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Mergers and Acquisitions in the Banking Sector: a Critical Study

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Mergers and Acquisitions in the Banking Sector: a Critical Study ISSN 2455-4782 MERGERS AND ACQUISITIONS IN THE BANKING SECTOR: A CRITICAL STUDY Authored by: Manoj Mohapatra* * Legal Associate at Gagrats, Advocates & Solicitors ______________________________________________________________________________ ANSTRACT A merger can be defined as a corporate strategy to combine two or more companies into one in order to enhance the financial and operational strengths of those organizations. Mergers and acquisitions involve a number of activities such as stake acquisition, control over assets etc. In India, mergers and acquisitions took a huge leap forward in the year 1969 and 1980 when a total of 20 major Indian banks were nationalized. Mergers between banks are done primarily for reasons such as (a) enlarging and expanding the capital assets of the bank, (b) realizing economies of scale, (c) diversifying services and (d) globalization. It is pertinent to note the importance of the law of competition in banking. The objective of competition law is to ensure that there is adequate production and supply, and also to enable goods and services to be available to the public at lower costs and with wider choices. Mergers can also possibly have anti-competitive effects. Therefore, it is necessary for mergers to be regulated by Competition law. A merger can also have an adverse impact on the parties who are involved such as the employees, shareholders, customers etc. Hence, it is highly essential for the interests of such constituencies to be adequately protected in case of a merger. Keywords: mergers, acquisitions, nationalization, competition law, tax 54 | P a g e JOURNAL ON CONTEMPORARY ISSUES OF LAW [JCIL] VOLUME 6 ISSUE 10 ISSN 2455-4782 INTRODUCTION In the banking sector, a merger could be undertaken: (a) between banks and (b) between a bank and a company. In case of merger between banks, S44A of the Banking Regulation Act 1949 would apply whereas in case of mergers between a bank and a company, S230-233 of the Companies Act 2013 would apply. When discussing the case of a merger between a bank and a company, it is very important for us to discuss the recent developments in cases where a bank and an NBFC merge. However, our task here is not just to understand the regulatory mechanisms of mergers and acquisitions but to critically analyse them. If we dig deep into the critical issues we would open our minds to a number of possible concerns in a case of a merger. Therefore, in this article we would firstly, discuss the nationalization era and the need for the government to take such an initiative. Secondly, we would analyse with examples the regulatory mechanism surrounding a merger between banks and between banks and NBFC’s. Thirdly, we would look into the competition law issues that arise in a merger. Fourthly, we will discuss the adverse effect of employees, shareholders and customer in case of a merger. Lastly, we will discuss the tax implications that arise in case of a merger. THE ERA OF NATIONALIZATION Prior to understanding the nationalization period, it would be appropriate for us to gain some understanding as to what made the government take this step in this very first place. The All India Rural Credit Survey Committee was established in the year 19511 in order to assess the position of the banks. The Committee provided that the then Imperial Bank of India was unable to expand its banking operations adequately. The suggestion of the Committee to convert the Imperial Bank of India into State Bank of India was accepted and the Government nationalized the Imperial Bank that later emerged as the State Bank of India. Furthermore, with regards to private banks there were concerns that the management of those banks was more concerned with acting in their interests and only directing advances to the large and medium scale industries. As a result of 1 D Thorner, “The All-India Rural Credit Survey: Viewed as a Scientific Enquiry” The Economic Weekly 1960. 55 | P a g e JOURNAL ON CONTEMPORARY ISSUES OF LAW [JCIL] VOLUME 6 ISSUE 10 ISSN 2455-4782 this, the small-scale industries were affected drastically. Therefore, in order to aim for the overall development of the industry, the Government planned for nationalization of the banks. In order to ensure that the managers in the big private banks did not just limit the banking strategies to large-scale industries, the Government of India on 1st of February 1969 imposed “social control” on the banks. The Government did so by imposing certain restrictions on the loans and advances given by the Banking Companies and also on the composition on the Board of Directors of the banks2. The Government of India, therefore, issued an ordinance on 19th July 1969 pursuant to which 14 commercial banks were nationalized. Initially, the