Merger & Acquisition of Banks

                                      Southern Economist,Volume 46(5) 2007

A paradigm shift is taking place in the global economic scenario. Organisations, big or small are looking for organic and inorganic growth so as to expand size and have larger share in the business pie. Technological innovations coupled with deregulation have prompted a wave of mergers in the banking industry throughout the world. The industry has realised that competition can be faced by cutting costs, improving service, launching new innovative products and by expanding size. Growing institutions are on look out to grab every opportunity for expanding market. Indian banking industry, which was hither to operating in protective regulations, has become most active players in mergers.
Expansion can either be done by exploring new markets or by merging with competitors or taking them over. Since the gestation period involved in starting a new product line and making a dent in the virgin market is long, the best option to cut short the gestation period and cost, is procuring control over similar other institution by merger or leverage buy out. Both merger and acquisition involve one or multiple institutions purchasing all or part of another organisation. Merger, amalgamation, acquisition and take over are different routes for arriving at the goal of absorption of one or multiple institutions. Consolidation is also absorption.

1)-What is Merger?

According to the Oxford Dictionary, the expression "merger" or "amalgamation" means "combining of two commercial companies into one" and "merging of two or more business concerns into one" respectively.
Merger is combination of two or more companies into a single entity where one survives and other ceases. Merger takes place when two business entities agree to go forward as a single new entity and the existing stakeholders of both the involved institutions retain a shared interest in the new entity. With the merger, all assets, liabilities and stocks of one entity stand transferred to the transferee institution. Shareholders of the amalgamating entity get shares of the amalgamated entity at a pre-agreed ratio or proportion in exchange of their existing share in the target institution.
The object behind merger is to achieve greater efficiencies of scale and productivity. Mergers are the potential for concentration of economic power and exploiting existing core competencies. Merger may involve absorption or consolidation. In absorption, one entity acquires another entity. In legal parlance, we call mergers as amalgamations in India.

Mergers can be broadly classified as:

1-a) Horizontal Merger

It is a merger of two institutions, which have common product line, or render the same services, and compete directly with each other. The merger is based on the assumption that it will provide economies of scale from the larger unit and will eliminate competition, duplication of facilities, reduction in cost, increase in market segments and exercise of better control over market.

1- b) Vertical Merger

It takes place between two institutions having different operations either as forward or backward integration i.e. where one of them is an actual or potential supplier of goods or services to the other. The main object is to ensure a source of supply, ready take off of the materials and outlet for products, gain control over product specifications, increase profitability by gaining margins of the previous supplier/distributor and improving efficiency.

1-c) Circular Merger

Companies producing different products seek amalgamation to share common distribution and research facilities and promoting market enlargement. The acquiring company benefits by economies of resource sharing and diversification.

1-d) Conglomerate Merger

It is a merger of indifferent or unrelated business output institutions. The merger entities have no common business lines. The purpose is to ensure utilisation of financial resources, enlarge debt capacity and to reduce risk by diversification. The entities opting for conglomerate merger control a range of activities in various industries requiring different skills in the specific functions. The purpose is to obtain greater stability of earnings through diversification; utilising spare resources whether capital or management; and to obtain benefit of economies of scale.

1-e) Reverse Merger

It is a method by which a private company becomes a public company, bypassing the lengthy and complex process of initial public offering (IPO). It is generally used in those cases where a company having higher net worth is merging into a company having net worth lower than it. Merger of ICICI Ltd., with ICICI Bank was the reverse merger.

2) What is Acquisition?

When one entity takes over another entity and establishes itself as a new owner, the purchase is called acquisition. In acquisition, one institution purchases bulk of stock of another organisation, creating an uneven balance of ownership in the institution. Acquisition is similar to big fish swallowing small fish. From legal point of view, the target entity ceases to exist. This can be affected by:
Agreement with the persons having majority of the stake
Purchase of shares in the open market
To make takeover offer to the general body of share holders
Purchased of new shares by private treaty
Acquisition of share capital

Acquisition can be –

2-a) Hostile

When one organisation without the consent of other organisation acquires significant portion of the stocks or equities of other concern with a view to having control over the organisation, it is termed as ‘hostile’ take over.

