Evolution and Opportunities of Indian Banking

1.1 STRUCTURE & EVOLUTION OF BANKING
1.1.1 History: -
Banking in India has its origin as early as the vedic period. It is believed that the
transition from money lending to banking must have occurred even before Manu, the
great Hindu Jurist, who has devoted a section of his work to deposits and advances and
laid down rules relating to rates of interest. During the Mogul period, the indigenous
bankers played a very important role in lending money and financing foreign trade and
commerce. During the days of the East India Company, it was the turn of the agency
houses to carry on the banking business. The General Bank of India was the first Joint
Stock Bank to be established in the year 1786. The others which followed were the Bank
of Hindustan and the Bengal Bank. The Bank of Hindustan is reported to have continued
till 1906 while the other two failed in the meantime. In the first half of the 19th
century
the East India Company established three banks; the Bank of Bengal in 1809, the Bank of
Bombay in 1840 and the Bank of Madras in 1843. These three banks also known as
Presidency Banks were independent units and functioned well. These three banks were
amalgamated in 1920 and a new bank, the Imperial Bank of India was established on 27th
January 1921. With the passing of the State Bank of India Act in 1955 the undertaking of
the Imperial Bank of India was taken over by the newly constituted State Bank of India.
The Reserve Bank which is the Central Bank was created in 1935 by passing Reserve
Bank of India Act 1934. In the wake of the Swadeshi Movement, a number of banks with
Indian management were established in the country namely, Punjab National Bank Ltd,
Bank of India Ltd, Canara Bank Ltd, Indian Bank Ltd, the Bank of Baroda Ltd, the
Central Bank of India Ltd. On July 19, 1969, 14 major banks of the country were
nationalized and on 15th
April 1980 six more commercial private sector banks were also
taken over by the government.
India's banking system has several outstanding achievements to its credit, the most
striking of which is its reach. An extensive banking network has been established in the
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last thirty years, and India's banking system is no longer confined to metropolitan cities
and large towns: in fact, Indian banks are now spread out into the remote corners of our
country. In terms of the number of branches, India's banking system is one of the largest,
if not the largest in the world today. An even more significant achievement is the close
association of India's banking system with India's development efforts. The
diversification and development of our economy, and the acceleration of the growth
process, are in no small measure due to the active role that banks have played in
financing economic activities in different sectors.
We can identify three distinct phases in the history of Indian Banking: -
 Early phase from 1786 to 1969
 Nationalization of Banks and up to 1991 prior to banking sector Reforms
 New phase of Indian Banking with the advent of Financial & Banking Sector
Reforms after 1991.
1.1.2 Composition of the Banking System: -
At present the banking system can be classified in following categories:
Public Sector Banks: -
 Reserve Bank of India
 State Bank of India and its 7 associate Banks
 Nationalized Banks
 Regional Rural Banks sponsored by Public Sector Banks
Private Sector Banks: -
 Old Generation Private Banks
 New Generation Private Banks
 Foreign Banks in India
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Co-operative Sector Banks: -
 State Co-operative Banks
 Central Co-operative Banks
 Primary Agriculture Credit Societies
 Land Development Banks
 Urban Co-operative Banks
 State Land Development Banks
 Scheduled Co-operative Banks
Development Banks: -
 Industrial Finance Corporation of India (IFCI)
 Industrial Development Bank of India (IDBI-Parent)
 Industrial Credit & Investment Corporation of India (ICICI-Parent)
 Industrial Investment Bank of India (IIBI)
 Small Industries Development Bank of India (SIDBI)
 National Bank for Agriculture & Rural Development (NABARD)
 Export-Import Bank of India
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Classification of Banks
4
Private Sector BanksPublic Sector Banks
Foreign BanksIndian Banks
Commercial Banks State Co-operative Banks
Non - Scheduled BanksScheduled Banks
Reserve Bank of India
Regional Rural Banks
Private Sector Banks
Nationalised BanksSBI & Its Subsidiaries

