5 Bank Mergers and
Acquisitions
UNIT 16 BANK MERGERS AND
ACQUISITIONS
ObjectivesAfter reading this unit you should be able to:
l understand the meaning and types of mergers in general; l appreciate the need for bank mergers;
l describe the legal framework in which merger takes place; and l analyse some bank merger case studies.
Structure
16.1 Introduction 16.2 Types of Mergers 16.3 Motives for Merger 16.4 Bank Mergers 16.5 Legal Framework
16.6 Procedure for Amalgamation of Banking Companies 16.7 Restructuring of Banks and Some Relevant Committees 16.8 Case Studies
16.9 Summary 16.10 Key Words
16.11 Self Assessment Questions 16.12 Further Readings
Appendix
16.1 INTRODUCTION
The Liberalisation, Privatisation and Globalisation process which was started in early 1990s has brought so many changes in the economic scene of the country. This process of economic reforms has brought competition not only from India but also from Overseas. In order to compete with these competitors, Indian corporate sector has tried to reorganise and restructure the companies by adopting various strategies. These strategies include Mergers, Acquisitions, Joint ventures, Spin off,
Divestitures, etc.
Restructuring can be broadly classified into three types. They are: a) Portfolio Restructuring,
b) Financial Restructuring, and c) Organisational Restructuring.
If a firm is reshuffling its assets by selling some of its existing production facilities or acquiring some new facilities to produce the feeding raw–material for the main product, it is called portfolio restructuring. In financial restructuring the composition of debt and equity are shuffled. In the process of organisational restructuring, Organisational Structure is revisited and changes are made. All these restructurings are aimed to achieve better results for the company.
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Special Issues Figure 16.1 presents a broad view of the different forms of Organisational
Restructuring which can be seen these days in the Corporate World:
Some of the sectors which saw a lot of activity in the last decade in relation to mergers are : fast moving consumer goods sector, financial services sector, cement, paper, chemicals and tyre industries. Some of the corporates which are involved actively in this activity are: Reliance group, Hindustan Levers, Aravind group, Eicher group, Vijay Mallaya, Chhabria group, etc. In the Banking sector ICICI Bank, HDFC Bank, and Punjab National Bank (PNB) are actively involved in the merger activity . In this unit we shall discuss the bank mergers in detail.
16.2 TYPES OF MERGERS
When a company acquires another company, the acquiring company is called the ‘Acquirer Company ’and the company which is being acquired is called the ‘Acquired Company’. The acquirer company has two alternatives for dealing the acquired company. First the acquiring company can takeover the management of acquired company and run it as a separate company with its own new Management. This is called the ‘Takeover’ or the ‘Change of Management’. The second alternative for Acquirer Company is to merge the acquired company into itself. This is called the ‘merger’. In this unit we shall be discussing mostly about the mergers. In case of mergers there could be three situations. They are:
i) The acquirer company merges the acquired company into itself and the acquired company looses its entity,
ii) The acquirer company may merge with the acquired company and may give up its own identity. Normally this kind of merger takes place for getting some Tax benefits.
iii) There could be a situation in which both the acquirer company and acquired company loose their identity and form a altogether new company with a new name.
Mergers can be broadly classified into three types. They are vertical mergers, horizontal mergers, and conglomerate mergers. Let us understand each of these types hereunder:
a) Vertical Mergers: If a company acquires another company, which buys the
products of Acquirer Company and uses them as raw material in its production process or acquires a company from which the company buys its raw material, then it is called vertical merger. If a bank acquires a marketing company which provides the bank, marketing services for its products as an outsourcing solution, then it can be stated as vertical merger.
Sell-offs l Spin-offs l Split – offs l Split – ups l Divestitures l Equity Carve-outs
Forms of Restructuring Business Firms
Corporate Control l Premium Buy-backs l Standstill Agreements l Anti-takeover Amendments l Proxy contests Changes in Ownership Structure l Exchange Offers l Share Repurchases l Going Private l Leveraged Buy-outs
Source: Adapted from Weston, Chung and Hong, 1998, Mergers, Restructuring and Corporate Control
Expansion l Mergers and
acquisitions
l Tender Offers l Joint Ventures
7 Bank Mergers and
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b) Horizontal Mergers: If a bank acquires another bank and merges it into itself,
it is known as Horizontal merger. Similarly if a company acquires another company which is operating in the same area of its operation and merges it into itself, it is said to be horizontal merger. This could be to increase the market share, or to get technological advantages, or to enter into the new geographical areas, or to acquire any other strategic advantages.
c) Conglomerate Mergers: If a company acquires a company which is not at all
connected with the area of operations of acquiring company, it is said to be a conglomerate merger. For example, if a bank acquires a cement company and merges it into itself, then it can be treated as conglomerate merger.
Depending upon the situation and need of the acquiring company, it may adopt any one of the above types of mergers.
16.3 MOTIVES FOR MERGER
Any acquisition takes place with a number of motivations culminating in a positive synergy (2+2=5 relationship). This means that the performance of the combined company is more than the sum of the performance of erstwhile two independent companies. Let us, now, examine the motives behind the merger.
A study conducted in the U.S.A., identified 12 motives that promote merger and acquisition activity. They are given below in the order of their priority:
1. Taking advantage of awareness that a company is undervalued. 2. Achieving growth more rapidly than by internal effort.
3. Satisfying market demand for additional products/services. 4. Avoiding risks of internal start-ups of expansion.
5. Increasing earnings per share.
6. Reducing dependence on a single product/service. 7. Acquiring market share or position.
8. Offsetting seasonal or cyclical fluctuations in the present business. 9. Enhancing the power and prestige of the Owner, CEO, or Management. 10. Increasing utilization of present resources, et., physical plant and individual
skills.
11. Acquiring outstanding Management or Technical Personnel. 12. Opening new markets for present products/services.
A survey, conducted in 1955, by the U.S. Federal Trade Commission, to find out why companies choose the merger and acquisition route, listed seven major benefits of acquisition for the acquiring company. They are:
1. Gaining additional capacity to supply to a market already being serviced by the acquirer.
2. Gaining extended product lines.
3. Achieving diversification of product base.
4. Gaining facilities to produce goods purchased earlier. 5. Gaining facilities to process or distribute goods sold earlier. 6. Gaining access to additional markets.
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Special Issues In India, the merger and takeover phenomenon in the past was understood largely as
one of the sick units being taken over by healthy ones. This is because of the reason that Sec. 72A of the Income Tax Act, 1961, provides for the carry forward of losses. The advantage that the merging corporations get is that the book losses of the sick corporation get written off against the future profits, thus saving the profitable corporations some tax outflow.
As far as the Banking sector is concerned following reasons are more relevant:
1. Growth with External Efforts: With the economic liberalization the competition
in the banking sector has increased and hence there is a need for mega banks, which will be intensely competing for market share. In order to increase their market share and the market presence some of the powerful banks have started looking for banks which could be merged into the acquiring bank. They realized that they need to grow fast to capture the opportunities in the market. Since the internal growth is a time taking process, they started looking for target banks.
2. Deregulation: With the liberalisation of entry barriers, many private banks came
into existence. As a result of this there has been intense competition and banks have started looking for target banks which have market presence and branch network.
