of Mines Dhanbad. Gourav can be reached at
(PGP 2007-09) holds a Mechanical Engineering Degree from Birla Institute of Technology Ranchi. Arvind can be reached at
Strategy, Banking, Financial Services, India, Mergers, Acquisitions
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