1.1.3 Banking Regulation Act, 1949: -
The Banking Regulation Act enacted in 1949 provides a framework for regulation and
supervision of commercial banking activity. The provisions of this Act shall be in
addition to, and not, in derogation of the Companies Act, 1956, and any other law for the
time being in force. However the provisions of the Companies Act apply to only the
banks in the private sector. Provisions of the Act do not apply to: -
 a primary agricultural credit society;
 a co-operative land mortgage bank; and
 any other co-operative society, except in certain cases
Definition of Banking Business
‘Banking’ as defined in the Section 5 (b) of the Banking Regulations Act, 1949 is the
business of "Accepting deposits of money from the public for the purpose of lending or
investment". These deposits are repayable on demand or otherwise, and withdraw able by
a cheque, draft or otherwise.
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1.2 OPPORTUNITY SPECTRUM FOR INDIAN
BANKS
Indian banks have the highest compounded annual growth rate of profits in the world.
They reported a CAGR of 39 per cent between 1996 and 2001, compared with the global
average of 18 per cent. The CAGR of Asian banks fell 1 per cent during the same period.
However, Indian banks failed to score on profitability per customer. The profitability of
Indian banks in terms of the return on capital and the profitability of core banking
operations are not adequate. There is a need for clear customer segmentation and product
offerings focus on cost efficiencies and entrepreneurial ability to face stiff competition.
India is a target market for global players because it offers significant growth
opportunities. Citibank and Standard Chartered Bank account for more than half of the
outstanding credit card receivables and personal loans in the Indian banking sector. This
possibly translates into an annual profit of about $30-50 million each. Consolidation has
not taken off in India, but will be triggered by capital scarcity. This is unlike the Asian
scenario where 51 per cent of the top 500 banks disappeared in four years after the
financial crisis in East Asia. The majority of these banks went off the scene after they
were merged or acquired by others. The return on capital of Indian banks is low because
they have failed to attract profitable businesses. Seventy to 80 per cent of the corporate
accounts and retail customers do not make money for banks. Banks tend to concentrate
on just the spreads without identifying the cost on a risk-adjusted basis as far as the
corporate customer is concerned. At the same time, they fail to see the cost of servicing
retail clients as they try to push banking-related products to all segments of customers.
Leading global banks are pushing financial services to individuals in Asia, but most are
struggling to earn sustainable profits. Multinational institutions have grabbed small
market shares, which are yet to contribute significant profits to their global parents.
Banks have found attractive retail banking opportunities in India, but a huge portion of
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their operations are unprofitable for want of a cutting edge over competition. This puts a
strain on the capital base. Banks should guard against adopting the universal banking
model because they may lose out on per customer profitability in trying to be everything
for every customer. Banks should focus on their core competence rather than opting for
the universal banking model.
The opportunities for Indian banks can be studied under two heads. They are (i) Domestic
Opportunities & (ii) Global Opportunities.
1.2.1 Domestic Opportunities: -
 Consumer Finance
 Low Penetration
 Rising Income Levels
 Growing Consumer Class
 Robust Industrial Investment Outlook
 Large Infrastructure Development Plans
 Rural Banking
 Untapped Market for Financial Products & Services
 Growing Transaction Sizes Leading to Higher Profitability
 Sustained Economic Growth
1.2.2 Global Opportunities: -
 Vast Indian Diaspora (About 20 million people of Indian origin)
 Permanent Residents Overseas
 Both India Linked and Local Personal Banking Needs
 Small and Medium Businesses
 Global Orientation of Indian Businesses
 Growth in Foreign Trade
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 Increase Export Revenues
 Emergence of Indian Multinationals
1.3 CHALLENGES IN INDIAN BANKING
INDUSTRY
It is by now well recognized that India is one of the fastest growing economies in the
world. Evidence from across the world suggests that a sound and evolved banking system
is required for sustained economic development. India has a better banking system in
place vis a vis other developing countries, but there are several issues that need to be
ironed out. The challenges that the banking sector in India faces are: -
1.3.1 Interest Rate Risk: -
Interest rate risk can be defined as exposure of bank's net interest income to adverse
movements in interest rates. A bank's balance sheet consists mainly of rupee assets and
liabilities. Any movement in domestic interest rate is the main source of interest rate risk.
Over the last few years the treasury departments of banks have been responsible for a
substantial part of profits made by banks. Between July 1997 and Oct 2003, as interest
rates fell, the yield on 10-year government bonds (a barometer for domestic interest rates)
fell, from 13 per cent to 4.9 per cent. With yields fell the banks made huge profits on
their bond portfolios. Now as yields go up (with the rise in inflation, bond yields go up
and bond prices fall as the debt market starts factoring a possible interest rate hike), the
banks will have to set aside funds to mark to market their investment. This will make it
difficult to show huge profits from treasury operations. This concern becomes much
stronger because a substantial percentage of bank deposits remain invested in government
bonds. Banking in the recent years had been reduced to a trading operation in government
securities. Recent months have shown a rise in the bond yields has led to the profit from
treasury operations falling. The latest quarterly reports of banks clearly show several
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banks making losses on their treasury operations. If the rise in yields continues the banks
might end up posting huge losses on their trading books. Given these facts, banks will
have to look at alternative sources of investment.
1.3. Non-Performing Assets: -
The best indicator of the health of the banking industry in a country is its level of NPAs.
Given this fact, Indian banks seem to be better placed than they were in the past. A few
banks have even managed to reduce their net NPAs to less than one percent (before the
merger of Global Trust Bank into Oriental Bank of Commerce, OBC was a zero NPA
bank). But as the bond yields start to rise the chances are the net NPAs will also start to
go up. This will happen because the banks have been making huge provisions against the
money they made on their bond portfolios in a scenario where bond yields were falling.
Reduced NPAs generally gives the impression that banks have strengthened their credit
appraisal processes over the years. This does not seem to be the case. With increasing
bond yields, treasury income will come down and if the banks wish to make large
provisions, the money will have to come from their interest income, and this in turn, shall
bring down the profitability of banks.
1.3.3 Competition in Retail Banking: -
The entry of new generation private sector banks has changed the entire scenario. Earlier
the household savings went into banks and the banks then lent out money to corporates.
Now they need to sell banking. The retail segment, which was earlier ignored, is now the
most important of the lot, with the banks jumping over one another to give out loans. The
consumer has never been so lucky with so many banks offering so many products to
choose from. With supply far exceeding demand it has been a race to the bottom, with the
banks undercutting one another. A lot of foreign banks have already burnt their fingers in
the retail game and have now decided to get out of a few retail segments completely. The
nimble footed new generation private sector banks have taken a lead on this front and the
public sector banks are trying to play catch up. The PSBs have been losing business to
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the private sector banks in this segment. PSBs need to figure out the means to generate
profitable business from this segment in the days to come.
1.3.4 The Urge to Merge: -
In the recent past there has been a lot of talk about Indian Banks lacking in scale and size.
The State Bank of India is the only bank from India to make it to the list of Top 100
banks, globally. Most of the PSBs are either looking to pick up a smaller bank or waiting
to be picked up by a larger bank. The central government also seems to be game about
the issue and is seen to be encouraging PSBs to merge or acquire other banks. Global
evidence seems to suggest that even though there is great enthusiasm when companies
merge or get acquired, majority of the mergers/acquisitions do not really work. So in the
zeal to merge with or acquire another bank the PSBs should not let their common sense
take a back seat. Before a merger is carried out cultural issues should be looked into. A
bank based primarily out of North India might want to acquire a bank based primarily out
of South India to increase its geographical presence but their cultures might be very
different. So the integration process might become very difficult. Technological
compatibility is another issue that needs to be looked into in details before any merger or
acquisition is carried out. The banks must not just merge because everybody around them
is merging. As Keynes wrote, "Worldly wisdom teaches us that it's better for reputation
to fail conventionally than succeed unconventionally". Banks should avoid falling into
this trap.
1.3.5 Impact of BASEL-II Norms: -
Banking is a commodity business. The margins on the products that banks offer to its
customers are extremely thin vis a vis other businesses. As a result, for banks to earn an
adequate return of equity and compete for capital along with other industries, they need
to be highly leveraged. The primary function of the bank's capital is to absorb any losses
a bank suffers (which can be written off against bank's capital). Norms set in the Swiss
town of Basel determine the ground rules for the way banks around the world account for
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loans they give out. These rules were formulated by the Bank for International
Settlements in 1988. Essentially, these rules tell the banks how much capital the banks
should have to cover up for the risk that their loans might go bad. The rules set in 1988
led the banks to differentiate among the customers it lent out money to. Different
weightage was given to various forms of assets, with zero percentage weightings being
given to cash, deposits with the central bank/govt etc, and 100 per cent weighting to
claims on private sector, fixed assets, real estate etc. The summation of these assets gave
us the risk-weighted assets. Against these risk weighted assets the banks had to maintain
a (Tier I + Tier II) capital of 9 per cent i.e. every Rs100 of risk assets had to be backed by
Rs 9 of Tier I + Tier II capital. To put it simply the banks had to maintain a capital
adequacy ratio of 9 per cent. The problem with these rules is that they do not distinguish
within a category i.e. all lending to private sector is assigned a 100 per cent risk
weighting, be it a company with the best credit rating or company which is in the
doldrums and has a very low credit rating. This is not an efficient use of capital. The
company with the best credit rating is more likely to repay the loan vis a vis the company
with a low credit rating. So the bank should be setting aside a far lesser amount of capital
against the risk of a company with the best credit rating defaulting vis a vis the company
with a low credit rating. With the BASEL-II norms the bank can decide on the amount of
capital to set aside depending on the credit rating of the company. Credit risk is not the
only type of risk that banks face. These days the operational risks that banks face are
huge. The various risks that come under operational risk are competition risk, technology
risk, casualty risk, crime risk etc. The original BASEL rules did not take into account the
operational risks. As per the BASEL-II norms, banks will have to set aside 15 per cent of
net income to protect themselves against operational risks. So to be ready for the new
BASEL rules the banks will have to set aside more capital because the new rules could
lead to capital adequacy ratios of the banks falling. How the banks plan to go about
meeting these requirements is something that remains to be seen. A few banks are
planning initial public offerings to have enough capital on their books to meet these new
norms.
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1.4 FUTURE
The future of Indian Banking represents a unique mixture of unlimited opportunities
amidst insurmountable challenges. On the one hand we see the scenario represented by
the rapid process of globalization presently taking shape bringing the community of
nations in the world together, transcending geographical boundaries, in the sphere of
trade and commerce, and even employment opportunities of individuals. All these
indicate newly emerging opportunities for Indian Banking. But on the darker side we see
the accumulated morass, brought out by three decades of controlled and regimented
management of the banks in the past. It has siphoned profitability of the Government
owned banks, accumulated bloated NPA and threatens Capital Adequacy of the Banks
and their continued stability. Nationalized banks are heavily over-staffed. The
recruitment, training, placement and promotion policies of the banks leave much to be
desired. In the nutshell the problem is how to shed the legacies of the past and adapt to
the demands of the new age. On the brighter side are the opportunities on account of: -
 The advent of economic reforms, the deregulation and opening of the Indian
economy to the global market, brings opportunities over a vast and unlimited
market to business and industry in our country, which directly brings added
opportunities to the banks.
 The advent of Reforms in the Financial & Banking Sectors (the first phase in the
year 1992 to 1995) and the second phase in 1998 heralds a new welcome
development to reshape and reorganize banking institutions to look forward to the
future with competence and confidence. The complete freeing of Nationalized
Banks (the major segment) from administered policies and Government
regulation in matters of day to day functioning heralds a new era of self-
governance and a scope for exercise of self initiative for these banks. There will
be no more directed lending, pre-ordered interest rates, or investment guidelines
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as per dictates of the Government or RBI. Banks are to be managed by
themselves, as independent corporate organizations, and not as extensions of
government departments.
 Acceptance of prudential norms with regards to Capital Adequacy, Income
Recognition and Provisioning are welcome measures of self regulation intended
to fine-tune growth and development of the banks. It introduces a new
transparency, and the balance sheets of banks now convey both their strength and
weakness. Capital Adequacy and provisioning norms are intended to provide
stability to the Banks and protect them in times of crisis. These equally induce a
measure of corporate accountability and responsibility for good management on
the part of the banks
 Large scale switching to hi-tech banking by Indian Scheduled Commercial
Banks(SCBs) through the application of Information Technology and
computerisation of banking operations, will revolutionalise customer service. The
age-old method of 'pen and ink' systems are over. Banks now will have more
employees available for business development and customer service freed from
the needs of book-keeping and for casting or tallying balances, as it was earlier.
All these welcome changes towards competitive and constructive banking could not
however, deliver quick benefits on account insurmountable carried over problems of the
past three decades. Since the 70s the SCBs of India functioned totally as captive capsule
units cut off from international banking and unable to participate in the structural
transformations, the sweeping changes, and the new type of lending products emerging in
the global banking Institutions. Our banks are over-staffed. The personnel lack training
and knowledge resources required to compete with international players. The prevalence
of corruption in public services of which PSBs are an integral part and the chaotic
conditions in parts of the Indian Industry have resulted in the accumulation of non-
productive assets in an unprecedented level. The future of Indian Banking is dependent
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on the success of its efforts as to how it shakes off these accumulated past legacies and
carried forward ailments and how it regenerates itself to avail the new vistas of
opportunities to be able to turn Indian Banking to International Standards.
PSBs in India can solve their problems only if they assert a spirit of self-initiative and
self-reliance through developing their in-house expertise. They have to imbibe the
banking philosophy inherent in de-regulation. They are free to choose their respective
paths and set their independent goals and corporate mission. The first need is
management upgradation. We have learnt prudential norms of asset classification and
provisioning. More important now, we must learn prudential norms of asset creation, of
credit assessment and credit delivery, of risk forecasting and de-risking strategies. The
habit of looking to RBI and Government of India to step in and remove the barriers in the
way of the Banks should be given a go-bye. NPA is a problem created by the Banks and
they have to find the cause and the solution - how it was created and how the Banks are
to overcome it. Powerful Institutions can be nurtured by strong and dynamic management
and not by corrupt and weak bureaucrats. These issues are discussed with frankness and
candor in these pages, under titles listed in the Table of Contents (see Menu Bar at the
top), which provide you a direct access to any or all the topics of your choice.
Public sector ownership need not result in inefficiency and poor customer service. These
are not due to the ills of ownership, but due to failure to accept the correct "Mission" and
"Goals" of management. On the other hand unlike several private sector units, Public
sector units have specific plus points. They do not evade taxes, and do not accumulate
unassessed wealth or unaccounted money. They do not bribe controlling persons to get
their way through. They do not indulge in predatory "take over" of weaker rival units. In
fact a public unit never competes unethically with its rival-units.
2. MERGERS AND ACQUISITIONS: -
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2.1 Introduction: -
Mergers and acquisitions and corporate restructuring--or M&A for short--are a big part of
the corporate finance world. Every day, investment bankers arrange M&A transactions
that bring together separate companies to make larger ones. When they're not creating big
companies from smaller ones, corporate finance deals do the reverse and break up
companies through spin-offs, carve-outs, or tracking stocks.
Not surprisingly, these types of actions often make the news. Deals can be worth
hundreds of millions or even billions of dollars, and they can dictate the fortunes of the
companies involved for years to come. For CEOs, leading M&A can represent the
pinnacle of their careers.
The Main Idea: -
One plus one makes three: this equation is the special alchemy of a merger or acquisition.
The key principle behind buying a company is to create shareholder value over and above
that of the sum of the two companies. Two companies together are more valuable than
two separate companies--at least, that's the reasoning behind M&A. This rationale is
particularly alluring to companies when times are tough. Strong companies will act to
buy other companies to create a more competitive, cost-efficient company. The
companies will come together hoping to gain a greater market share or achieve greater
efficiency. Because of these potential benefits, target companies will often agree to be
purchased when they know they cannot survive alone.
2.2 Distinction between Mergers and Acquisitions: -
Although they are often they are used as synonymous, the terms "merger" and
"acquisition" means slightly different things.
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When a company takes over another one and clearly becomes the new owner, the
purchase is called an acquisition. From a legal point of view, the target company ceases
to exist and the buyer "swallows" the business, and stock of the buyer continues to be
traded.
In the pure sense of the term, a merger happens when two firms, often about the same
size, agree to go forward as a new single company rather than remain separately owned
and operated. This kind of action is more precisely referred to as a "merger of equals."
Both companies' stocks are surrendered, and new company stock is issued in its place.
For example, both Daimler-Benz and Chrysler ceased to exist when the two firms
merged, and a new company, DaimlerChrysler, was created.
In practice, however, actual mergers of equals don't happen very often. Often, one
company will buy another and, as part of the deal's terms, simply allow the acquired firm
to proclaim that the action is a merger of equals, even if it's technically an acquisition.
Being bought out often carries negative connotations. By using the term "merger,"
dealmakers and top managers try to make the takeover more palatable.
A purchase deal will also be called a merger when both CEOs agree that joining together
in business is in the best interests of both their companies. But when the deal is
unfriendly--that is, when the target company does not want to be purchased--it is always
regarded as an acquisition.
So, whether a purchase is considered a merger or an acquisition really depends on
whether the purchase is friendly or hostile and how it is announced. In other words, the
real difference lies in how the purchase is communicated to and received by the target
company's board of directors, employees and shareholders.
2.3 Synergy: -
Synergy is the magic force that allows for enhanced cost efficiencies of the new business.
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Synergy takes the form of revenue enhancement and cost savings. By merging, the
companies hope to benefit from the following:
• Staff reductions - As every employee knows, mergers tend to mean job losses.
Consider all the money saved from reducing the number of staff members from
accounting, marketing and other departments. Job cuts will also include the
former CEO, who typically leaves with a compensation package.
• Economies of scale - Yes, size matters. Whether it's purchasing stationery or a
new corporate IT system, a bigger company placing the orders can save more on
costs. Mergers also translate into improved purchasing power to buy equipment or
office supplies--when placing larger orders, companies have a greater ability to
negotiate price with their suppliers.
• Acquiring new technology - To stay competitive, companies need to stay on top of
technological developments and their business applications. By buying a smaller
company with unique technologies, a large company can keep or develop a
competitive edge.
• Improved market reach and industry visibility - Companies buy companies to
reach new markets and grow revenues and earnings. A merge may expand two
companies' marketing and distribution, giving them new sales opportunities. A
merger can also improve a company's standing in the investment community:
bigger firms often have an easier time raising capital than smaller ones.
2.4 Types of Mergers: -
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From the perspective of business structures, there are a whole host of different mergers.
Here are a few types, distinguished by the relationship between the two companies that
are merging:
 Horizontal merger: Two companies that are in direct competition in the same
product lines and markets.
 Vertical merger: A customer and company or a supplier and company. Think of a
cone supplier to an ice cream maker.
 Market-extension merger: Two companies that sell the same products in different
markets.
 Product-extension merger: Two companies selling different but related products in
the same market.
 Conglomeration: Two companies that have no common business areas.
From the perspective of how the merge is financed, there are two types of mergers:
purchase mergers and consolidation mergers. Each has certain implications for the
companies involved and for investors:
 Purchase Mergers - As the name suggests, this kind of merger occurs when one
company purchases another one. The purchase is made by cash or through the
issue of some kind of debt instrument, and the sale is taxable.
Acquiring companies often prefer this type of merger because it can provide them
with a tax benefit. Acquired assets can be "written-up" to the actual purchase
price, and the difference between book value and purchase price of the assets can
depreciate annually, reducing taxes payable by the acquiring company.
 Consolidation Mergers - With this merger, a brand new company is formed and
both companies are bought and combined under the new entity. The tax terms are
the same as those of a purchase merger.
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2.5 Acquisitions: -
As you can see, an acquisition may be only slightly different from a merger. In fact, it
may be different in name only. Like mergers, acquisitions are actions through which
companies seek economies of scale, efficiencies, and enhanced market visibility. Unlike
all mergers, all acquisitions involve one firm purchasing another--there is no exchanging
of stock or consolidating as a new company. Acquisitions are often congenial, with all
parties feeling satisfied with the deal. Other times, acquisitions are more hostile.
In an acquisition, as in some of the merger deals we discuss above, a company can buy
another company with cash, with stock, or a combination of the two. Another possibility,
which is common in smaller deals, is for one company to acquire all the assets of another
company. Company X buys all of Company Y's assets for cash, which means that
Company Y will have only cash (and debt, if they had debt before). Of course, Company
Y becomes merely a shell and will eventually liquidate or enter another area of business.
Another type of acquisition is a reverse merger, a deal that enables a private company to
get publicly-listed in a relatively short time period. A reverse merger occurs when a
private company that has strong prospects and is eager to raise financing buys a publicly-
listed shell company, usually one with no business and limited assets. The private
company reverse merges into the public company, and together they become an entirely
new public corporation with tradable shares.
Regardless of their category or structure, all mergers and acquisitions have one common
goal: they are all meant to create synergy that makes the value of the combined
companies greater than the sum of the two parts. The success of a merger or acquisition
depends on how well this synergy is achieved.
2.6 Valuation Matters: -
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Investors in a company that is aiming to take over another one must determine whether
the purchase will be beneficial to them. In order to do so, they must ask themselves how
much the company being acquired is really worth.
Naturally, both sides of an M&A deal will have different ideas about the worth of a target
company: its seller will tend to value the company as high as possible, while the buyer
will try to get the lowest price possible.
There are, however, many legitimate ways to value companies. The most common
method is to look at comparable companies in an industry, but dealmakers employ a
variety of other methods and tools when assessing a target company. Here are just a few
of them:
1. Comparative Ratios – The following are two examples of the many comparative
metrics on which acquirers may base their offers:
o P/E (price-to-earnings) ratio – With the use of this ratio, an acquirer
makes an offer as a multiple of the earnings the target company is
producing. Looking at the P/E for all the stocks within the same industry
group will give the acquirer good guidance for what the target's P/E
multiple should be.
o EV/Sales (price-to-sales) ratio – With this ratio, the acquiring company
makes an offer as a multiple of the revenues, again, while being aware of
the P/S ratio of other companies in the industry.
2. Replacement Cost: In a few cases, acquisitions are based on the cost of replacing
the target company. For simplicity's sake, suppose the value of a company is
simply the sum of all its equipment and staffing costs. The acquiring company can
literally order the target to sell at that price, or it will create a competitor for the
same cost. Naturally, it takes a long time to assemble good management, acquire
property and get the right equipment. This method of establishing a price certainly
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wouldn't make much sense in a service industry where the key assets--people and
ideas--are hard to value and develop.
3. Discounted Cash Flow (DCF): A key valuation tool in M&A, discounted cash
flow analysis determines a company's current value according to its estimated
future cash flows. Forecasted free cash flows (operating profit + depreciation +
amortization of goodwill – capital expenditures – cash taxes - change in working
capital) are discounted to a present value using the company's weighted average
costs of capital (WACC). Admittedly, DCF is tricky to get right, but few tools can
rival this valuation method.
Synergy: The Premium for Potential Success
For the most part, acquirers nearly always pay a substantial premium on the stock market
value of the companies they buy. The justification for doing so nearly always boils down
to the notion of synergy: a merger benefits shareholders when a company's post-merger
share price increases by the value of potential synergy.
It would be highly unlikely for rational owners to sell if they would benefit more by not
selling. That means buyers will need to pay a premium if they hope to acquire the
company, regardless of what pre-merger valuation tells them. For sellers, that premium
represents their company's future prospects. For buyers, the premium represents part of
the post-merger synergy they expect can be achieved. The following equation offers a
good way to think about synergy and how to determine if a deal makes sense. The
equation solves for the minimum required synergy:
In other words, the success of a merger is measured by whether the value of the buyer is
enhanced by the action. However, the practical constraints of mergers often prevent the
expected benefits from being fully achieved. Hence, the synergy promised by dealmakers
might just fall short.
21