3. Technology: The new banks which entered as a result of lifting of entry barriers
have started many value added services with the help of their technological superiority. The older banks which can not compete in this area may decide to go for mergers with these high-tech banks.
4. New Products/Services: New generation private sector banks which have
developed innovative products/services with the help of their technology may attract some old generation banks for merger due to their incapacity to face these challenges.
5. Over Capacity: The new generation private sector banks have began their
operation with huge capacities. With the presence of many players in the market, these banks may not be able to capture the expected market share on its own. Therefore, in order to fully utilise their capacities these banks may look for target banks which may not have modern day facilities.
6. Customer Base: In order to utilise the capacity of the new generation private
sector banks, they need huge customer base. Creating huge customer base takes time. Therefore, these banks have started looking for target banks with good customer bases. Once there is a good customer base, the banks can sell other banking products like car loans, Housing loans, consumer loans, etc., to these customers as well.
7. Merger of Weak Banks: There has been a practice of merging weak banks with
a healthy bank in order to save the interest of customers of the weak Bank. Narasimham Committee–II discouraged this practice. Khan Group suggested that weak Developmental Financial Institutions (DFIs) may be allowed to merge with the healthy banks.
16.4 BANK MERGERS
In the 1950s and 1960s there were instances of private sector banks, which had to be rescued or closed down because they had very low capital and were mostly operating with other people’s money. For instance, against total deposits of Rs.2750 crore at the end of December 1968, the paid-up capital of private sector banks was only Rs.28.5 crore or just a little over 1%. In 1960, the failure of Palai Central Bank and Laxmi Bank led to loss of confidence in the banking system as a whole. So mergers were initiated to avoid losses to depositors and maintain confidence in the system. In 1961, the Banking Companies (Amendment) Act empowered RBI to formulate and carry out
9 Bank Mergers and
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a scheme for the reconstitution and compulsory amalgamation of sub-standard banks with well-managed ones. Consequently, out of 42 banks which were granted
moratoria, 22 were amalgamated with other banks, one was allowed to go into voluntary liquidation, one to amalgamate voluntarily with another bank, three were ordered to be wound up and the moratorium on three was allowed to lapse.
In India, mergers have been used to bail out weak banks till the Narasimham Committee-II discouraged this practice. For instance, since the mid-1980s, several private banks had to be rescued through mergers with public sector banks, as shown in the Table 16.1 given below:
Table 16.1: Bank Mergers in India
Name of Bank Year of No. of Merged with Merger Branches
Lakshmi Commercial Bank 1984 230 Canara Bank
Bank of Cochin 1984 108 State Bank of India
Miraj State Bank 1984 26 Union Bank of India
Hindustan Commercial 1985 140 Punjab National Bank
Traders Bank 1987 34 Bank of Baroda
United Industrial Bank 1988-89 145 Allahabad Bank
Bank of Tamilnadu 1988-89 99 Indian Overseas Bank
Bank of Thanjavur 1988-89 156 Indian Bank
Parur Central Bank 1988-89 51 Bank of India
Prubanchal Bank 1990 40 Central Bank of India
New Bank of India 1993 591 Punjab National Bank
BCCI (Mumbai) 1993 1 State Bank of India
Bank of Karad 1994 48 Bank of India
Kasinath Seth Bank 1995 11 State Bank of India
Bari Doab Bank & Punjab 1997 Oriental Bank of Commerce Co-operative Bank
The merger of the loss making New Bank of India with the profitable Punjab National Bank was the first instance of merger of two public sector commercial banks. Now public sector commercial banks are themselves in need of restructuring so it may be more efficient to close down unviable bank. However, the recent merger of banks in private sector , i.e., HDFC Bank and Times Bank (1999) as well as ICICI Bank and Bank of Madura (2000) , could herald a welcome trend as it is driven by commercial considerations. It is only such mergers among banks that will impart strength and stability to the banking system in the new millennium.
With economic reforms and opening up of the economy, like other sectors, banking sector also saw a lot of changes. Two major changes are worth mentioning. They are: increased competition, and falling interest rates. There has been a decline in the interest rates in the last decade world wide. As a result of this profitability of the banks has been under tremendous pressure. The interest rates both on the deposits and on the loans have come down drastically. The ‘spread’ which was available to the banks thinned down and banks have started searching for cost reduction and market enhancing strategies. Use of technology in their operations has come up as an immediate strategy and banks have started using technology in a big way. This has resulted in saving of salary expenses, which used to be a major part of the banks’ expenditure. In addition to this, banks have started looking for strategies which allow the banks to grow faster. One of the options before the banks was to merge their counterparts in it and become not only big but also gain entry into the new markets. As a result of these mergers, banks are able to use their full capacities and avoid unnecessary duplication of efforts. Some of the banks which merged in recent times
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Special Issues are: Times Bank merged with HDFC Bank, Bank of Madura Merged with ICICI
Bank, Nedungadi Bank Merged with Punjab National Bank. Subsequently the RBI allowed Development Financial Institutions also to merge with banks on the
recommendation of Khan Group. As a result of this ICICI Limited merged itself with ICICI Bank and IFCI Limited is being merged with the Punjab National Bank. As far as the merger activity in banking sector is concerned, there used to be mostly merger of sick and weak banks with a healthy bank. The only purpose of this type of mergers was to save the sick bank and its customers from the problems. With the process of liberalization the thinking of the government also changed. We do not see much of mergers of this type now-a-days. The merger of New Bank of India with Punjab National Bank was a bad experience. This has not served any purpose. As a result of the merger, PNB had to face lot of court litigations and also incurred a loss in the year 1996 which was unusual in the history of the Bank.
With the liberalization policies of the government, many private banks came into existence. In 1995 the government also removed entry barriers in the banking sector. As a result of this good number of technology savvy, customer friendly banks have started operating in India. In order to survive in the competition and get a market share these new banks started offering innovative and attractive products with the help of their technology. Some of the services like mobile banking, internet banking, tele-banking, online share trading services, depository services , anywhere banking, anytime banking which are offered by these new generation banks were never thought of about a decade ago in India. These services have given an edge to these banks over the public sector banks. The public sector banks also realised the need of the hour and started using technology in a big way. These banks are also collaborating with the new generation banks in offering certain services and getting mutually benefited. Some of the new generation banks like HDFC Bank and ICICI Bank have started looking for external growth by way of merger route. These banks have started looking for healthy banks rather than sick and weak banks for acquisition. The main criteria while selecting target bank was synergy benefits like market growth, market presence, effect on profit and so on. It can be said merger of Times Bank with HDFC Bank in 1999 is a beginning of this new trend. HDFC Bank emerged as the largest private sector bank in India after the merger. By this merger HDFC Bank got the customer base of Times Bank, its infrastructure, and branch network. This merger also had product harmonization effect, as HDFC Bank had Visa network and Times Bank had Master card network. Following HDFC, ICICI also merged Bank of Madura into it. ICICI Bank was looking for a bank which could be merged into it and which could provide some synergic benefits after the merger. ICICI Bank had considered two possible banks, Federal Bank and the Bank of Madura and finally went for Bank of Madura, considering its better technological edge, attractive business per employee, and its vast branch network in Southern India. At the time of merger the Bank of Madura had 263 branches.
