Mergers and Acquisitions of Banks in Post-Reform India

SPECIAL ARTICLE Mergers and Acquisitions of Banks in Post-Reform India T R Bishnoi, Sofia Devi A major perspective of the Reserve Bank of India’s n the Reserve Bank of India’s (RBI) First Bi-monthly banking policy is to encourage competition, consolidate Monetary Policy Statement, 2014–15, Raghuram Rajan (2014) reviewed the progress on various developmental and restructure the system for financial stability. Mergers I programmes and also set out new regulatory measures. On and acquisitions have emerged as one of the common strengthening the banking structure, the second of “fi ve methods of consolidation, restructuring and pillars,” he mentioned the High Level Advisory Committee, strengthening of banks. There are several theoretical chaired by Bimal Jalan. The committee submitted its recom- mendations in February 2014 to RBI on the licensing of new justifications to analyse the M&A activities, like change in banks. RBI has started working on the framework for on-tap management, change in control, substantial acquisition, licensing as well as differentiated bank licences. “The intent is consolidation of the firms, merger or buyout of to expand the variety and effi ciency of players in the banking subsidiaries for size and efficiency, etc. The objective system while maintaining fi nancial stability. The Reserve Bank will also be open to banking mergers, provided competi- here is to examine the performance of banks after tion and stability are not compromised” (Rajan 2014). mergers. The hypothesis that there is no significant Mergers and acquisitions (M&A) have been one of the improvement after mergers is accepted in majority of measures of consolidation, restructuring and strengthening of cases—there are a few exceptions though. Therefore, banks. M&A in the banking sector seeks to enlarge the size of banks to tap economies of scale, or prevent bank failure. Motives the strategy of M&A to consolidate banks for purposes of of bank mergers and amalgamations vary from change of efficiency seems flawed. Future banking policy must ownership to enhancing size for effi ciency gains. Thus, M&A in take note of this empirical reality and long-drawn Indian banking needs to be examined in the context of the experience of the past two decades. changing banking scenario and global economic environment. This study examines RBI’s policy of M&A of banks from the perspective of effi cient banking structure. In Section 1, we discuss, in brief, theory of M&A. In Section 2, we describe the regulatory framework of M&A in India. Section 3 carries a review of literature, followed by a Section 4 on trends in M&A. In Section 5, we analyse M&A. The next section concludes with a short summary. 1 Theory of Mergers and Acquisitions There are several theoretical arguments to analyse M&A activities. According to Marris (1964), and Manne (1965), the takeover threat is a process to discipline managers who devi- ate from profi t maximisation. Grossman and Hart (1981) argue that a takeover is a result of undervaluation of a company in the stock market. Linter (1971), Levy and Sarnat (1970), and Lewellen (1971) have looked at takeovers and mergers as ways to diversify the business risks of a fi rm by operating in differ- Our grateful thanks to the referee for expert comments and suggestions ent areas without going through the initial stages involved in for improvements in the paper. starting a new company. T R Bishnoi ([email protected]) is Reserve Bank of India Hay and Morris (1991: 686) have classifi ed the motives Chair Professor, Faculty of Commerce, The MS University of Baroda, behind mergers and takeovers by fi rms into the transactions Vadodara. Sofi a Devi ([email protected]) teaches economics at and the type of markets. The transactions can be subdivided The MS University of Baroda, Vadodara. into four categories: agreed merger, contested takeovers, 50 SEPTEMBER 12, 2015 vol L no 37 EPW Economic & Political Weekly SPECIAL ARTICLE divestment and management buyouts. Viewed from the per- This section notes banks that are weak, unsound, or not properly spective of markets, mergers can be classifi ed into three cate- managed can be merged with those that are on a sound footing. gories: horizontal mergers, vertical mergers and conglomerate RBI’s policy is to encourage amalgamation to protect the mergers. A horizontal merger is between two or more compa- interest of depositors in particular and strengthen the banking nies that compete in the same business and geographical mar- structure in the area in general. RBI also encourages banking ket. A vertical merger is a combination of two or more fi rms integration through the transfer of assets and liabilities of small involved in different stages of production or distribution of and unsound, weak and small units into fewer and strong the same product, and can be either forward or backward banking units. Section 36AE of