What to look for: -
It’s hard for investors to know when a deal is worthwhile. The burden of proof should fall
on the acquiring company. To find mergers that have a chance of success, investors
should start by looking for some of these simple criteria:
• A reasonable purchase price - A premium of, say, 10% above the market price
seems within the bounds of level-headedness. A premium of 50%, on the other
hand, requires synergy of stellar proportions for the deal to make sense. Stay
away from companies that participate in such contests.
• Cash transactions - Companies that pay in cash tend to be more careful when
calculating bids, and valuations come closer to target. When stock is used as the
currency for acquisition, discipline can go by the wayside.
• Sensible appetite – An acquirer should be targeting a company that is smaller and
in businesses that the acquirer knows intimately. Synergy is hard to create from
companies in disparate business areas. And, sadly, companies have a bad habit of
biting off more than they can chew in mergers.
Mergers are awfully hard to get right, so investors should look for acquirers with a
healthy grasp of reality.
2.7 Doing the Deal: -
1.) Start with an Offer: -
When the CEO and top managers of a company decide they want to do a merger or
acquisition; they start with a tender offer. The process typically begins with the
acquiring company carefully and discreetly buying up shares in the target company,
building a position. Once the acquiring company starts to purchase shares in the open
market, it is restricted to buying 5% of the total outstanding shares before it must file
22