Another trend which is taking place in Bank Mergers is merging of Developmental Financial Institutions (DFIs) with the Banks. Some of the examples are; merger of ICICI Ltd. with ICICI Bank, and the proposed merger of IFCI Ltd. with Punjab National Bank. This trend is a fall out of the recommendations of Khan Group and Narasimham Committee-II.
16.5 LEGAL FRAMEWORK
Mergers and Takeovers are generally seen in Public Policy as activities, which, if left uncontrolled, can lead to negation of Public interests. As a result, these activities are controlled through various Statutes and Codes of Conduct. Some of the contentious issues that emphasise the need for evolving a Takeover Code are discussed below.
1 1 Bank Mergers and
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Sec.s 111 and 390 to 396a of the Companies Act, 1956, govern mergers and
acquisitions. Similarly Sections 19, 26 and 29 of the erstwhile FERA relate to transfer of shares. Where one of the transacting parties is a Non-Resident Indian, the Act prohibits the transaction except with the sanction of the Reserve Bank of India (R.B.I.). Sec.s 30(A) to 30 (F) of the MRTP Act pertain to transfer of shares relating to dominant undertakings as defined in the Act. Further, Sec. 22 (A) of the Securities Contract (Regulation) Act, 1956, deals with the transfer of shares. Clauses 40 (A) and 40 (B) of the Stock Exchange Listing Agreement Form also lay down the rules in case of takeover bids.
Before 1960, section 44A of the Banking Regulation Act only provided for the voluntary amalgamation of banks. But after widespread weakness in the banking sector, the Act was amended by adding Section 45 to allow for compulsory amalgamation wherever necessary and on a voluntary basis wherever possible, in order to strengthen the banking system by eliminating small and weak banks. The main difference between an amalgamation and a transfer is that, under amalgamation the company, which is taken over, ceases to exist, while under transfer the company can opt to either go into liquidation or convert itself into a non-banking company. Under Section 45 of the Act, RBI has the power to compulsorily reconstruct or amalgamate a weak bank with any other bank.
Section 44A of the Banking Regulation Act lays down the procedure for
amalgamation of banking companies. Section 44B of the Act further empowers RBI in the matter of compromise arrangements between a bank and its creditors. These have to be approved by RBI and such compromise cannot be sanctioned even by a High Court. Under Section 36 AE of the Act, the Central Government can under advice from RBI take over a weak bank. When a bank is placed under liquidation, the High Court can appoint RBI, SBI or any other bank as the official liquidator and monitor the speedy disposal of winding up proceedings.
Part-II C of the Banking Regulation Act deals with the acquisition of the undertaking of banking companies. Section 36-AE of the Banking Regulation Act deals with the power of Central Government to acquire undertakings of banking companies in certain cases. Sec.36-AF deals with the powers of Central Government to make scheme and Section 36AG deals with compensation to be given to shareholders of the acquired bank.
The Central Government on receipt of a report from the RBI may acquire a banking company if it fails to comply with the directions given to it under Sec.21 or Sec. 35-A of the Banking Regulation Act. Similar action may also be taken if the Banking Company is being managed in a manner which is detrimental to the interest of its depositors, or against the banking policy. Reasonable opportunity should be given to the bank before taking such action.
Let us now see how the Takeover Code evolved over a period of time in India:
The Evolution of the Takeover Code 1990
The Government amends clause 40 of the listing agreement according to which, threshold acquisition level reduced from 25% to 10% ; change in management control to trigger public offer’; minimum mandatory public offer of 20% disclosure
requirement through mandatory public announcement.
November 1994
SEBI notifies Substantial Acquisition of Shares and Takeover, 1994. New provisions introduced to enable both negotiated and open market acquisitions and competitive bids allowed.
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Special Issues November 1995
SEBI sets up committee under former Chief Justice of India P.N. Bhagwati to review the 1994 takeover Regulations in order to frame comprehensive regulations.
January 1997
The Bhagwati Committee submits its report on the takeover code to SEBI.
February 1997
SEBI accepts Bhagwati committee report and the Substantial Acquisition of Shares and Takeovers Regulations, 1997, notified.
February 1998
SEBI proposes to revise the takeover code make it mandatory for acquirers to make a minimum open offer for 20% (and not 10% as earlier) of the target company’s equity, even if the holding goes beyond 51% as a result of the offer.
June 1998
SEBI asks justice Bhagwati to conduct a complete review of the takeover code. Issues likely to be taken up are, the extent of disclosure in an open offer and if any change in the objective of the offer needs to be spelt out in the revised offer.
June 1998
SEBI proposes to raise the creeping acquisition limit under its Takeover Code from 2% to 5%. It also proposes to increase the share acquisition limit for triggering the takeover code from 10% to 15%.’
November 1998
Takeover panel amends the takeover code to incorporate buyback offers by companies. The committee decides to allow takeover offers to be made when a buyback offer is open and vice versa.
December 1998
Justice P.N. Bhagwati criticizes SEBI for unilaterally increasing the trigger limit for making a public offer from 10% to 15%. The Bhagwati Committee also recommends that once an acquirer acquires 75% of shares or voting rights in a company, he should be outside the purview of the Takeover Regulations.
January 2000
SEBI again proposes that all open offers made by promoters for consolidating their holding in a company will have to be for a minimum of 20% of equity. Exemption to the minimum 20% requirement should be given only in the case of such companies in which promoters hold over 75%.
The SEBI’s Takeover Committee also recommends that a special resolution approved by 75% of the shareholders should be made mandatory for effecting a change in the management of professionally managed companies. The step aims to avoid misuse of the earlier provision, under which certain groups with 51% stake could effect the changes through a simple resolution.
Another recommendation that follows was that venture capital funds should be treated on par with State Financial Institutions. And like financial institution, they should be exempted from making a public offer, in the event of acquiring a 15% stake in a company.
1 3 Bank Mergers and
Acquisitions February 2000
SEBI finalizes the recommendations of takeover panel and review the takeover norms. However, the crucial decision on issue relating to ‘change in management control of professionally managed companies’ left unresolved.
June 2000
SEBI plans to bring public financial institutions under the ambit of its takeover code, both as acquirers and as pledgees.
October 2000
Confederation of Indian Industry, FICCI and ASSOCHAM seek amendments in the takeover code, especially in the case of creeping acquisitions, to provide the promoters a level-playing field against corporate raiders who may disrupt existing managements. Under the current takeover code, corporate raiders can pick up 15% of the paid-up equity of the target company over a 12 month period without triggering off the takeover code.
November 2000
SEBI takeover panel decides to make it mandatory for an ‘acquirer’ to disclose his holdings in the target company to the company as well to the exchanges, at three levels; 5 %, 10% and 14%, instead of the existing stipulation of only 5%.
December 2000
SEBI promises a new draft on the takeover code in place by the end of March 2001 with ‘investor protection’ as its pivot. The main objective of the new code would be to ensure that acquiring companies are prompt in informing the stock exchanges when they cross the prescribed limits of holding a company’s stake, make public
announcements and allow companies to make counter offers. Source: www.capitalmarket.com
16.6 PROCEDURE FOR AMALGAMATION OF
BANKING COMPANIES
Sec. 44A of the Banking Regulation Act,1949, deals with the procedure for amalgamation of banking companies. This procedure is discussed hereunder: 1. No banking company shall be amalgamated with another banking company,
unless the shareholders of both the banking companies approve merger scheme in a meeting called for the purpose by a majority in number representing two-thirds in value of the shareholders of each of the said company.