2-b) Friendly

When one institution makes a financial proposal to the management and Board of another institution, which is to be acquired it is termed as “friendly” take over. The objective is to take over the institution with its consent. The proposal might involve the merger of two institutions or consolidation of two institutions or creation of parent/subsidiary relationship. The Mergers and acquisitions are through the negotiations, willingness and consent of the acquiree company.

2-c) Leveraged Buyouts

This is the acquisition of a company by its management personnel. It is also known as management buyout. Management may raise capital from the market or institutions to acquire the company on the strength of its assets.

3) What is Amalgamation?

It is acquiring a controlling interest by one organisation in another organisation. It is blending of two or more existing undertakings into one undertaking. The blended company loses its identity and form springs into a separate legal identity. The shareholders of each blending company become the shareholders in the company, which is to carry on the blending undertaking.

4) What is Take over?

It is acquisition of a certain block of equity capital of a company, which enables the acquirer to exercise control over the affairs of the company. Normally merger/amalgamation and acquisition/take over are the terms used interchangeably. Takeover differs with merger in approach to business combinations i.e., the process of takeover, transaction involved, determination of exchange rate of the shares of the companies that would undergo a merger known as Swap Ratio. This is calculated by the valuation of various assets and liabilities of the merging companies.
Take over is change in a corporation's controlling interest either through a friendly acquisition or a hostile bid. Hostile takeovers aim to replace the target company's existing management and are usually attempted through a public tender offer. In an "unfriendly" takeover (Hostile), acquirer may not offer the proposal to acquire the target company’s undertaking, but may offer incentives to stockholders such as offering a price well above the current market value to gain controlling interest in it against the wishes of the management. They are also called raids or takeover raids. Other takeover methods are unsolicited merger proposals to directors, accumulation of shares in the open market, or proxy fights.

4-a) Clandestine Takeover (or) Creeping Takeover

The clause 40 of the Listing Agreement of stock exchange allows a person to buy up to 5% stake in a company without any prior permission. After 5%, they ought to inform the stock exchange.

5-Rules governing Mergers and take over

The terms merger and amalgamation have not been defined in the Companies Act, 1956, the provisions relating to merger and amalgamation are contained in sections 391 to 396A in Chapter V of Part VI of the Act. A procedure has been laid down in the Indian” Companies Act, 1956”, in terms of which a merger can be effectuated. Sanction of the Company Court (High Court) is an essential prerequisite for the effectiveness of and for effectuating a scheme of merger.
Mergers and Amalgamations are outside the purview of Securities and Exchange Board of India (SEBI). However, only takeovers and substantial acquisition of shares of a listed company fall within the regulatory purview of SEBI. These Regulations are called the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997.The regulatory provisions governing merger contained in the Monopolies and Restrictive Trade Practices Act, 1969,were removed with effect from 27-9-1991, through the 1991 amendments .

6) What is Consolidation?

It is fusion of two existing entities into a new unit. In consolidation two or more entities combine to form a new entity. Both the entities lose their identity and cease to exit and a new institution takes birth. The stakeholders of both the entities become stakeholders of new entity. The idea behind consolidation is that strong unit can absorb shocks and survive in difficult times.

7) Difference between Merger and Acquisition

Basically there is no difference between merger and acquisition. The difference is only in the operational process of acquisition. In merger, one entity gets merged with other loosing its identity by way of share transactions/assets/liability transfers. In acquisition/take over, one concern acquires the controlling interest of ownership of capital. However, the acquired organisation retains its own individual identity.

8) Why Merger & Acquisition?

Merger is a way of changing and expanding the organisation. By merging with a major competitor, an organisation can dominate the market they compete in. The main purpose of merger and acquisition is to enhance market share, absorbing, eliminating or reducing competition, reducing operating cost, to fill the gap of expert and professional staff and to take advantage of tax benefits, if the institution being merged or acquired is a debt ridden or loss entity. Another object could be to acquire the technology of the competitor or of the target company. This has been observed in the IT sector, where a number of companies have taken over other IT companies offering rich products or services developed by them, or to enhance capacity and to become major player both in domestic and global market for example “Tata Steel” acquiring “Corus”, A V Birla Company –Hindalco taking over Novelis a Canadian aluminum giant.