with the SEC. In the filing, the company must formally declare how many shares it
owns and whether it intends to buy the company or keep the shares purely as an
investment.
Working with financial advisors and investment bankers, the acquiring company will
arrive at an overall price that it's willing to pay for its target in cash, shares, or both. The
tender offer is then frequently advertised in the business press, stating the offer price and
the deadline by which the shareholders in the target company must accept (or reject) it.
2.) The Target's Response: -
Once the tender offer has been made, the target company can do one of several
things:
• Accept the terms of the offer - If the target firm's top managers and shareholders
are happy with the terms of the transaction, they will go ahead with the deal.
• Attempt to negotiate - The tender offer price may not be high enough for the
target company's shareholders to accept, or the specific terms of the deal may not
be attractive. In a merger, there may be much at stake for the management of the
target--their jobs, in particular. So, if they're not satisfied with the terms laid out
in the tender offer, the target's management may try to work out more agreeable
terms that let them keep their jobs or, perhaps even better, send them off with a
nice, big compensation package.
Not surprisingly, highly sought-after target companies that are the object of
several bidders will have greater latitude for negotiation. And managers have
more negotiating power if they can show that they are crucial to the merger's
future success.
• Execute a poison pill or some other hostile takeover defense – A poison pill
scheme can be triggered by a target company when a hostile suitor acquires a
predetermined percentage of company stock. To execute its defense, the target
23

company grants all shareholders--except the acquirer--options to buy additional
stock at a dramatic discount. This dilutes the acquirer's share and intercepts its
control of the company.
• Find a white knight - As an alternative, the target company's management may
seek out a friendlier potential acquirer, or white knight. If a white knight is found,
it will offer an equal or higher price for the shares than the hostile bidder.
3.) Closing the Deal: -
Finally, once the target company agrees to the tender offer and regulatory
requirements are met, the merger deal will be executed by means of some transaction.
In a merger in which one company buys another, the acquirer will pay for the target
company's shares with cash, stock, or both.
A cash-for-stock transaction is fairly straightforward: target-company shareholders
receive a cash payment for each share purchased. This transaction is treated as a taxable
sale of the shares of the target company.
If the transaction is made with stock instead of cash, then it's not taxable. There is simply
an exchange of share certificates. The desire to steer clear of the taxman explains why so
many M&A deals are carried out as cash-for-stock transactions.
When a company is purchased with stock, new shares from the acquirer's stock are issued
directly to the target company's shareholders, or the new shares are sent to a broker who
manages them for target-company shareholders. Only when the shareholders of the target
company sell their new shares are they taxed.
When the deal is closed, investors usually receive a new stock in their portfolio--the
acquiring company's expanded stock. Sometimes investors will get new stock identifying
a new corporate entity that is created by the M&A deal.
24

2.8 Restructuring Methods: -
There are several restructuring methods: doing an outright sell-off, doing an equity carve-
out, spinning off a unit to existing shareholders, or issuing tracking stock. Each has
advantages and disadvantages for companies and investors. All of these deals are quite
complex.
• Sell-Offs
A sell-off, also known as a divestiture, is the outright sale of a company
subsidiary. Normally, sell-offs are done because the subsidiary doesn't fit into the
parent company's core strategy. The market may be undervaluing the combined
businesses due to a lack of synergy between the parent and subsidiary.
Management and the board therefore decide that the subsidiary is better off under
different ownership.
Besides getting rid of an unwanted subsidiary, sell-offs also raise cash, which can
be used to pay off debt. In the late 1980s and early 1990s, corporate raiders would
use debt to finance acquisitions, and then after making a purchase they would sell-
off its subsidiaries to raise cash to service the debt. The raiders' method certainly
makes sense if the sum of the parts is greater than the whole. When it isn't, deals
are unsuccessful.
• Equity Carve-Outs
More and more companies are using equity carve-outs to boost shareholder value. A
parent firm takes a subsidiary public through an initial public offering (IPO) of
shares, amounting to a partial sell-off. A new publicly-listed company is created, but
the parent keeps a controlling stake in the newly traded subsidiary.
A carve-out is a strategic avenue a parent firm may take when one of its
subsidiaries is growing faster and carrying higher valuations than other businesses
25

owned by the parent. A carve-out generates cash because shares in the subsidiary
are sold to the public, but the issue also unlocks the value of the subsidiary unit
and enhances the parent's shareholder value.
The new legal entity of a carve-out has a separate board, but in most carve-outs,
the parent retains some control. In these cases, some portion of the parent firm's
board of directors may be shared. Since the parent has a controlling stake,
meaning both firms have common shareholders, the connection between the two
will likely be strong.
That said, sometimes companies carve-out a subsidiary not because it's doing
well, but because it is a burden. Such an intention won't lead to a successful
result, especially if a carved-out subsidiary is too loaded with debt, or had trouble
even when it was a part of the parent, lacking an established track record for
growing revenues and profits.
• Spin-offs
A spin-off occurs when a subsidiary becomes an independent entity. The parent
firm distributes shares of the subsidiary to its shareholders through a stock
dividend. Since this transaction is a dividend distribution, no cash is generated.
Thus, spin-offs are unlikely to be used when a firm needs to finance growth or
deals. Like the carve-out, the subsidiary becomes a separate legal entity with a
distinct management and board.
Like carve-outs, spin-offs are usually about separating a healthy operation. In
most cases, spin-offs unlock hidden shareholder value. For the parent company, it
sharpens management focus. For the spin-off company, management doesn't have
to compete for the parent's attention and capital. Set free, managers can explore
new opportunities.
26

Investors, however, should beware of throw-away subsidiaries the parent created
to separate legal liability or to off-load debt. Once spin-off shares are issued to
parent company shareholders, some shareholders may be tempted to quickly
dump these shares on the market, depressing the share valuation.
• Tracking Stock
A tracking stock is a special type of stock issued by a publicly held company to track
the value of one segment of that company. The stock allows the different segments of
the company to be valued differently by investors.
Let's say a slow-growth company trading at a low P/E happens to have a fast
growing business unit. The company might issue a tracking stock so the market
can value the new business separately from the old one and at a significantly
higher P/E rating.
Why would a firm issue a tracking stock rather than spinning-off or carving-out
its fast growth business for shareholders? The company retains control over the
subsidiary; the two businesses can continue to enjoy synergies and share
marketing, administrative support functions, a headquarters, and so on. Finally,
and most importantly, if the tracking stock climbs in value, the parent company
can use the tracking stock it owns to make acquisitions.
Still, shareholders need to remember that tracking stocks are class B, meaning
they don't grant shareholders the same voting rights as those of the main stock.
Each share of tracking stock may have only a half or a quarter of a vote. In rare
cases, holders of tracking stock have no vote at all.
27

2. Why M & As Can Fail: -
It's no secret that plenty of mergers don't work. Those who advocate mergers will argue
that the merger will cut costs or boost revenues by more than enough to justify the price
premium. It can sound so simple: just combine computer systems, merge a few
departments, use sheer size to force down the price of supplies, and the merged giant
should be more profitable than its parts. In theory, 1+1 = 3 sounds great, but in practice,
things can go awry.
Historical trends show that roughly two thirds of big mergers will disappoint on their own
terms, which means they will lose value on the stock market. Motivations behind mergers
can be flawed and efficiencies from economies of scale may prove elusive. And the
problems associated with trying to make merged companies work are all too concrete.
• Flawed Intentions
For starters, a booming stock market encourages mergers, which can spell trouble.
Deals done with highly rated stock as currency are easy and cheap, but the strategic
thinking behind them may be easy and cheap too. Also, mergers are often attempts to
imitate: somebody else has done a big merger, which prompts top executives to
follow suit.
A merger may often have more to do with glory-seeking than business strategy.
The executive ego, which is boosted by buying the competition, is a major force
in M&A, especially when combined with the influences from the bankers,
lawyers and other assorted advisers who can earn big fees from clients engaged in
mergers. Most CEOs get to where they are because they want to be the biggest
and the best, and many top executives get a big bonus for merger deals, no matter
what happens to the share price later.
On the other side of the coin, mergers can be driven by generalized fear.
Globalization, or the arrival of new technological developments, or a fast-
28

changing economic landscape that makes the outlook uncertain are all factors that
can create a strong incentive for defensive mergers. Sometimes the management
team feels they have no choice and must acquire a rival before being acquired.
The idea is that only big players will survive a more competitive world.
• The Obstacles of Making it Work
Coping with a merger can make top managers spread their time too thinly, neglecting
their core business, spelling doom. Too often, potential difficulties seem trivial to
managers caught up in the thrill of the big deal.
The chances for success are further hampered if the corporate cultures of the
companies are very different. When a company is acquired, the decision is
typically based on product or market synergies, but cultural differences are often
ignored. It's a mistake to assume that people issues are easily overcome. For
example, employees at a target company might be accustomed to easy access to
top management, flexible work schedules or even a relaxed dress code. These
aspects of a working environment may not seem significant, but if new
management removes them, the result can be resentment and shrinking
productivity.
More insight into the failure of mergers is found in the highly acclaimed study
from the global consultancy McKinsey. The study concludes that companies often
focus too intently on cutting costs following mergers, while revenues and,
ultimately, profits suffer. Merging companies can focus on integration and cost-
cutting so much that they neglect day-to-day business, thereby prompting nervous
customers to flee. This loss of revenue momentum is one reason so many mergers
fail to create value for shareholders.
But remember, not all mergers fail. Size and global reach can be advantageous,
and strong managers can often squeeze greater efficiency out of badly run rivals.
But the promises made by dealmakers demand the careful scrutiny of investors.
The success of mergers depends on how realistic the dealmakers are and how well
they can integrate two companies together while maintaining day-to-day
operations.
29

CASE STUDY
Bank of Madura with ICICI Bank
&
Times Bank with HDFC Bank
30

1. Introduction: -
The Indian banking industry in past few years has seen a spate of mergers and
acquisitions such as the merger of ICICI Bank with Bank of Madura, HDFC Bank with
Times Bank and a takeover of Global Trust Bank by Oriental Bank of Commerce.
Some six years ago the then chairman and managing director of Union Bank,
Panneerselvam, who was also the president of IBA at that time, referred to the imperative
for consolidation. He then pointed to a timeframe of some six to ten years during which
this consolidation would take place, eventually paving way for the emergence of a few
strong banks that would endeavor to match the size of some of the global banks.
Indian Finance minister Dr. P. Chidambaram has also expressed his inclination towards
mergers of public sector banks. Though the government or the RBI won’t be giving any
directives to the banks, both have shown willingness to facilitate such moves of mergers
and acquisitions. RBI is also working on regulating such future mergers. The actual
decision to go for M&A has been left to the board of directors of the involved banks.
Consolidation in the banking sector is inevitable. Mergers and acquisition route is
providing a quick step to acquire competitive size and offering banks an opportunity to
share markets and reduce cost of product development and delivery.
Mergers of smaller, newer banks would be much easier than the PSU banks, due to legal
and social constraints. India is now moving in the direction of fewer but larger mega
banks.
31