the BRA gives central govern- merger. A conglomerate merger is a combination of fi rms en- ment power—it requires a consent report from RBI—to acquire gaged in unrelated lines of business activity. The type of M&A any banking unit in the interest of the depositors, in the inter- also dictates the acquisition logic, the framework for the est of banking policy, or for the better provision of credit to any evaluation of targets, the acquisition target profi le and the particular section of the community (nationalisation of banks). post-acquisition integration. Thus, 14 big banks were nationalised in 1969 to strengthen The objectives of the fi rms that opt for mergers may be public sector undertaking (PSU) dominance. It is assumed that all attributed to: (i) change in management, (ii) change in control, these processes contribute towards an effi cient and optimal bank- (iii) substantial acquisition, (iv) consolidation of the fi rms, ing structure. Thus, the restructuring and consolidation through (v) merger or buyout of subsidiaries for size and effi ciency, etc. strategy of M&A is a continuous process to improve the working The present study analyses the performance of banks that of Indian banking and steer it towards optimal structure in terms went in for mergers during and after the fi nancial sector of size distribution, ownership and organisational diversity. reforms. The main emphasis is to see whether M&As in bank sector have contributed to overall growth, and economies of 3 Literature Survey scale and effi ciency of the banks. Various studies on the effect of bank mergers on performance have been conducted in many countries. Cost–benefi t analyses 2 Regulatory Framework in India showed bank M&A produced mixed results. Different tools and The Banking Regulation Act (BRA), 1949 provides the regulatory banking parameters were used by analysts for measuring bank framework for M&A in India’s banking sector. The act provides performance. Some studies found that mergers can potentially for two types of amalgamations: (i) voluntary, and (ii) com- lower costs and increase profi t effi ciency (Shaffer 1993; pulsory. RBI has the discretionary power to approve the volun- Akhavein et al 1997), while others concluded that mergers tary amalgamation of two banking companies under Section have not resulted in any signifi cant improvement in effi ciency 44(A) of the BRA. Compulsory amalgamations are induced or (Berger and Humphrey 1994; Rhoades 1993). A study by forced by RBI under Section 45 of the BRA, in public interest or Rhoades (1993) found that horizontal (in-market) mergers dur- in the interest of the depositors of a distressed bank, or to ing 1980–86 did not improve total cost effi ciency. secure proper management of a banking company, or in the In an earlier study, Alhadeff and Alhadeff (1955) examined interest of the banking system. In this regard, the amalgamation bank mergers of 208 United States (US)-based banks between will become effective on the date indicated in the notifi cation January 1953 and mid-1954. They analysed the causes of the issued by the government. The act does not require obtaining mergers and attempted to determine their signifi cance for the RBI approval in case of voluntary mergers or acquisitions of fi - ongoing merger movement. Bank-by-bank basis data shows nancial businesses by banking institutions. Guidelines regard- that management issues and matters pertaining to cost and ing the process of merger proposal, determination of swap profi t ratios, branch banking, growth rates, legislation, anti- ratios, disclosures, buying/selling norms of shares before and trust laws, and market structures were behind the mergers. during the process of merger are laid down by RBI for volun- The study shows that large- and middle-size banks acquired tary mergers involving banking companies, as well as between considerably small banks during the period. non-banking and banking companies. Rhoades and Yeats (1974) analysed a stratifi ed random sam- Till 1960, amalgamations of banks took place on voluntary ple of 600 US commercial banks over 1960–71. Theirs was an basis under Section 44A of the BRA as there was no other provision attempt to update the fi ndings of Alhadeff and Alhadeff (1955). for the purpose. Though there was urgent need to strengthen They wanted to see if Alhadeff and Alhadeff’s major conclu- the banking system by eliminating the small and weak banks, sion still holds, and also to determine the impact of mergers on the result of voluntary bank amalgamation was very poor and dis- growth. The fi ndings supported the hypothesis that large couraging. In view of this, RBI acquired statutory powers banks grow less than the system as a whole. The regressions through an amendment in the BRA in 1960 for reconstruction fi tted for bank consolidation yielded unambiguous results and or compulsory amalgamation of banks.

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