Companies (Acquisition and Transfer of Undertakings) Bill 1969 was passed. However, the Bill was challenged before the Supreme Court in the case of Rustom Cowasjee Cooper v UOI3 held that although the Bill was within the competence of the Parliament, it was totally void. The Supreme Court gave two reasons in its judgment. Firstly, the Act permitted nationalization of some commercial banks and prohibiting them to carry an business activity but permitted other Indian, foreign banks to carry on their banking businesses. Secondly, the principles formulated to determine compensation of the banks were illusory and irrelevant. Therefore, as a result of the judgment the undertakings of the 14 banks were reverted. However, in order to regain control the President of India promulgated another Ordinance that removed the primary objections of “hostile discrimination” and “illusory compensation” which was raised by the Supreme Court. The nationalization was, therefore, pursuant to the new Act Banking (Acquisition and Transfer of Undertakings) 1970. However, the Act was later amended by the Banking (Acquisition and Transfer of Undertakings) (Amendment) Act 1994 pursuant to which the public can hold the share capital of up to 49% and the Government of India would own the rest. Later, on 15th April 1980 further six banks were nationalised as under the Banking Companies (Acquisition and Transfer of Undertakings) Act 1980. The Ordinance not only transferred and vested the undertakings of the six banks in the new banks but also provided for the payment for such acquisitions, the management of the new banks and other banks and other miscellaneous provisions. 2ML. Tannan, “Tannan’s Banking Law and Practice in India” (21st, Wadhwa 2005) 64. 31970 AIR 564. 56 | P a g e JOURNAL ON CONTEMPORARY ISSUES OF LAW [JCIL] VOLUME 6 ISSUE 10 ISSN 2455-4782 Now, upon understanding the nationalisation era of the banks it would be appropriate to focus as to whether nationalisation was a “good or a bad” step? Nationalisation was considered to be a major step in ensuring that the economic power of the nation is not concentrated in the hands of a few organizations. So, what could be advantages of nationalisation? Firstly, nationalisation has succeeded in ensuring even people in the rural area can avail the banking services. Secondly, it was also a major step in ensuring the protection of the rights and interests of the depositors and also enhancing the confidence of the public in the banking institutions. However, it can also be argued that during the period of nationalisation the shareholders of various institutions were forced to sell their stakes that they held in the institution. Therefore, there are advantages and disadvantages that one could argue of but it was nevertheless a good step taken by the Government of India. MERGERS: WHY DO BANKS MERGE? The Indian Economic crisis in the year 1991 made the Government of India appoint several committees to understand the evolving needs of the banking sector. Under the Chairmanship of M. Narsimham, two expert committees were established. The Narsimham Committee-II was the first committee to extensively discuss the scope of mergers in India. The Narsimham Committee proposed for mergers between banks and also between banks and NBFC’s. The Committee proposed that mergers should be based on synergies and also must certainly make commercial sense4. Mergers between public sector banks can also be beneficial if they lead to rationalization of the workforce and the branches of the institution. The RBI has through a circular accepted the recommendations of the Committee and has allowed for a merger between a NBFC and a bank5. The Committee very importantly identified the fact that the mergers should not be considered as a means of “bailing out the weak banks”. It is clear to us that a number of mergers between SBI and its associates have been done with the view to rescue the banks that were financially very weak. 4 Committee on Banking Sector Reforms (Narsimham Committee-II)< https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?ID=251> accessed on 1st December 2017. 5 (Circular MPD.BC.196/07.01.279/99- 2000 Dt. 27.4.2000). 57 | P a g e JOURNAL ON CONTEMPORARY ISSUES OF LAW [JCIL] VOLUME 6 ISSUE 10 ISSN 2455-4782 According to the Committee mergers should be between strong banks or between strong financial institutions because then that would make much more commercial sense. It was addressed by the Committee that merger could be a very viable solution to the problems of weak banks but must only be done after clearing the balance sheet of the weak banks. If there were no response to take over a weak bank then it would be appropriate to adopt for a Restructuring Commission so as to safeguard the interests of the depositors and employees and also to deal with the negative externalities. Now, it would be appropriate for us to understand the reasons that motivate banks to merge.
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