2. Need for Merger: -
1. Size matters
Today, size has assumed much greater importance and there has not been much to
differentiate in the services offered by the different public sector banks. With a
more liberal reform-oriented finance minister at the helm, a merger can help
rationalize the operations of the merged entities through shedding excess staff and
also merging branches in contiguous locations. With the acquisition of Bank of
Madura, ICICI bank became richer by almost 260 branches, 2500 personnel and
deposit base of around Rs37bn. Since in most of the southern states, ICICI bank
has a low presence, it was able to use its technology in the existing network of
BoM. The merged entity forms the largest private sector bank with total assets of
Rs 16,500 crore, 360 branches and about 4300 employees
2. Sharing of technology
With a fast spread of ATMs and automation of operations through large capacity
central processing units, the traditional focus on brick-and-mortar entities has lost
much of its meaning. Banks can reduce their cost of technology by sharing ATM
and branch network.
3. Large Capital base
The driving force for any merger is to set up a robust bank with a high capital
base. It helps the merged entities to cope with pressures in the form of increasing
capital adequacy requirements, tightening prudential norms, and the increasing
demands on resources to be committed for technology and infrastructure.
4. Geographical spread
Another major reason behind mergers is that mergers provide faster way to
expand the geographical presence and branch network. In case of the acquisition
32

of GTB which has good presence in South India by OBC operating mainly in
north India, the merged entity benefited greatly by geographical spread.
5. Product Portfolio and Economies of scale
Banks can offer a large variety in product portfolio because of increased
economies of scale and large size. It also helps the bank in customer retention by
offering services at lower prices. BOM was quite strong in its small and medium
enterprises portfolio, especially those, which are trader, lead. ICICI bank
encashed on this as its presence in this sector was very low. In the area of micro-
credit lending too, BOM had a strong presence, especially in those areas where
the lending is to self help groups involved with handicrafts, weaving etc. In the
area of agricultural lending, which falls under priority sector lending norms,
ICICI bank with the help of BOM reached near the industry average of about
35%.
3. Issues involved in mergers and acquisitions: -
While merging banks should keep in mind the inherent strengths and weaknesses of a
taken over bank, fundamental features like product Portfolio, NPA levels, capital
adequacy, technology levels and staff issues should be closely considered when
planning for a merger.
Mergers have a lot to do with organizational culture and technology. The merger of
ICICI bank with Bank of Madura was not very smooth because of diverse
organizational culture. The merging banks should be comparable in terms of culture
and technology.
Retrenchment of staff is another key issue. Employees from both banks, who do not
fit in the scheme of things, will face prospects of retrenchment. Already the members
of the United Forum of Bank Unions (UBFU), which represents over 10 lakh bank
33

employees and officers, has conveyed its strong resentment over the issue of mergers
and acquisitions of public sector banks on several occasions.
Shareholders consent is another issue. The shareholders should approve the swap
ratio of the shares of the merging banks. A miscalculated swap ratio could result in
advantage of one bank’s shareholders at the cost of other bank’s shareholders.
34

Bank of Madura with ICICI Bank
MERGER – One word that had badly hammered the stock price of ICICI Bank in the
last few years. And there seems to be no ending to the affair of the stock with the merger
news. If earlier, it was talks of merger with ICICI Ltd, now it is about an old private
sector bank, Bank of Madura. The final ratio was declared at 2 shares of ICICI Bank
(ICBA) for every 1 share of Bank of Madura (BoM). The share exchange ratio approved
by the respective Boards was based on recommendations made by M/s. Deloitte, Haskins
& Sells, which acted as independent valuers to the transaction.
The Scheme of Amalgamation was placed for approval at the meeting of shareholders of
the two banks on January 19, 2001 and was accepted subject to approval of the Reserve
Bank of India. The Appointed Date of merger was proposed to be February 1, 2001.
DSP Merrill Lynch Limited acted as advisor to Bank of Madura for the transaction.
Kotak Mahindra Capital Company was the advisor to the ICICI Bank on the merger
process.
"This merger is full of possibilities. The large customer base, geographical reach and
infrastructure managed by trained personnel would help us accelerate our growth plans,"
said Mr. H. N. Sinor, Managing Director and CEO, ICICI Bank.
According to Dr K. M. Thiagarajan, Chairman of Bank of Madura, "merger with a new
private sector bank, particularly a financially and technologically strong bank like the
ICICI Bank should add to shareholder value and enhance the career opportunities for our
employees besides providing first rate, technology-based, modern banking services to
customers."
The proforma analysis of the merged bank had shown that the merger was EPS accretive
for ICICI Bank shareholders by 23% based on September 2000 half-year results (Rs 7.1
per share (annualized) to Rs. 8.7 per share (annualized) proforma for the merged entity).
35

On proforma basis, as on September 30, 2000, the merged entity would have total assets
of Rs. 160.51 billion and deposits of Rs. 131.23 billion.
Synergies in Operations
Considerable synergies were expected to accrue from the combination of ICICI Bank and
Bank of Madura as they brought together complementary business strengths which would
enhance product portfolio, distribution network and brand image. The merged entity was
expected have around 2.6 million customer accounts and an extensive network of about
350 branches spread across India, giving it the critical mass in an intensely competitive
banking arena. The expanded customer base and distribution network of the merged
entity would provide considerable cross-selling opportunities enhancing the universal
banking strategy of ICICI Bank. The enlarged distribution network would also offer
scope to enhance fee income particularly in core areas like cash management services, a
traditional strongpoint of both banks and payment and collection services.
Bank of Madura had a number of branches in upcoming semi-urban and rural areas and
had developed robust micro-credit systems that combined with the strong brand image of
ICICI. This Bank was thought to successfully leverage the rural markets. The merger also
offered larger amount of low cost deposits and possibility of reorienting assets profile to
enable better spreads for the merged entity.
The focus of both banks was on developing a knowledge-oriented employee base with a
strong focus on technology to facilitate the process of post merger integration.
About Bank of Madura
Bank of Madura was a profitable and well-capitalized private sector bank, in operation
for 57 years with a national network of 263 branches including presence in each of the
top 30 banking centres in the country. The Bank had fostered an environment akin to new
36

private sector banks with a progressive employee base and technology driven operations
in major branches. It had a lowest cost of deposits at 7.3% and a high return on equity of
21.3%. As on September 30, 2000, the Bank had total assets of Rs. 39.88 billion and
deposits of Rs 33.95 billion. In India, the Bank's equity shares were listed on the Stock
Exchanges at Mumbai and Chennai and the National Stock Exchange.
About ICICI Bank
ICICI Bank is a leading technology-oriented private sector bank, promoted by ICICI
Limited (NYSE: IC). 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 as on September
30, 2000 stood at 17.59 %. The Bank's network of branches and extension counters
covered 106 locations across India. ICICI Bank is India's largest ATM provider with 366
ATMs. In India, the equity shares of ICICI Bank are listed on the Stock Exchanges at
Mumbai, Calcutta, Delhi, Chennai, Vadodara and the National Stock Exchange. ICICI
Bank's American Depositary Shares (ADS) are listed on the New York Stock Exchange.
But was the ratio justified…
But the question making rounds was about the fairness of the swap ratio, which was more
in favor of the shareholders of BoM.
If we compare the average share prices of the two banks over the different time period,
the ratio works out as shown below:
Table 1
Average Share Price (11-12-200) ICICI BoM Ratio (ICICI :
BoM)
1 month 143.1 89.4 0.62
3 months 140.3 79.2 0.56
37

6 months 174.0 77.2 0.44
Source: Indiainfoline
So the management of ICICI must have had something else in their agenda to decide the
ratio and perhaps the factor could have been the book value of the banks. The ratio seems
to be arrived after making adjustments for NPAs in the Book Value (as shown above).
But the important question is whether the book value of a new private sector bank like
ICICI can be compared with an old private sector bank like BoM. The new banks have
attained significant premium to their book values in the markets because of their
technology initiatives and the market expects these banks to achieve a higher growth rate
then the industry standards. So even if the Book Value of ICICI’s share is Rs65, it is
trading at a multiple of 2.5-3 while BoM had its share trading almost at 60% discount to
its book value.
Rationale behind the merger
Everyone was aware of the intentions of ICICI, which had been looking for an
acquisition for a long time. HDFC Bank had already acquired Times Bank a year ago and
it has resulted in a significant growth in the valuations of HDFC Bank. Since ICICI was
also keen on following the same route and expand its business operations, it had to
acquire a bank, which would have given it a stronger retail presence and higher profits.
With the acquisition of BoM, ICICI would be richer by almost 260 branches, 2500
personnel and deposit base of around Rs37bn. Since in most of the southern states, ICICI
has a low presence, it would be able to use its technology in the existing network of
BoM.
38

Efficiency levels of the banks just before the proposed merger
Table 2
(As on 31-03-2000) ICICI BoM
PAT (Rsmn) 1052 455
NPAs (%) 1.53 4.7
CAR (%) 19.6 15.8
ROANW (%) 30.1 19.8
RoA (%) 0.87 1.12
Business per employee(Rs lac) 595 202
Profits per employee(Rs lac) 7.8 1.7
Book Value 58.4 211.7
Adjusted Book Value(for NPAs) 55.6 132.5
EPS 5.35 38.89
As ICICI has been riding on its technological initiatives and growing at a much higher
rate, the efficiency ratios of BoM was also better as compared to the other older banks.
The only concern for the bank stems from its high level of NPAs, which the merged
entity would be burdened with. Also since, most of the workforce of BoM is computer
39

literate; ICICI would not have much difficulty in getting them used to its working
environment.
How the financial statements would emerge after the proposed merger
Table 3
ICICI ICICI
(Rs mn) pre-merger post-merger
Deposits 98660 134970
Advances 36573 53227
Investments 44166 61294
Share Capital 1968 2202
Net Worth 11494 14088
Net Interest Income 1859 2901
Other Income 1940 2927
Employee Costs 363 990
PAT
1052
1507
NPAs (Rsmn) 559 1486
NPAs (%) 1.53 2.8%
No of employees 1344 3967
40