9) Advantages of Merger & Acquisitions

9-i) Growth

One of the fundamental motives that entice merger is impulsive growth. Organisations that intend to expand need to choose between organic growth and acquisition driven growth. Since the former is very slow, steady and relatively consume more time, dynamic organisations that are ready to capitalise on opportunities prefer the latter. Merger helps in diversifying the areas of activities. It helps in achieving optimum size of business and removes certain key factors and other bottlenecks of input supplies.

9-ii) Managerial Efficiency

Some acquisitions are motivated by the belief that the acquirer’s management can better manage the target’s resources.

9-iii) Revenue enhancement

The reason can differ on a case-to-case basis. When two business entities have complementary business interests, mergers may result in consolidating their position in the market resulting into cost reduction, and revenue enhancement.

9-iv) Tax benefit

This plays a significant role in acquisition. If the distressed entity has accumulated losses and unclaimed depreciation benefits on their books, such acquisition can eliminate the acquiring institution’s liability by benefiting merger.

10) Merger/Amalgamations- Banking Regulation Act, 1949

Amalgamation of banking companies under Banking Regulation Act falls under two categories i.e. voluntary amalgamation and compulsory amalgamation.
Section 44A deals with Voluntary Amalgamation of Banking Companies. As per the provisions, a banking company may be amalgamated with another banking company by approval of shareholders of each banking company by resolution passed by the majority of two third in value of the shareholders of each of the said companies. The banks have to obtain Reserve Bank’s sanction for the approval of the scheme of Amalgamation. The Reserve Bank generally encourages amalgamation when it is satisfied that the scheme is in the interest of depositors of the amalgamating bank.
Under Section 45 (4) of the Banking Regulation Act, 1949 Reserve Bank may prepare a scheme of amalgamation of a banking institution. A compulsory amalgamation is pressed into action where the financial position of the bank has become weak and urgent measures are required to safe guard the interest of depositors’. Section 45 of the Banking Regulation Act, 1949 provides for a bank to be reconstructed or amalgamated compulsory, i.e. without the consent of its members or creditors, with any other banking institutions as defined in sub-section (15) thereof.
According to Section 45, the Reserve Bank of India can submit a scheme to the Central Government for amalgamation of banking unit with a well managed bank within a period of not more than six months moratorium granted by the Government on an application made earlier in that behalf by Reserve Bank of India.
One advantage of compulsory amalgamation over liquidation is that the depositors get immediate credit to the extent of readily realizable assets at the commencement of the amalgamation, additional payments being made as and when the remaining assets are realised.

11) Narsimaham Committee on Merger

Narasimaham Committee report on financial system had recommended a broad pattern of the structure of the banking system as under-
a) 3 or 4 large banks (including the State Bank of India) which could become international in character.
b) 8 to 10 national banks with a network of branches throughout the country engaged in “Universal” banking.
c) Local banks whose operations would be generally confined to a specific region: and
d) Rural Banks (including Regional Rural Banks) whose operations would be confined to the rural areas and whose business would be confined to the rural areas and whose business would be pre dominantly engaged in financing of agriculture and allied activities.
The Narasimaham Committee on banking sector reforms suggested that “Mergers between banks and Development Finance Institutions (DFIs) and Non Banking Finance Companies (NBFCs) need to be based on synergies and should make a sound commercial sense. Committee also opined that mergers between strong banks/Financial Institutions would make greater economic and commercial sense and would be a case where the whole is greater than the sum of its parts and have a “force multiplier effect”. It also opined that mergers should not be seen as means of bailing out weak banks.
A weak bank could be nurtured into healthy units. Merger could also be a solution to a weak bank, but Committee suggested that it should only be after cleaning up their balance sheets. It also suggested that if there is no voluntary response to take over such banks, a restructuring commission for such Public Sector Banks can consider options such as restructuring, merger, amalgamation or if not closure.”
To find a solution on the lines suggested by Narasimaham Committee, the Government passed an ordinance on September 4, 1993 and took initiative to merge New Bank of India with Punjab National Bank, which turned out to be an unhappy event.