2. The approved scheme of amalgamation shall be sent to RBI for its approval. 3. Any shareholder who has voted against the scheme of merger or has given notice
in writing at or prior to the meeting shall be entitled to claim from banking company the value of the shares held by him as determined by the RBI while approving the scheme.
4. Once the scheme of amalgamation is sanctioned by the RBI, the property and the liabilities of the amalgamated company shall become the property and the liabilities of the acquiring company.
5. After sanctioning the scheme of amalgamation by the RBI, the RBI may further order the closure of acquired bank and the acquired bank stands dissolved from such a data as may be specified.
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16.7 RESTRUCTURING OF BANKS AND SOME
RELEVANT COMMITTEES
The reports of three committees appointed by the RBI are relevant in relation to the restructuring of Banks. These are: Report of the Narasimham Committee on Banking Sector Reforms, Report of the Working Group for Harmonizing the Role and
Operations of DFIs and Banks, and the Report of the Working Group on
Restructuring of Weak Public Sector Banks. If we study these three reports we can get a good idea of the trends and future of Bank restructuring in India.
1. Narasimham Committee
The Narasimham Committee on Banking Sector Reform was set up in December, 1997. This Committee’s terms of reference include; review of progress in reforms in the banking sector over the past six years, charting of a programme of banking sector reforms required making the Indian banking system more robust and internationally competitive and framing of detailed recommendations in regard to banking policy covering institutional, supervisory, legislative and technological dimensions. The Committee submitted its report on 23 April, 1998 with the following suggestions: l Merger with strong banks, but not with the weak.
l Two or three banks with international orientation, eight to 10 national banks and a large number of local banks.
l Rehabilitate weak banks with the introduction of narrow banking l Confine small, local banks to States or a cluster of Districts.
l Review the RBI Act, the Banking Regulation Act, the Nationalisation Act and the State Bank of India Act.
l Speed up computerisation of public sector banks.
l Review the recruitment procedures, and the training and remuneration policies of PSU banks.
l Depoliticisation of appointments of the bank CEOs and professionalisation of the bank Boards.
l Strengthen the legal framework to accelerate credit recovery. l Increase capital adequacy to match the enhanced banking risk. l Budgetary support non-viable for recapitalisation.
l No alternative to the asset reconstruction fund. 2. Khan Group
The Group was set up by the RBI in December, 1997, under the Chairmanship of Shri S.H. Khan, the then Chairman of IDBI. The Group was to review the role and structure of the Developmental Financial Institutions and the Commercial Banks in the emerging environment, and to recommend measures to achieve coordination and harmonization of Lending policies of financial institutions before they move towards Universal Banking. Some of the recommendations of this Group are given below: i) A progressive move towards universal banking and the development of an
enabling regulatory framework for the purpose.
ii) A full banking licence may be eventually granted to DFIs. In the interim, DFIs may be permitted to have a banking subsidiary (with holdings up to 100 per cent), while the DFIs themselves may continue to play their existing role. iii) The appropriate corporate structure of universal banking should be an internal
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iv) Management and shareholders of banks and DFIs should be permitted to explore and enter into gainful mergers.
v) The RBI/Government should provide an appropriate level of financial support in case DFIs are required to assume any developmental obligations.
3. Verma Group
The Reserve Bank of India set up a Working Group on Restructuring Weak Public Sector Banks, under the Chairmanship of Shri M.S. Verma, former Chairman, State Bank of India, to suggest the measures for revival of weak Public Sector Banks. The group has gone deep into the issue and analyzed the problem fully and made specific suggestions. The summary report of this is given in the appendix to this unit. This group has identified some core principles for incorporation into the future
restructuring strategies for weak banks. They are reproduced below from the report. Future restructuring strategies for weak banks must incorporate the following core principles:
a) Manageable Cost: The restructuring effort that is embarked upon has to be at
the least cost possible. However, the fact that injudiciously chosen lower cost alternatives may lead to much higher costs in the long term must not be lost sight of.
b) Least Possible Burden on the Public Exchequer: As far as practicable the cost
of restructuring must come out of the unit being restructured. Even if its contribution to the cost of restructuring is not available upfront, it should be possible to recover this later, out of the value that can be created by the
restructuring. The need to minimise the burden of such cost, preferably initially, but certainly finally is obvious and cannot be overstated. Any plan for
restructuring which does not clearly result in value addition at the end of the exercise, is not worth attempting.
c) All Concerned must Share Losses: The restructuring strategy as also the
instruments employed in the implementation of this strategy have to make a clear statement about the manner in which the losses already incurred and to be incurred have to be shared. The principle of sharing of losses will have to remain fully operative in both operational and financial restructuring envisaged for a bank. Such a plan for sharing losses will include reduction in staff as well as all other administrative cost of operations.
d) Changes for Strong Internal Governance: The internal governance of the banks
and their operations at all levels has to be strengthened and fully sensitised to the needs of protecting against all foreseeable future problems. Restructuring always involves some amount of destabilisation in the organisation and during this period as also immediately after it, management and all its operatives have to make sure that the intended benefits of the restructuring plans are not allowed in any way to be frittered away or lost due to delays and lack of diligence in its implementation.
e) Effective Monitoring and Timely Course Corrections: Individual restructuring
plans are to be implemented by the banks concerned internally and their success will depend upon the quality of governance and organisational commitment to the proposed restructuring. However, for a successful restructuring it is important that there is an independent agency which will own it and in the process of driving it forth, constantly monitor its progress. This role can be played by the owner but such an arrangement has limitations because of the conflict of
interests that are likely to arise in such cases and the lack of time and skill for the job, which the owner may suffer from. It will be more so when the ownership of the banks is with the government. For obvious reasons, this responsibility cannot
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Special Issues be given to the regulator either. The regulator will no doubt have interest in the
success of the restructuring programme but direct efforts on its part to ensure its implementation could result in conflict of interests. The objective can, therefore, be best achieved by an independent agency, which with the express consent of the owner shall have full authority over the restructuring process and be in a position to effectively monitor its progress. In this process, while this independent agency will monitor to ensure that the restructuring process remains on course, wherever necessary it shall also take steps to facilitate due implementation of the plan. Such steps by this agency may include devising corrective measures and ensuring that the banks concerned adopt these measures.
f) Ease of Implementation: Above all there must be an all-round consensus on the
process of restructuring, its modalities and timing. The process itself and all the attendant instruments and instrumentalities will have to be simple and easy to employ.
While setting the core principles, which should govern any programme of bank restructuring is not so difficult, deciding upon precise modalities of restructuring, is indeed, quite a vexatious and difficult issue to settle. As can be learnt from
international experiences various modalities and quite a few variations of each of these modalities have been tried with varying degrees of success. In their time and given socio-economic environment each of these options chosen had good logic behind them. While, therefore, they have their applicability and merit these are certainly not
transplantable where the prevailing conditions are different.