All figures are as on 31st
March’ 2000
It was a known fact that ICICI Bank had failed in its earlier attempts to acquire a new
generation private sector bank because of differences in the swap ratio. So moving
towards the older private sector banks, it needed to pick someone who had a good retail
penetration, higher productivity ratios and could change faster to the tech banking of
ICICI. Since BoM was able to satisfy most of the parameters, the merger made sense, as
it would give ICBA a two-year growth at one shot.
Who gains... who loses?
The shareholders of BoM would not have even dreamt of such higher valuations. At the
prevalent market price of Rs140 of BoM, it would mean a premium of over 130% as per
the new ratio. The management of ICICI would justify the ratio as short-term phenomena
and would focus more on the inorganic growth they would be achieving once the merger
is through. But the question still remains as to how the stock prices react to the news.
After the ratio was announced, as expected, BoM could hit the circuit and would have
continued to do so till the arbitrage opportunity was present. But it could have also
resulted in a drop in share prices of ICICI to lower the valuation gap.
In the merger of HDFC Bank and Times Bank, the timing had proved in favor of both the
banks once the ratio was arrived on the basis of the stock prices (after making minor
adjustments). This had resulted in a substantial increase in the prices of the bank post
merger. But one was not sure whether the same thing would be evident in the ICICI case
also. The market had been assigning very significant differences to the valuations of
banks across different sectors. While most of the old banks that have found it difficult to
change to the new environment and have witnessed a substantial drop in their market
values, the new banks traded at a premium.
41

Hence the stock price over a certain time period should have been taken over a period as
it would have been a better indicator to arrive at the swap ratio and it would have truly
reflected the market values of both the entities.
.
Times Bank with HDFC Bank
42

Times Bank was a new generation private sector bank established by the Times group. As
art of HDFC Bank's strategy of attaining great heights it decided to merge with Times
Bank. As per the scheme of amalgamation issued by HDFC bank to its shareholder the
following were the reasons cited for the merger deal.
REASONS TO MERGE
 Branch Network would increase by over 50 percent and thus providing increased
eographical coverage.
 Increase the total number of retail customer accounts so as to increase deposit and
loan
 Products.
 3 After the merger the bank would be able to use Times Bank's lower cost
alternative hannels like phone banking, internet banking etc. and thereby the
reducing of operating costs.
 The merger would increase the presence of HDFC bank in the depository
participant activities.
 Improved infra structure facilities and central processing would help in deriving
economies of large scale.
METHODOLOGY
The researcher has depended heavily on secondary data. Data has been gathered from the
annual reports of HDFC and Times bank for a period ranging from 1999 to 2002. The
whole evaluation is based on the principle that if one plus one gives a figure greater than
two then the variable under study has resulted in a synergy. In other words the study
adopts a before and after approach for evaluating the merger's impact. Since
interpretations drawn from actual figures may be misleading CAGR has been employed
as a principal tool. Accordingly an attempt has been made to analyze the profitability,
43

total income, efficiency of branch, deposit mobilization efficiency, working fund,
performance variables and share holding pattern have been looked into.
PROFITABILITY
Profit is the ultimate aim of any business. And the future of a business depends upon the
level of profitability. Here the Spread –Burden model has been adapted to measure banks
profitability. Where Spread denotes the difference between interest income and interest
expense, Burden implies difference between non interest income and non interest expense
and profit margin refers to the profit earned by the bank before making provisions and
contingencies
CAGR OF PROFITABILITY RATIOS (%)
Item Combined Pre –
merger
Post- merger
Spread / Total Income 6.56 -9.85
Burden / Total Income 418.55 -14.52
Profit margin / Total
Income
-18.25 9.20
Source: Annual reports of HDFC Bank & Times Bank Ltd.
TOTAL INCOME
Income refers to the streams of revenue of a business. Bank may generate income from
activities directly related to its activities or other activities. Since it assumes great
importance it has been chosen as a variable for measuring the impact of merger
CAGR OF BUSINESS INCOME RATIOS OF MERGED BANKS (%)
Item Combined Average Post Merger
44

Pre-Merger
Interest Income/ Total
Income
6.15 -0.49
Interest Expense/Total
Income
8.53 6.56
Non interest income / Total
Income
-26.49 2.63
Non Interest expense / Total
Income
-0.22 -1.69
Contingencies / Total
Income
-34.28 -16.31
Source: Annual reports of HDFC Bank and Times Bank Ltd.
EFFICIENCY OF BRANCH
The branch of any bank is a representative of the whole banking business. Possessing
geographically widespread network of branches is a valuable asset for any bank. It would
assist mobilizing and disbursing huge amount of funds over a wider portfolio.
Considering the importance of branches for the success of a bank it has been included as
a variable cost per branch.
CAGR OF BRANCH WISE PERFORMANCE (%)
Item Combined Pre –
merger
Post – merger
Advance per branch 7.10 14.70
Deposit per branch 1.45 16.61
Net revenue per branch -7.14 26.75
Working fund per branch 7.61 15.10
Transaction 1.66 25.97
DEPOSIT MOBILIZATION EFFICIENCY
45

Deposits are an important source of Finance for all banks. In this era of globalization
there is intense Competition among banks in mobilizing deposits. In the private sector,
remuneration of bank officials to an extend depends upon the targets of deposits raised by
them. Thus deposits being an important Component for a bank it is taken as a variable for
measurement. Here deposit mix refers to the ratio of total of current and saving deposits
to total deposits. Investment refers to the total of all investments made by the bank.
Deposits
DEPOSIT MOBILIZATION RATIOS
Item Combined Pre – merger Post – merger
Investment to deposit 12.03 -0.15
Credit deposit ratio -7.16 -1.16
Operating expense/ Total
Deposit
1.00 8.03
Deposit Mix 31.88 6.33
Source: Annual reports of HDFC Bank Ltd and Times Bank Ltd.
WORKING FUND
Working fund refers to that part of capital that is required for financing the activities
during its operating cycle. Working capital has assumed such significance that it is now
being taught as a discipline in various universities. Here working fund refers to total of all
assets and this definition has been adopted from the annual reports of HDFC Bank
CAGR OF WORKING FUND RATIOS
46

OPERATING PERFORMANCE VARIABLES
Some more variables which are considered to be indicators of a banks operating
performance have also been included to measure exactly the real impact of merger
between HDFC and Times bank.
CAGR OF PERFORMANCE VARIABLES
47

Source: Annual Reports of HDFC Bank and Times Bank Ltd.
SHARE HOLDING PATTERN
The share holding pattern that the share holding pattern that might be influenced in a
merger deal has also been closely analyzed.
SHARE HOLDINE PATTERNS OF HDFC Bank (%)
Item Pre – merger Post – merger
HDFC 28.78 25.74
Indian Private Equity Fund 10.00 8.95
Indo cean Financial
Holdings
4.99 4.46
Bennet Coleman Co. and
group ( Times Bank
promoters)
Nil 7.78
Public 56.23 53.07
It can be noted that there has not been much of a dilution of ownership. The Times
group only got a 7.78 percent stake in the merged HDFC Bank. Some of the other major
findings based on actual figures have been summarized below
Summary of findings and conclusions
48

On analyzing all the above variables it can be found that
1. Before the merger the combined average non-operating losses of the bank was only 2.2
per cent of the total income. But that has increased to 6.15 per cent after the merger.
2. The average spread has increased by 10 per cent after the merger. This implies that
HDFC Bank has truly benefited by merging with Times bank that had a good retail
banking business.
3. During the pre merger era the combined entity used to consume only 8.08 per cent of
its total income for provisions. But after the merger this increased to 13.82 per cent
denoting a rising level of N.P.A
4. After the merger the bank has been following a policy of generating income from non-
business activities. This is very clear from the investment deposit ratio.
5. The post merged HDFC bank has been able to mobilize more amounts of cheap funds
in the form of current and savings deposits. So it can be inferred that the HDFC bank
could properly utilize the good foundation that Times bank had in retail banking.
6. The merger deal did not result in a huge dilution of ownership as the Times group
promoters got only a 7% stake in the newly merged entity.
From the foregoing analysis we can see that out of the 25 variables which have been
identified for measuring the impact of merger, 15 ratios indicate a synergy. This implies a
success ratio of 60 percentage. So we conclude that the merger between times and HDFC
Bank has turned out to be successful.
AVERAGE MOVEMENT OF IMPORTANT RATIOS
49