12) Necessity of Merger and Acquisition in banks

India is fast emerging as an economic power. It requires two-three banks that can be termed global. Indian banks do not enjoy a global status. It is facing the crisis of global identity. Big banks have edge over small ones. They can raise money at a cheaper rate and can offer competitive lending rates.
Their assets are more diversified, both sector-wise and geographically. Therefore, it is less risky. Their risk absorption capacity is high. They are also in a position to offer wide range of services for which fees can be charged. This reduces their dependence on the net interest income.
In the post Basel II era, banks have to enhance risk taking abilities, which can be done through mergers, acquisitions and strategic alliances. Hence, there will be more often banking consolidation.

13) Trends in Merger of Banks

In order to compete with large and well-established Public Sector banks, Private Sector banks are not only foraying into IT, but also shaking hands with peer banks to establish them in the market. To have a hold on South Indian market, which has higher rate of economic development, ICICI Bank merged 57 year old Bank of Madura on 9th December, 2000.The swap ratio was 1:2, two shares of ICICI Bank for every one share of Bank of Madura.The trend is continuing. To name a few Times Bank merged with HDFC Bank Limited, Bank of Punjab merged with Centurion Bank, Global Trust bank merged with Oriental Bank of Commerce and many more banks are keeping eagle’s eye on other banks. In the global context, in recent times whether its Citi Traveller group, RBS Natwest or the latest one, Barclays ABN Amro, the age of the mega merger is rolling on.

14) Advantages of Bank Mergers

The consolidation /merger of banks will not give instant results. However, once the incubation period is over and the bank is back on the track, the mergers of banks result into –

14-i) Financial capability

Amalgamation will enable banks to have a stronger financial and operational structure and will enable it to face global competition. It will also help banks in greater resource/deposit mobilisation and profitable utilisation of surplus funds.

14-ii) Branch network

With the merger, existence of two branches in the same locality may not be necessary. Closure of branches in the near by vicinity will reduce overheads. Merger helps in rationalisation of branch and staff. It helps in increasing network of branches and enhances geographical coverage.

14-iii) Customer base

The merger results into larger customer base, offering of different banking and financial services and products and also facilitating cross selling of products and services. However, it has to be ensured that the customers of the branches that are being merged with the nearby branches are not put to inconvenience as this may result in customers migrating to other banks.

14-iv) Cost reduction

Merger would also result into reduction in operative cost to a greater extent viz. payment of annual maintenance charges for software as well as numerous other items such as servers, computers, machinery, equipment etc. It would also help in closing down unviable branches of the bank in the same vicinity. It would also result into reduction in administrative cost by closing down controlling offices i.e. Regional and Zonal offices.

14-v) Effective staff deployment

With the merger, the bank will be in a position to pool staff having expertise in different operational areas whose services could be utilized profitably. Surplus staff can be redeployed fruitfully for business development, marketing of assets and liability products, fee-based services, recovery, and reducing Non Performing Assets.

14-vi) Technological Challenges

Merger of highly technological bank with lesser technological bank helps in quick introduction of technology in the merged bank. Merger would enhance the utility and viability of ATMs and increase the number of transactions, as there will be more availability of ATMs to customers.

15) Disadvantages

The first and foremost disadvantage of merger is that the top executives of the acquired /merged bank are shown the door of the bank or such situations are created that they that feel suffocated and are compelled to leave the bank. This is what was experienced from the mergers that took place in the recent past in the banking industry in India. People occupying pretty senior hierarchical position were fixed at a much lower grade without regard to their experience and length of service, or they were side tracked by assigning unimportant task, or were demoralised by derogatory remarks.
This gives wrong impression to the staff of the merged bank. They feel alienated and their productivity and enthusiasm gets a setback, in the process they become unproductive.