16.8 CASE STUDIES
In this section we shall be discussing three case studies of bank mergers. They are: 1. Punjab National Bank (PNB) and New Bank of India (NBI),
2. ICICI Bank and Bank of Madura, and 3. ICICI Bank and ICICI Ltd.
The case of Punjab National Bank and New Bank of India is a case of two Public Sector Banks merging together as a solution to protect a weak bank (New Bank of India) by merging with a healthy bank (PNB).The case study of ICICI Bank and Bank of Madura is a representative case of modern thinking in the banking industry, i.e., growth through the merger route. The merger of ICICI Bank and ICICI Ltd is a case of a Developmental Financing Institution merging with a Commercial Bank and emerging into an Universal Bank. The first case (PNB-NBI) reflects the old thinking and the remaining two cases reflect new trends in the banking and financial services sector. Let us now know more details about these cases.
Punjab National Bank and New Bank of India Merger
In year 1970 fourteen banks including PNB were nationalized. In 1980 six more banks including New Bank of India were nationalized. Both these banks were merged in 1993 by the Central Government. The New Bank of India was incurring losses and by the year 1991-92, its financial position had become so bad that its capital and deposits completely stood eroded.
Punjab National Bank commenced its operations on April 12,1895 from Lahore with an authorized capital of Rs. 2 lakhs and working capital limit of Rs. 20,000/- . The Bank has more than 100 years of history and has faced many financial and other crises in the Indian financial system over these years.
New Bank of India was a comparatively small bank among the nationalized banks. It had around 600 branches all over the country with 12,400 employees and was having 2,500 crores of deposits and advances Rs. 970 crores.
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Whereas PNB was working with 3734 branches all over the country with total employees numbered 71,650. it was having total deposits of Rs. 25,280 crore and advances of Rs. 12,078 crore.
This was the first case in the Indian History that one nationalized bank was merged with another nationalized bank. The basic reasons for this merger were as follows: – The New Bank of India was in loss consecutively for last three years when
merger took place on 4th September, 1993.
– Productivity per employee of New Bank of India was low. – Work ethics of the union(s) workers was low.
– Only option left out was either liquidation or merger with another bank.
Since it was a small bank having its head office in Delhi and also with the similarities of work culture of Punjab National Bank whose head office also happened to be in Delhi, Govt. of India under recommendations of Narasimham Committee report decided to merge New Bank of India with Punjab National Bank.
Table 16.2: Financials of the PNB and NBI at the time of Merger (1992-93) PNB NBI PNB+NBI
Capital (Rs. in Crore) 187.84 68.69 256.53
No. of Shares 187842200 186000000 373842200
Reserves (Rs. in Crore) 360.94 8.43 369.37
Profits (Rs. in Crore) 38.01 (-)75.79 (–)37.382
Earnings per Share (Rs.) 2.02 (-) 4.07 (–) 1.01
Deposits (Rs. in Crore) 18241.31 2362.32 20603.63
Advances (Rs. in Crore) 9915.21 974.81 10890.02
The PNB and NBI merger has not been a marriage of convenience. It had the seeds of long-term detrimental effect to the health of PNB. The most ticklish problem which the amalgamated entity faced was the complete absorption of the sizeable NBI workforce into its own work-culture. The NBI was notorious for rampant indiscipline and intermittent dislocation of work due to fierce inter-union rivalries.
ICICI Bank and Bank of Madura Merger
Bank of Madura (BOM) was a profitable, well-capitalized, Indian private sector commercial bank operating for over 57 years. The bank had an extensive network of 263 branches, with a significant presence in the southern states of India. The bank had total assets of Rs. 39.88 billion and deposits of Rs.33.95 billion as on September 30,2000. The bank had a capital adequacy ratio of 15.8% as on March 31,2000. The Bank’s equity shares were listed on the Stock Exchanges at Mumbai and Chennai and National Stock Exchange of India before its merger.
ICICI Bank then was one of the leading private sector banks in the country. ICICI Bank had total assets of Rs. 120.63 billion and deposits of Rs. 97.28 billion as on September 30, 2000. The bank’s capital adequacy ratio stood at 17.59% as on September 30, 2000. ICICI Bank was India’s largest ATM provider with 546 ATMs as on June 30, 2001. The equity shares of the bank were listed on the Stock
Exchanges at Mumbai, Calcutta, Delhi, Chennai, Vadodara and National Stock Exchange of India. ICICI Bank’s American Depository Shares were listed on the New York Stock Exchange.
1 8
Special Issues In February 2000, ICICI Bank was one of the first few Indian banks to raise its
capital through American Depository Shares in the international market, and received an overwhelming response for its issue of $ 175 million, with a total order of USD 2.2 billion. At the time of filling the prospectus, with the US Securities and
Exchange Commission, the Bank had mentioned that the proceeds of the issue would be used to acquire a bank.
As on March 31, 2000, bank had a network of 81 branches, 16 extension counters and 175 ATMs. The capital adequacy ratio was at 19.64% of risk-weighted assets, a significant excess of 9 % over RBI Benchmark.
ICICI Bank was scouting for private banks for merger, with a view to expand its assets and client base and geographical coverage. Though it had 21% of stake, the choice of Federal bank, was not lucrative due to employee size (6600), per employee business was as low as Rs. 161 lakh and a snail pace of technical upgradation. While, BOM had an attractive business per employee figure of Rs. 202 lakh, a better technological edge and a vast base in southern India as compared to Federal Bank. While all these factors sound good, a cultural integration was a tough task ahead for ICICI Bank.
ICICI Bank had then announced a merger with the 57 year old BOM, with 263 branches, out of which 82 of them were in rural areas, with most of them in southern India. As on the day of announcement of merger (09-12-2000), Kotak Mahindra group was holding about 12% stake in BOM, the Chairman BOM, Mr. K.M.
Thaigarajan, along with his associates was holding about 26% stake, Spic group had about 4.7%, while LIC and UTI were having marginal holding. The merger was supposed to enhance ICICI Bank’s hold on the south Indian market.
The swap ratio was approved in the ratio of 1:2- two shares of ICICI Bank for normal every one share of BOM. The deal with BOM was likely to dilute the current equity capital by around 2%. And the merger was expected to bring 20% gains in EPS of ICICI Bank and a decline in the bank’s comfortable Capital Adequacy Ratio from 19.64% 17.6%.
Table 16.3: Financials of ICICI Bank and Bank of Madura
(Rs. In Crores)
Parameters ICICI Bank ICICI Bank Bank of Madura Bank of Madura 1999-2000 1998-1999 1999-2000 1998-1999 Net worth 1129.90 308.33 247.83 211.32 Total deposits 9866.02 6072.94 3631.00 3013.00 Advances 5030.96 3377.60 1665.42 1393.92 Net Profit 105.43 63.75 45.58 30.13 Shre capital 196.81 165.07 11.08 11.08
Capital adequacy ratio 19.64% 11.06% 14.25% 15.83%
Gros less NPAs/gross 2.54% 4.72% 11.09% 8.13%
advances
Net NPAs/net advances 1.53% 2.88% 6.23%5 4.66%
The scheme of amalgamation was expected to increase the equity base of ICICI Bank to Rs. 220.36 crore. ICICI Bank was to issue 235.4 lakh shares of Rs. 10 each to the shareholders of BOM. The merged entity will have an increase of asset base over Rs. 160 billion and a deposit base of Rs. 131 billion. The merged entity will have 360 branches across the country and also enable ICICI Bank to serve a large customer base of 1.2 million customers of BOM through a wider network, adding to the customer base to 2.7 million.