5. CONSOLIDATION: RATIONAL: -
50

Globalisation of financial services: -
Growing integration of economies and the markets around the world is making global
banking a reality. The surge in globalization of finance has also gained momentum with
the technological advancements which have effectively overcome the national borders in
the financial services business. Widespread use of internet banking has widened frontiers
of global banking, and it is now possible to market financial products and services on a
global basis. In the coming years globalization would spread further on account of the
likely opening up of financial services under WTO. India, as you know, is one of the 104
signatories of Financial Services Agreement (FSA) of 1997. This gives India’s financial
sector including banks an opportunity to expand their business on a quid pro quo basis.
Indian Banks at the global stage: A Reality check: -
As per Indian Banks' Association report ‘Banking Industry Vision 2010’, there would be
greater presence of international players in Indian financial system and some of the
Indian banks would become global players in the coming years. So, the new mantra for
Indian banks is to go global in search of new markets, customers and profits. Let us not
forget that the competition is not only on foreign turf but also in the domestic field as
well from foreign banks operating in India. Now against these lofty objectives of Indian
banks going global, let us see where we stand. Although, Indian banks have also made
their presence overseas, yet it is limited. Only twenty Indian banks including private
sector banks appear in the list of “Top 1000 World Banks” as listed by the London based
magazine “The Banker”. What is even more revealing is that State Bank of India, India’s
largest bank, ranks 82nd
amongst the top global banks. Size is increasingly becoming
important for the global banks as it is crucial to improved efficiency. However, India’s
largest bank, SBI is not even a 10th
in size of the 9th
largest bank, Sumitomo Mitsui,
which has assets of $950 billion as against SBI’s assets of $91 billion. Therefore, the
51

notion that SBI or ICICI Bank can compete in the international arena seems far fetched at
the moment.
Is size the only constraint for Indian banks: -
The problem is not just one of lacking the necessary size; few Indian banks have the
necessary products or human resource capabilities. If anything, the implementation of
Basel II norms has raised the bar for Indian banks seeking an international presence. The
top international banks can lower their capital requirements through the use of
sophisticated risk management techniques and thus compete more aggressively than
before.
What is being done to prepare Indian banks to meet global challenge?
Indian banking sector has already implemented internationally followed prudential
accounting norms for classification of assets, income recognition and loan loss
provisioning. The scope of disclosure and transparency has also been raised in
accordance with international practices. India has complied with almost all the Core
Principles of Effective Banking Supervision of the Basel Committee. Some of the Indian
banks are also presenting their accounts as per the U.S. GAAP. The roadmap for adoption
of Basel II is also under formulation. All these factors give Indian banks much needed
confidence for overseas operations. But as I said earlier overseas operations is one thing
and competing against the global players in the international market is quite another. And
Indian banks have a lot of catching up to do before they can emerge as truly global
players.
Supporting Regulatory Framework: -
52

Supporting institutional and regulatory framework at home is vital for domestic banks
aspiring for global operations. RBI has suitably changed the country’s regulatory
framework from time to time to support Indian financial institutions to withstand the
competitive pressures placed on them by increasing globalization. Proper steps have been
taken to guide the banking sector to see that the banks pass through this transition phase
by and large successfully. The reforms initiated in the banking sector have now reached a
crucial stage. Government’s stake in some PSBs is reduced and as a consequence public
equity in these PSBs is enlarged. This led to greater responsibility on the bank
managements since the level of accountability has increased. Pressures of performance
and profitability will keep them on their toes all the time as the public shareholders
expect good performance along with good returns on their equity. Many PSBs have
already started the exercise of cleaning up of their balance sheets by shedding the excess
baggage. The VRS scheme in the recent past in some of the banks was aimed not only at
downsizing the manpower but also at cutting down the staff costs and increasing the
performance levels of the staff in the long run. Some of these banks are able to run the
show to certain extent by low cost funds that are available thanks to the branch network
spread over the length and breadth of the country.
Consolidation and move towards Universal Banking: -
We are slowly but surely moving from a regime of “large number of small banks” to
“small number of large banks.” The new era is going to be one of consolidation around
identified core competencies. Mergers and acquisitions in the banking sector are going to
be the order of the day. Successful merger of HDFC Bank and Times Bank earlier and
Stanchart and ANZ Grindlays three years ago has demonstrated that trend towards
consolidation is almost an accepted fact. We are also looking for such signs in respect of
a number of old private sector banks, many of which are not able to cushion their NPAs,
expand their business and induct technology due to limited capital base. Coming times
may usher in large banking institutions, if the development financial institutions opt for
53

conversion into commercial banking in line with the recommendation of Narasimhan (II).
In India, one of the largest financial institutions, ICICI, took the lead towards universal
banking with its reverse merger with ICICI Bank coming through a couple of years ago.
Another mega financial institution, IDBI has also adopted the same strategy, and has
already transformed itself into a universal bank. Now the process of its progeny IDBI
Bank merging itself with the parent IDBI is underway, and is likely to be completed
soon. This trend may lead logically to promoting the concept of financial super market
chain, making available all types of credit and non-fund facilities under one roof or
specialized subsidiaries under one umbrella organisation. Consolidated accounting and
supervisory techniques would have to evolve and appropriate fire walls built to address
the risks underlying such large organizations and banking conglomerates.
Will the stable conditions continue for the banks?
The big question we have to ponder is whether these stable conditions marked by all
round improvement in banks’ performance can continue into 2005 onward in the light of
potentially dramatic changes that include, among others, a sliding dollar, rising interest
rates, introduction of Basel II accord and international accounting standards, and the
possible flattening of consumer lending boom. Hopefully, the banking industry in tandem
with the regulatory authorities will rise to the occasion, and collectively face the
challenges and opportunities that lie ahead.
54

5. BANKS CONSOLIDATION: FUTURE: -
It is inevitable in the Indian banking scenario; consolidation is the next step for evolution.
A look at the international scene suggests that, size does matter. To put things in
perspective; State Bank of India is three times the size of Bank of America (BoA). SBI is
reaching 90 to 100 million customers while BoA has 30 million customers. But if you
look at assets, BoA has more than a trillion dollar of assets as against SBI's asset size of
Rs 4,000 billion. That gives BoA the muscle to cut costs and amplify earnings.
The statistics for total loans to GDP ratio also draws a sorry picture of the Indian banking
industry.
As net interest margins get thinner, the need for more sophisticated products and low-cost
technology is felt. The only answer to this is to create synergies by consolidating with
complimenting entities to trigger the next phase of consolidation in the banking sector;
the Reserve Bank of India is expected to draw a fresh set of guidelines. It is believed that
the new draft guidelines will encourage foreign banks to acquire stakes in Indian banks.
The government has clearly indicated that more capital from private and foreign banks is
needed to make the banking sector robust. There are several foreign banks, which are yet
to start their operations in India and are looking at strategic alliances to make their
presence felt in India. There are 29 private banks in the country. Of these, around 15 are
envisaging to raise resources in the near future. Once the government comes out with
55

clear guidelines, these banks will either go in for IPO’s, seek strategic alliances or
placements with private equity funds.
It is also expected that most of the profitable private sector banks will fall prey to a
takeover bids by their brawny counterparts. The question now is, which are the possible
targets for takeover and what are the likely benefits expected from them? The following
analysis seeks to answer this.
- J & K Bank IndusInd Bank Karur Vyasa
Bank
Bank of
Rajasthan
Bharat
Overseas
Bank
- FY03 FY04 FY03 FY04 FY03 FY04 FY03 FY04 FY03 FY04
Advances (Rs m) 80,109 92,849 53,478 78,122 33,444 40,232 22,212 24,316 11,531 13,915
Deposits (Rs m) 146,749 186,613 85,978 112,002 51,219 59,114 52,992 74,059 21,491 24,715
Profitability % - - - - - - - - - -
ROA 2.1 2.1 0.9 2.1 2.2 2.4 1.3 1.0 1.3 1.3
ROE 31.0 28.7 15.5 37.4 25.3 25.4 26.4 22.5 21.7 22.5
Net Profit / Spread 64.2 65.6 48.9 82.7 73.9 54.2 37.8 36.4 47.1 41.1
Net Profit margin 19.7 22.3 9.0 19.7 19.3 22.3 11.4 10.2 13.5 15.2
Quality of Assets
% - - - - - - - - - -
CAR 16.5 16.9 12.1 12.8 17.0 17.1 11.3 11.2 13.9 16.3
NPA / Net
Advances 1.6 1.5 4.3 2.7 4.2 2.3 6.9 3.0 3.3 2.3
Avg cost of deposits 6.3 5.3 6.0 5.1 7.1 6.0 6.2 4.9 5.7 4.8
Avg yield on
advances 9.1 8.0 7.4 7.9 9.1 9.8 8.6 6.9 7.7 7.6
Productivity (Rs
m) - - - - - - - - - -
Income / Branch 37.7 38.3 188.8 218.2 30.3 32.3 17.8 19.2 26.8 28.7
Income/ Employee 2.4 2.7 10.5 7.6 2.3 2.5 1.4 1.6 2.1 2.2
Liquidity - - - - - - - - - -
56

Credit Deposit ratio 54.6% 49.8% 62.2% 69.8% 65.3% 68.1% 41.9% 32.8% 53.7% 56.3%
Borrowings/deposits 1.5 1.6 2.8 2.1 5.2 1.8 0.3 2.4 2.6 0.7
Jammu and Kashmir Bank is the first state owned bank of the country and 53% of equity
is held by the government of J&K. The bank has a network of 475 branches spread over
the country. During FY04, the bank recorded a 23% growth in its total revenues over the
previous year. Although divestment on the part of the government is uncertain, the
performance ratios of the bank surely make it a good contender for acquisition.
IndusInd Bank also is in the same league with an impressive net worth growth (from Rs 3
billion to Rs 8 billion) during the past six years. The total deposits and advances of the
bank in FY04 grew by 30% and 46%, respectively, faster than the industry growth rate.
It has comparatively smaller branch network of 61 and 80 ATMs across the country. But
at the same time, the bank has the highest productivity ratios amongst the Tier II private
banks.
The Karur Vysya Bank (one of the oldest private sector banks operating in India since
1916) has been ranked as one of the top five banks in the private sector. The bank has a
strong hold in the South with a total of 216 branches across the nation. The bank has an
impressive capital adequacy ratio and also boasts of a credit deposit ratio to the tune of
68%.
Bank of Rajasthan having its network across 12 states, mainly concentrated in the north,
has an edge in terms of relatively low cost of deposits. The bank has also successfully
cleansed its assets by bringing down the net NPA / advances ratio from 7% in FY03 to
3% in FY04.
Bharat Overseas Bank, a fast growing Chennai based bank is unique in the sense that it is
promoted by seven other banks, namely, IOB, Bank of Rajasthan, Vyasa Bank, Karur
Vyasa Bank, Federal Bank, South Indian Bank and Karnataka Bank. Established to take
57

over from Indian Overseas Bank's Bangkok branch, it is one of the few private banks
permitted by the Reserve Bank of India to have a branch outside India and is the only
bank to represent India in Thailand. The bank has been able to leverage its overseas
presence to access low cost deposits and this is reflected in the fact that its borrowings /
deposits ratio have declined from 2.6 times in FY03 to 0.7 times in FY04.
Fundamentally, a merger must satisfy its objectives. There needs to be an increment in
market share, augmented scale, reduction in expenses and last but not the least, it has to
be attractive to shareholders.
The credibility of the acquiring entity and the complimenting benefit offered by the
acquired target will together decide the fortunes of the shareholders.
As domestic and international competition hots up, banks may have to shift their focus to
`cost', which will be determined by revenue minus profit. Cost-control in tandem with
efficient use of resources and increase in productivity will determine the winners and
laggards.
The report has been prepared for the Indian Banks' Association by a committee of experts
headed by Mr. S. C. Gupta, Chairman and Managing Director, Indian Overseas Bank.
58