16) Problems in consolidation /merger

16-i) Customer Service

Merger sometimes causes disruptions in services to customers. It may cause a permanent reduction in service to some customers, because the acquiring organization is less willing to or able to serve those customers that were acquired originally. It involves time in customer developing a sense of belonging to the bank. There is also a fear that the attitude of the staff of-absorbing bank towards the clients of merged bank may not be encouraging.

16-ii) Technological Issues

There is no uniformity in technology in banks. Different technology is being followed in different banks, which makes it difficult to integrate the system.

16-iii) Attitudinal Problems

Merger of two entities involves merger of two different work cultures, work ethics and work ethos. Cultural integration takes time. Intermediate period creates attitudinal problems towards work and management. During the gestation period of integration there is lack of clarity in job responsibility. There is absence of teamwork and shared responsibilities for getting work done. This demotivates the workforce.

16-iv) Systems and procedure

Over a period of time, each bank has developed its own systems and procedures, which have been embedded in its culture. Each bank has its own set of rules and regulations, which have been documented in the form of book of instructions. Unless rules and regulations, systems and procedures are standardised, merger will lead to confusion amongst staff and will result into chaos in operation. This will have direct impact on the efficiency of the staff and customers would feel the burnt.

16-v) Unions

Every bank has unions for protecting the interest of employees. Office bearers of unions enjoy several hierarchical posts. Even there is employees’ representation in the board of the bank. Power and supremacy enjoyed by each leader within his bank varies. Merger of two banks will trigger struggle for power amongst the leaders, which will have adverse impact on the working of the bank, as member of one union may not cooperate with the members of other union.

17) Human Side of Merger

The merger is not only a financial event. It is not of mortar and brick institutions, but it is of two cultures. Mergers result in new reporting relationship. There are cultural differences in the entities. Work ethics differ. There are difficulties of adequately blending culture and integration. The staff of merged bank finds themselves in loss. They crave for identity and recognition. There is a threat to the seniority of the staff of the merged bank. In some banks there were fast promotions and in some late. Even problems of figment of salary and grades arise. Employees fear relocation and transfer. They lose self-confidence and mistrust develops.

A bank taking over another bank has to project that the staff of amalgamated bank is welcomed. They are to be given psychological support. Those in command should help the staff of merged bank in giving them briefing about culture of the bank and should show confidence in them. The staff of merged bank should be properly treated. They should not be treated as second grade citizens in the merged institution. There should not be any preconceived notion, lest there may be far reacting consequences and the whole object of merger will suffer.

18) Planning for Merger/Take Over/Acquisition?

The first and foremost thing, which an organization has to decide, is the purpose/ objectives behind the Merger, Take Over or Acquisition. It has to visualise the problems that may occur and to chalk out the strategies well in advance to solve them .It has to be clear

Whether the object is to tap untapped market?
Whether the purpose is to eliminate or reduce competition?
Whether it wants to become financially strong?
Whether the object is to increase the size of balance sheet?
Whether the object is cultural integration?
Whether the object is to procure an existing product and leverage?
Whether the object is to avail Tax benefit?
Whether the object is to leverage on technology?
Whether the object is to cut short the time involved in growth?
Whether the purpose is to have managerial efficiency?
Whether the object is to reduce operational cost?

The solution to all these issues is merger/acquisition, amalgamation and consolidation, which are different routes in that direction. Before finally deciding about merger the organisation has also to look into;

Average age of work force of the entity to be merged.
Financial commitments of the entity?
Assets and liabilities of the institution to be merged and its quality?
Book value of assets and shares?
What is the history of business growth? Is it increasing or decreasing?
Market share of the entity to be merged and its reputation?
Quality of work force, their approach and commitment?
Laws affecting merger?
What is the organizational culture?
What are the future prospects?
What are the bottlenecks that may be faced?
What are the strength, weakness, opportunities and threats?
Whether the technological platform is same or different?
What is the cost of merger or acquisition, and will it be met?
If it is to be met by borrowings, what will be repayment schedule, interest obligation how will it be met and whether it will result into liquidity crunch?
What will be the impact on market value of shares?
What will be the immediate gain or benefit?

If the ultimate analysis indicates that merger/acquisition will be beneficial the institution should proceed in that direction.