1 9 Bank Mergers and
Acquisitions
Some Issues of the Merger
The Board of Directors at ICICI Bank had contemplated the following synergies emerging from the merger:
Financial Capability: The amalgamation will enable them to have a stronger financial
and operational structure, which is supposed to be capable of grater resource/deposit mobilization. In addition to this, ICICI will emerge as one of the largest private sector banks in the country.
Branch Network: The ICICI’s branch network would not only increase by 263. but
also increase its geographic coverage as well as convenience to its customers.
Customer Base: The emerged largest customer base will enable the ICICI Bank to
offer other banking and financial services and products to the erstwhile customers of BOM and also facilitate cross selling of products and services of the ICICI group to their customers.
Tech Edge: The merger will enable ICICI Bank to provide ATM, phone and the
Internet banking and such other technology based financial services and products to a large customer base, with expected savings in costs and operating expenses.
Focus on Priority Sector: The enhanced branch network will enable the bank to
focus on micro finance activities through self-help groups, in its priority sector initiatives through its acquired 87 rural and 88 semi-urban branches.
Managing Rural Branches: Most of the branches of ICICI were in metros and major
cities, whereas BOM had its branches mostly in semi urban and city segments of south India. The task ahead lying for the merged entity was to increase dramatically the business mix of rural branches of BOM. On the other hand, due to geographic location of its branches and level of competition, ICICI Bank will have a tough time to cope with.
Managing Software: Another task, which stands on the way, is technology. While
ICICI Bank, which is a fully automated entity was using the package, banks 2000, BOM has computerized 90% of its businesses and was conversant with ISBS software. The BOM branches were supposed to switch over to banks 2000. Thought it is not a difficult task, 80% computer literate staff would need effective retraining which involves a cost. The ICICI Bank needs to invest Rs.50 crores, for upgrading BOM’s 263 branches.
Managing Human Resources: One of the greatest challenges before ICICI Bank was
managing the human resources. When the head count of ICICI Bank is taken, it was less than 1500 employees; on the other hand, BOM had over 2,500. The merged entity will have about 4000 employees which will make it one of the largest banks among the new generation private sector banks. The staff of ICICI Bank was drawn from 75 various banks, mostly young qualified professionals with computer background and prefer to work in metros or big cities with good remuneration packages.
Managing Client Base: The client base of ICICI Bank, after merger, will be as big as
2.7 million from its past 0.5 million, an accumulation of 2.2 million from BOM. The nature and quality of clients is not uniform. The BOM has built up its client base over a long time, in a hard way, on the basis of personalized services. In order to deal with the BOM’s clientele, the ICICI Bank needs to redefine its strategies to suit to the new clientele. If the sentiments or a relationship of small and medium borrowers is hurt; it may be difficult for them to reestablish the relationship, which could also hamper the image of the bank.
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Special Issues
ICICI Ltd. and ICICI Bank Merger
The merger between ICICI Bank and ICICI Ltd. pioneered the concept of Universal Banking in India. Taking the reverse merger route ICICI Ltd. Merged with its erstwhile subsidiary, ICICI Bank. The swap ratio has been decided at 2:1 that is 1 share of ICICI Bank for every 2 shares held in ICICI Ltd. It was also supposed to include merger of two ICICI subsidiaries, namely, ICICI Personal Finance Services Limited and ICICI Capital Services Limited with ICICI Bank.
At the time of merger, ICICI Ltd was holding (held) 46 per cent stake in ICICI Bank. In the case of merger, instead of extinguishing the shares, the company has decided to transfer the stake to a Special Purpose Vehicle (SPV) to be created in the form of a trust. Post merger, this was to form about more than 16 per cent of the total capital. This is an intelligent move by the company, as it would serve many purposes. First of all it is not prudent to extinguish capital in a scenario where the cost of raising capital itself is very high. Secondly, by doing so the bank would be able to safeguard its capital adequacy ratio. Thirdly, the plan is to divest the stake to a strategic partner few years down the line, which would fetch the bank considerable amount of cash. The shares would be transferred to the SPV at the price at which ICICI bought the shares i.e. Rs 12 per share.
Reason for Merger
l Analysts say ICICI wanted to merge with its banking subsidiary to obtain cheaper funds for lending, and to increase its appeal to investors so that it can raise capital needed to write off bad loans.
l This merger was basically a survival, more for ICICI, as its core business didn’t look too good and they needed some kind of a bank because only a bank has access to low-cost funds.
l Cheap Cash was another reason for merger.
Main Concerns
l A major concern in the road ahead to the merger was the reserve requirement that a bank was supposed to maintain. At that time these requirements were not applicable to ICICI Ltd. A bank has to maintain a Cash Reserve Ratio of 5.5 per cent with RBI and Statutory Liquidity Ratio of 25 per cent. ICICI required a total of Rs.18,000 crore to fulfill this requirement. This was a huge amount and given the scenario of that time and it was difficult for the institutions to raise such an amount. The group planned to raise the required funds partly through ICICI and partly through ICICI Bank.
l Another issue was of fulfilling the priority sector lending requirement. This requirement at the time of merger was at 40 per cent i.e. 40 per cent of the lending was to be made to priority sectors.
Benefit to the Players
l The main objective of adopting the path of Universal Banking is that
financial institutions are finding it increasingly hard to survive in a scenario of high cost of borrowing and decreasing spread with interest rates going down. Cost of borrowing for a financial institution through bonds is much higher than a bank, which can raise current and saving deposits. As per regulations, financial institutions cannot raise these deposits. Post merger it would be possible to do so.
l Also increasing disintermediation had made things increasingly difficult for ICICI Ltd. Some of the customers of ICICI Ltd. were in a position to access funds at much lower cost than from ICICI Ltd. and ICICI Ltd. could not afford
2 1 Bank Mergers and
Acquisitions
to lend at that rate as its own cost of funds was high. Once converted into a bank, its access to cheap funds would enable it to lend at competitive rates. l ICICI Ltd. as a combined entity would be better equipped to handle issues
arising from potential asset liability mismatches due to more stable deposit base. l Post merger ICICI Bank would be able to significantly enhance its fee based
income based on the strength of its balance sheet. Before the merger, ICICI Ltd. could not carry out certain activities as it was not a bank and therefore loses out on the fee based income. ICICI Bank on the other hand was constrained because of the limited size of its balance sheet. The sheer size of the balance sheet post merger would boost the fee based income.
l The high margin retail loan portfolio before the merger was with the various subsidiaries. Post merger this was to be transferred to ICICI Bank.
The Negative Side of the Merger
l The assets quality of ICICI Bank, which has been its major strength, would be affected post merger. ICICI Ltd. had NPAs of 5.2 per cent for FY01 as against ICICI Bank’s NPAs of 1.4 per cent.
l Before the merger, ICICI Ltd. could claim a deduction upto 40 per cent of its profits from its long term lending by transferring the amount to special reserve. Post merger, this benefit was to stand withdrawn in the case of incremental loans. l Average cost of borrowing for ICICI Ltd. for financial year 2001 was 11.71 per
cent. Its Gross yield was 13.54 per cent for the same period. Either way ICICI Ltd. would have to take a hit in the bottom-line in the initial years.
l By bringing down its loan portfolio and diverting these funds for the reserve requirement it would have to forego some of the interest spread.
l CRR would get a return of 6.5 per cent and amount in SLR would generate a return of about 9.5 per cent. Even in the case of fresh funds the cost of borrowing would be higher and the return on those funds would be less.