In the sheltered days of banking, when customers could be freely charged, banks
concerned themselves with only `revenue' which was equal to cost plus profit. Post-
reforms, when the cost of services became nearly equal across banks and cost-control was
key to higher profits, the focus of banks shifted to `profit', which was equal to revenue
minus cost. In the future, as domestic and international competition hots up, banks may
have to shift their focus to `cost' which will be determined by revenue minus profit. In
other words, cost-control in tandem with efficient use of resources and increase in
productivity will determine the winners and laggards in the future, says the report.
Qualitative growth
The growth of banking in the coming years is likely to be more qualitative than
quantitative, according to the report. Based on the projections made in the "India Vision
2020" prepared by the Planning Commission and the Draft 10th Plan, the report forecasts
that the pace of expansion in the balance-sheets of banks is likely to decelerate.
The total assets of all scheduled commercial banks by end-March 2010 is estimated at Rs
40, 90,000 crore. That will form about 65 per cent of GDP at current market prices as
compared to 67 per cent in 2002-03.
Banks assets are expected to grow at an annual composite rate of growth of 13.4 per cent
during the rest of the decade against 16.7 per cent between 1994-95 and 2002-03.
On the liability side, there is likely to be large additions to capital base and reserves. As
the reliance on borrowed funds increases, the pace of deposit growth may slow down.
On the asset side, the pace of growth in both advances and investments is forecast to
weaken.
Conclusion
On the growing influence of globalization on the Indian banking industry, the report is of
the opinion that the financial sector would be opened up for greater international
59

competition under WTO. Opening up of the financial sector from 2005, under WTO,
would see a number of global banks taking large stakes and control over banking entities
in the country.
They are expected to bring with them capital, technology, and management skills which
would increase the competitive spirit in the system leading to greater efficiency.
Government policy to allow greater FDI in banking and the move to amend Banking
regulations Act to remove the existing 10 per cent cap on voting rights of shareholders
are pointer to these developments, says the report.
The pressure on banks to gear up to meet stringent prudential capital adequacy norms
under Basel II and the various Free Trade Agreements that India is entering into with
other countries, such as Singapore, will also impact on globalization of Indian banking.
However, according to the report, the flow need not be one way. Some of the Indian
banks may also emerge global players. As globalization opens up opportunities for Indian
corporate entities to expand their business overseas, banks in India wanting to increase
their international presence could naturally be expected to follow these corporate entities
and other trade flows out of India.
Alongside, the growing pressure on capital structure of banks is expected to trigger a
phase of consolidation in the banking industry. In the past mergers were initiated by
regulators to protect the interest of depositors of weak banks. In recent years, there have
been a number of market-led mergers between private banks.
This process is expected to gain momentum in the coming years, says the report. Mergers
between public sector banks or public sector banks and private banks could be the next
logical development, the report adds. Consolidation could also take place through
strategic alliances or partnerships covering specific areas of business such as credit cards,
insurance etc.
60

The ability to gauge the risks and take appropriate position will be the key to successful
banking in the emerging scenario. Risk-takers will survive, effective risk mangers will
prosper and risk-averse are likely to perish, the report asserts.
In this context, the report makes a very pertinent recommendation that risk management
has to trickle down from the corporate office to branches.
As audit and supervision shifts to a risk-based approach rather than transaction oriented,
the risk awareness levels of line functionaries also will have to increase.
The report also talks of the need for banks to deal with issues relating to `reputation risk'
to maintain a high degree of public confidence for raising capital and other resources.
Technological developments would render flow of information and data faster leading to
faster appraisal and decision-making. This would enable banks to make credit
management more effective, besides leading to an appreciable reduction in transaction
cost.
To reduce investment costs in technology, banks are likely to resort more and more to
sharing facilities such as ATM networks, the report says. Banks and financial institutions
will join together to share facilities in the areas of payment and settlement, back-office
processing, date warehousing, and so on.
The advent of new technologies could see the emergence of new players doing financial
intermediation. For example, according to the report, we could see utility service
providers offering, say, bill payment services or supermarkets or retailers doing basic
lending operations. The conventional definition of banking might undergo changes.
All these developments need not mean banks will give the go-by to social banking.
Rather than being seen as directed lending such lending would be business driven, the
report predicts. Rural market comprises 74 per cent of the population, 41 per cent of the
middle-class, and 58 per cent of disposable income.
61

Consumer growth is taking place at a fast pace in 17,000-odd villages with a population
of more than 5,000. Of these, more than 50 per cent are concentrated in just seven states.
Small-scale industries would remain important for banks.
However, instead of the narrow definition of SSI based on the investment in fixed assets,
the focus may shift to small and medium enterprises (SMEs) as a group. Changes could
be expected in the delivery channel for small borrowers, agriculturists and unorganized
sectors also.
The expected integration of various intermediaries in the financial system would require a
strong regulatory framework, the report states. It would also require a number of
legislative changes to enable the banking system to remain contemporary and
competitive. Underscoring that there would be an increased need for self-regulation, the
report states that development of best practices could evolve better through self-
regulation rather than based on regulatory prescriptions.
For instance, to enlist the confidence of the global investors and international market
players, the banks will have to adopt the best global practices of financial accounting and
reporting. It is expected that banks would migrate to global accounting standards
smoothly, although it would mean greater disclosure and tighter norms, the report adds.
Notwithstanding the limited time ahead, the expectations, suggestions and
recommendations of the Banking Industry Vision report are well within the realm of
realization in part or whole. The first phase of banking reforms was born out of panic.
The second phase can be implemented from a position of strength and confidence in a
compressed time-frame.
The roles and responsibilities of the Board of directors of large companies are subject to
many codes, statutes, regulations and guidelines in several countries around the world. It
is being increasingly accepted that companies and there boards are responsible not only
to their shareholders but also to their 'real' stakeholders, even though this often entails
62

managing incongruent objectives and interest conflicts. The protection of such wide
ranging interest is fraught with its own set of challenges for Boards and there executive
management in every ongoing business corporation. In case of mergers, acquisitions and
divestures, there is a further compounding of these problems, but the Boards have to
resolve such issues with utmost balance, equity and fairness
BALANCING NON-CONGRUENT STAKEHOLDERS CLAIMS
At the best of times, claims of different stakeholders will be mutually non-congruent.
Shareholders will want to maximize their wealth, employees will seek higher rewards for
their labour, customers and patrons in a competitive market place will insist on more
value for their money in terms of price and service, vendor's claims will usually be a
mirror image of the demands of the customers, creditors will be eager to see their
earnings going up and risks coming down, and the government will want to ensure that
all taxes and duties are properly computed and paid. The task of the executive
management is to balance the competing demands of different stakeholders, and to
produce on a sustainable basis a return to shareholders that exceeds their required rate, so
that the companies overall cost of capital may be brought down.
The fact that stakeholders interest are as much a concern for the company and its Boards
as the duty to maximize shareholders wealth and protect wealth creating assets is now
well established. Traditional arguments, based on the residual claimant theory supporting
exclusive accountability to shareholders, are now tempered with the realism of having to
recognize the interest of other stakeholders. This moderation is reflected in a number of
national and international guidelines on corporate governance
6. CORPORATE GOVERNANCE IN MERGERS &
ACQUISITIONS: -
For ease of treatment, the issues are grouped together under stakeholder's categories, that
is, those pertaining to shareholders, employees, customers, suppliers and immediate
63

communities. In practice, many of these issues would have multiple stakeholder impact
and would have multiple stakeholder impact and would need to be addressed so as to
balance conflicting requirements
• RELATING TO SHAREHOLDERS : -
The most important issue concerning the shareholders of the company is the likely impact
of the merger on the valuation of their equity capital. While the Board would most likely
have asked for valuation of the company or the business sought to be acquired, so as to
decide, upon an attractive offer price, it is somewhat less common to find Boards calling
for such valuations of the acquiring company post- acquisition. Except possibly in case of
a distress sale, the acquiring company usually offers a price in excess of the acquired
company's real worth, in order to emerge as an attractive proposition. This is also
justified on the basis that the acquiring company's expertise, inputs, synergies etc, the
acquired business would lead to improved cash flows than what would have been
possible had the business continued on its own.
Although markets have there intuitive methods of capturing such possibilities, it is better
for the Board of the acquiring company to calculate the internal financials with and
without acquisitions, and adopt the usual probing and challenges approach to any
assumptions on which such projections are made.
Due diligence and validation of the financials and the underlying assets and resources of
the acquired entity are standard procedures. The board should ensure that this is done
with utmost objectivity that various documents of title are duly inspected and that
ownership is clearly established. The board must ensure that these tasks are done
efficiently, and satisfy itself by asking probing questions and challenging key
assumptions, in the light of the directors own expertise and experience.
It is necessary in case of acquisitions to ensure that the promoters or controlling group of
the acquired company or their associates do not compete with the acquiring company in
the same line of business for a reasonable period of time, and that they do not solicit
64

Evolution and Opportunities of Indian Banking

Evolution and Opportunities of Indian Banking

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