Table 16.4: Some Financial Parameters at the time of Merger Particular ICICI Ltd. ICICI Bank
MP at the time of merger (Rs.) 51 101
EPS (Rs.) 15.4 11.9
Book Value (Rs.) 102.8 65.5
MP/ Book Value 0.50 1.54
PE ratio 3.3 8.5
ICICI group has pioneered the concept of universal banking in India. IFCI Ltd is also in the process of merging with PNB. The concept of universal banking has found favour with many global players. Some of the international players, which have realized the benefits of universal banking are ABN-AMRO, Citigroup, HSBC, UBS etc. No doubt in the times to come the benefits of this will start flowing in.
16.9 SUMMARY
As a result of economic changes and liberalization, the corporate sector has been undergoing major changes and restructuring themselves to face these challenges. Corporate restructuring can take place in three different ways; restructuring of business portfolios, financial restructuring, and organisational restructuring. Mergers could be of three types; vertical mergers, horizontal mergers, and conglomerate
2 2
Special Issues mergers. Before the liberalization process started in India, there used to be bank
mergers as and when a bank lands itself into problems. However, the merger of Times Bank into HDFC Bank started a new wave of merger of healthy banks in order to get synergic benefits. After the Khan Group recommendations the DFIs have also started thinking of merging with banks in order to have easy and cheap access to funds.
16.10 KEY WORDS
Narrow Banks mean banks which place their funds only in short-term, risk-free
assets or demand deposits of banks are matched by safe and liquid assets. They have access to deposit insurance as well as to the payment system.
Universal Banks: Banking that includes investment services in addition to services
related to savings and loans.
Merger: Merger is a combination of two or more companies into one company. In
India, we call mergers as amalgamations, 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.
Takeover: Takeover can be defined as the acquisition of controlling interest in a
company by another company. It does not lead to the dissolution of the company whose shares are being acquired. It simply means a change in the controlling interest of a company through the acquisition of its shares by another group.
16.11 SELF ASSESSMENT QUESTIONS
1. Why do banks go for mergers? Explain the reasons with suitable examples. 2. Explain the trends in bank restructuring in India?
3. Distinguish between mergers and Takeovers.
4. Describe the procedure for Bank Amalgamations as laid down by the Banking Regulation Act, 1949.
5. Discuss the major recommendations of Khan Group.
6. Discuss the different types of Bank mergers that are taking place in India in recent time.
16.12 FURTHER READINGS
Ravi Sankar, K.,2003, Financial Analysis of Takeovers, Anmol Publishers (pvt.) Ltd., New Delhi.
Mattoo, P.K, 1998, Corporate Restructuring: An Indian Perspective, Macmillan India, New Delhi.
Shiva Ramu, 1998, Corporate Growth through Mergers and Acquisitions, Response Book, New Delhi.
Weston J. Fred, Chung Kwang S, and Hong Susan E., 1998, Mergers, Restructuring, and Corporate Control ,Prentice-Hall of India, New Delhi.
Alexandra M. post, 1994 Anatomy of a merger: the causes and effects of Mergers and Aacquisitions, Prentice Hall, Englewood cliffs, New Jersey.
Report of the Narasimham Committee on Banking Sector Reforms.
Report of the Working Group for Harmonizing the Role and Operations of DFIs and Banks. Report of the Working Group on Restructuring of Weak Public Sector Banks.
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Appendix 16.1
Summary Report of the Working Group on
Restructuring Weak Public Sector Banks
Introduction
1. The Reserve Bank of India, in consultation with the Government of India, set up the present Working Group under the chairmanship of Shri M.S. Verma, former Chairman, State Bank of India, and presently Honorary Adviser to the Reserve Bank of India, to suggest measures for revival of weak public sector banks. The terms of reference were (a) criteria for identification of weak public sector banks, (b) to study and examine the problems of weak banks, (c) to undertake a case by case examination of the weak banks and to identify those which are potentially revivable, and (d) to suggest a strategic plan of financial, organisational and operational restructuring for weak public sector banks.
International Experience
2. During the last twenty years, over 130 countries, developed and developing, have experienced banking crises in one form or the other. The Working Group has tried to understand the strategies adopted by some of these countries in the handling of the crises. Restructuring of a banking system needs to address macro systemic issues pertaining to factors responsible for ensuring banking soundness and also the micro level, individual bank problems. While there is no unique solution to banking crises that could be prescribed and applied across the board to all countries, there are some common threads that seem to run through all cases of successful restructuring. Initially, each bank needs to be restored to a minimum level of solvency through financial restructuring. Thereafter, only longer term operational and systemic
restructuring can help them maintain their competitiveness and enable them to ensure sustained profitability. Only a comprehensive approach to restructuring can have a lasting effect on the cost, earnings and profits of the banks to be restructured.
Public Sector Banks: An Overview
3. Till the adoption of prudential norms relating to income recognition, asset classification, provisioning and capital adequacy, twenty-six out of twenty-seven public sector banks were reporting profits (UCO Bank was incurring losses from 1989-90). In the first post-reform year, i.e., 1992-93, the profitability of the PSBs as a group turned negative with as many as twelve nationalised banks reporting net losses. By March 1996, the outer time limit prescribed for attaining capital adequacy of 8 per cent, eight public sector banks were still short of the prescribed level.
4. The emphasis on maintenance of capital adequacy and compliance with the requirement of asset classification and provisioning norms put severe pressure on the profitability of PSBs. Deregulation of interest rates on deposits and advances has intensified competition and PSBs now have to contend with competition not only from other public sector banks but also from old/new private sector banks, foreign banks and financial institutions. While some public sector banks have succeeded in adjusting to the changing business environment and managed competition some others have not been able to do so, and have displayed serious weaknesses.
5. The malady has been deep in the case of three banks, viz., Indian Bank, UCO Bank and United Bank of India. Continuous decline in profitability and efficiency of these banks and their dependence on capital support from government are causes for concern. They are trapped in a vicious circle of declining capability to attract good business and increasing need for capital support.
2 4
Special Issues 6. It is likely that the seeds of weakness are latent in some other public sector banks
as well. The problem of weak banks, which could have spill over effect on the system itself, therefore, assumes serious proportions.
7. The Committee on Banking Sector Reforms (CBSR) had recommended that a weak bank would be one (a) where accumulated losses and net NPAs exceed the net worth of the bank or (b) one whose operating profits less the income on
recapitalisation bonds has been negative for three consecutive years. To identify a bank’s weakness or strength with a fair degree of certainty, the Group has
recommended the use of the following seven parameters in conjunction with the two suggested by the CBSR: (i) capital adequacy ratio, (ii) coverage ratio, (iii) return on assets, (iv) net interest margin, (v) ratio of operating profit to average working funds, (vi) ratio of cost to income, and (vii) ratio of staff cost to net interest income (NII) + all other income.
Identification of Weak Banks
8. All the public sector banks were evaluated on the above seven parameters keeping the median as the threshold in five of the parameters. For capital adequacy ratio, the threshold was 8 per cent and in respect of the coverage ratio it was kept at 0.50 per cent. 9. Indian Bank did not meet any of the parameters in both the years. UCO Bank and United Bank of India could comply with the capital adequacy prescription but failed in all the other six parameters. These banks, along with Indian Bank, were the only banks to have received capital infusion during the last two years and would not have attained minimum capital adequacy otherwise.
10. The above approach serves the immediate objective of setting the criteria for identifying weakness in banks in general and for locating potentially weak banks. The Working Group, therefore, recommends building a database in respect of banks on an ongoing basis for the purpose of benchmarking and on that basis identifying signals of weakness.
Causes of Weakness
11. The causes of weakness need to be addressed properly so that the remedial measures adopted prove effective and actually succeed in improving the functioning of the weak banks. The weaknesses relate to three areas: operations, human resources and management.
12. Operational failures mainly relate to high level and fresh generation of NPAs, slow decision making with regard to fresh sanction of advances and compromise proposals and loss of fund-based advances and fee income. Declining market share in key areas of operations, limited product line and revenue stream, absence of cost control and effective MIS and costing exercise, weak internal control and
housekeeping, poor risk management and insufficient customer acquisition due to mediocre service, low level of technology and non-competitive rates are the other causes. 13. The operations of subsidiaries and foreign branches, which are a drain on two of the banks, lead bank and RRB responsibilities and locational disadvantages are also related issues.
14. Overstaffing, low productivity and a high age profile are the main HR related issues. Restrictive practices in deployment of staff have further aggravated the cost of overstaffing. In the three identified banks, staff cost as a proportion of total operating income has been above the industry median. Another area of concern is the level of skill and low levels of motivation. Skills in foreign exchange, treasury management and other specialised areas are not significant enough to generate business in these areas on a sustained basis.
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15. Training facilities are not adequate to meet the training requirements of the staff of the banks and motivation and morale of employees at all levels is low.
16. Under management related issues, lack of succession planning, short tenures and frequent changes in top management, inadequate support from the Board of Directors and the lackadaisical implementation of earlier SRPs and MOUs are causes of
weakness. Even after infusion of Rs. 6,740 crore in the three banks over the last seven years, their basic weaknesses persist. Unconditional recapitalisation from the
Government of India has proved to be a moral hazard as no worthwhile attempt has been made by the banks to gain adequate good business or to reduce costs.
Past Efforts at Restructuring
17. The restructuring efforts initiated so far have not had the desired impact. Hard options have been avoided and the steps taken so far have only had the objective of maintaining the capital adequacy ratio of the banks with the assistance of Government of India. The banks have failed to develop the required resilience or strength to become competitive in the true sense.
Present Position of the Weak Banks Indian Bank
18. Indian Bank continued to incur operating losses in 1998-99 also. The capital adequacy which had turned positive and reached 1.41 per cent in March 1998 with capital infusion of Rs. 1,750 crore from the Government of India turned negative again in March 1999. The decline in other income continued during 1998-99 as well. The bank did not make any provision for liabilities arising on account of the
proposed wage revision. The deterioration on the NPA front is unabated. Gross NPA went up from Rs. 3,428 crore as on 31 March 1998 to Rs. 3,709 crore as on
31 March 1999, i.e., 37 per cent of gross advances. This was the highest among public sector banks.
UCO Bank
19. UCO Bank’s operating profit improved marginally in 1998-99. However, if the interest income on recapitalisation bonds is excluded, the bank would have incurred operating loss of Rs. 91 crore in 1997-98 and Rs. 157 crore in 1998-99.
Recapitalisation by the government to the tune of Rs. 200 crore helped the bank achieve capital adequacy of 9.63 per cent in 1998-99. The bank has not made
provision for liability on account of wage revision. Gross NPAs as on 31 March 1999 aggregated Rs. 1,716 crore (23 per cent). Net NPAs at Rs. 715.63 crore were higher as compared to Rs. 705 crore as on 31 March 1998. The inability of the bank to register any improvement in the net NPA position is a matter for concern.
United Bank of India
20. United Bank of India’s operating profit decreased substantially in 1998-99. Operating income increased mainly on account of extraordinary income by way of interest received on income tax refund. Further, if the interest income on
recapitalisation bonds is excluded, the bank would have incurred operating loss of Rs. 89 crore in 1997-98 and Rs. 117 crore in 1998-99. Recapitalisation by the Government of India to the tune of Rs. 100 crore helped the bank achieve capital adequacy of 9.60 per cent in 1998-99. The bank has not made provision during 1998-99 for future pension liability and wage revision. The gross NPAs of the bank as on 31 March 1999 increased in absolute terms to Rs. 1,549 crore (32 per cent) from Rs. 1,451 crore as on 31 March 1998 (34 per cent). Net NPAs also went up to Rs. 573 crore (15 per cent) as on 31 March 1999 from Rs. 472 crore (14 per cent) as on 31 March 1998.
2 6
Special Issues Assessment of Revival Plans Prepared by the Banks
21. The plans prepared by the banks at the Working Group’s instance were no better than the earlier ones that had failed in that they continue to be based on ambitious projections of growth in business and income for which the banks are not equipped in terms of skill or technology. The plans do not reflect the growing compulsions of having to achieve steady growth in income and sustained control of expenditure within as short a time as possible. Therefore, the restructuring plans drawn up by the banks do not meet the objectives. It is felt that, as long as government assurance as to continued capital infusion is there, the banks would only look at soft options regardless of the time and cost involved.
Future Course of Action
22. The restructuring exercise has to be comprehensive and must address operational and financial restructuring simultaneously. There is no room for half way measures or gradualism. It is tempting to confine restructuring to financial aspects since solvency is immediately restored and there is a visible impact on the balance sheet. But, if operational aspects are not attended to, long term sustainability cannot be ensured. This will only lead to additional problems necessitating further and costlier restructuring down the road.
23. Future restructuring strategies must incorporate the core principles of manageable cost, least burden on the exchequer, sharing of losses equitably and strong internal governance. There should be an independent agency that will constantly monitor the progress of restructuring.
24. Bank restructuring has been attempted mainly by using one or more of the following modalities: merger or closure, change in ownership, narrow banking and a comprehensive operational and financial restructuring. The Working Group has examined the applicability of each of the above options in the present Indian context.
Merger or Closure
25. Merger would be advantageous only if it takes into account the synergies and complementing strengths of the merging units. The Working Group does not recommend merger as a possible solution in reviving the weak banks without first preparing them for it.
26. Closure has a number of negative externalities affecting depositors, borrowers, other clients, employees and, in general, the areas served by the banks being closed. This is an extreme option and would need to be exercised after all other options of successful restructuring are ruled out.
Change in Ownership
27. Privatisation is an acceptable course as this process alone can reduce the
government’s responsibility of capitalising the three banks further and, in the long run, enable it to recoup, fully or partially, the investment made in their capital. This will remove the moral hazard implicit in the present situation that government support will always be available and make the three banks responsive to the rules of market economy. The three banks will then also have a sense of accountability to all the stakeholders and appreciate the need for good performance.
28. However, in their present state, it is just not possible to consider their privatisation because the cost of restructuring is prohibitively high and no private group can normally be expected to bring in the kind of resources that the three banks require at present. These banks are also not likely to succeed in accessing the capital market given their present position. Their present staffing pattern and level of skills and technology will be deterrents to any investor.
