Chapter-3

Mergers and Amalgamations in the Banking Sector of India

since Economic Liberalization: An Overview

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Chapter 3

Mergers and Amalgamations in the Banking Sector of India

since Economic Liberalization: An Overview

3.1 Introduction

3.2 Financial Sector Reforms in India

3.3 Indian Banking Sector: An Overview

3.4 Banking sector Reforms since Economic Liberalization in India

3.5 Growth and Development of Commercial Banks in India

3.6 Merger and Amalgamation: Reports of Committees on Banks

3.7 Merger and Amalgamation: Banking Regulation Act, 1949

3.8 Major Merger and Amalgamation in Indian Banking Sector

since Economic Liberalization

3.9 Conclusion

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3.1 Introduction In the previous chapter, a conceptual approach of Merger and Amalgamation has been

given and it emphasized on the global, Indian and cross border mergers scenario. It

explained the legal process too and is subjected to various laws and regulations. The

present chapter has made an attempt to sketch a brief outline of banking sector

reforms initiated by Indian government since economic liberalizations and lightened

an overview of Merger and Amalgamation of Banking sector in India since economic

liberalizations.

3.2 Financial Sector Reforms in India The financial sector reform was characterized as a radical shift from the whole

constitutional perspectives drawn since independence. Strong government control was

the norm in India’s financial sector since 1947. This period witnessed government

control over all financial institutions, markets, and the government even directed

credit programs resulting in highly segmented and arguably inefficient markets’.1 The

secondary market of Government securities was dormant. Both the money and capital

markets were underdeveloped. The foreign exchange market was extremely thin,

mainly due to stringent restrictions under Foreign Exchange Regulation Act (FERA).

So, the basket-linked exchange rate was administered and the financial markets stood

segmented. Though the regulated environment brought a considerable growth in the

financial sector but the desired level of efficiency was absent.

India’s efforts was clearly a journey on the way of many developing countries which

implemented financial sector reforms since late 1980s as a part of broader market

oriented economic reforms. India initiated the financial liberalization in 1991

followed by a comprehensive package of financial sector reforms2. In order to build

an efficient financial market in terms of operation and allocation, market forces were

allowed to determine both rates and volumes in different segments of the market.

Opening of several sub-sectors of the financial system to the private sector,

deregulation of interest rates and a greater market orientation for financial institutions

1Reserve Bank of India, ‘Report of the Committee to Review the Working of the Monetary System’, (Chairman, S. Chakravarty), (1985), New Delhi. 2 Shirai Sayuri (2004),” Impact of Financial and capital market Reforms on corporate finance in India”, Asia- Pacific Development Journal, Vol. II December pp 12-15.

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as for both sources and placements of funds were the initial outcome of the reforms3.

Now, after one and half decades since the financial sector reforms, India is dealing

with number of issues both at micro and macro levels, especially issues are raised

regarding social sector development, employment generation, poverty eradication and

infrastructure development.

In the balance of payment crisis, the need for a policy shift became evident. Many

countries in East Asia achieved high growth and poverty reduction through policies

that emphasized greater reforms, export orientation and encouragement of the private

Sector. India took some steps in this direction in the 1980s, but it was not until 1991

that the government signaled a systemic shift to a more open economy with greater

reliance upon market forces, a larger role for the private sector including foreign

investment, and a restructuring of the role of government. The economic reforms of

1990s faced two braving contemporary crises in the financial sector; the crisis of

balance of payments that threatened India’s international credibility and pushed the

country to the currency crisis, and the growing threat of insolvency confronting the

banking system which continued for years and further concealed its problems with the

help of defective accounting policies4.

Moreover, financial sector also faced a host of chronic and deep-rooted problems that

affected the national economy in the early nineties. The problem of financial control

in the sense of McKinnon-Shaw5 induced by administering interest rates pegged at

unrealistically low levels. Large scale pre-emption of resources from the banking

system by the government to finance, its fiscal deficit, excessive structural and micro

regulations, which inhibited financial innovation and increased transactions costs.

Relatively inadequate level of prudential regulation in the financial sector, poorly

developed debt, money market, outdated technology and institutional structures made

the capital markets and the rest of the financial system highly inefficient. Financial

sector reforms have therefore been an important part of the overall reform process.

However, even after 15 years of reforms, a number of deep-rooted problems remain

unresolved in the financial sector, despite showing impressive progress in the initial

3Ahluwalia, Montek S. “ Reforming India’s financial sector: An Overview”, in Hanson, James A. and Sanjay Kathuria (Ed) “ India- A financial Sector for the Twenty first century”, OUP, New Delhi. pp 3-4. (1999) 4 Varma Jayanth R, ‘Indian Financial sector after a Decade of reforms’, View Point 3, Centre for civil society, BIS working Papers, April, p-4 (2002) 5 Mckinnon and Shaw “The study the effect of interest rate savings in Lekshmi R Nair, working Paper, centre for development Studies, Kerala, p- 4,(1973)

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years of the reforms. The state has good control only on some isolated pockets of the

financial sector and competition has not been limited in the financial sector on a scale

sufficient to produce visible benefits in terms of efficiency, innovation and customer

service. Reforms have brought high growth in an environment of macroeconomic and

financial stability. These were broadly classified that touched every segment of the

economy and were designed essentially to promote greater efficiency in the economy

through promotion of greater competition. The story of Indian reforms is by now well

documented.6 Nevertheless, what is less appreciated is that India achieved this

acceleration in growth by maintaining price and financial stability.

As far as the mode of reforms is concerned, India’s root has been very much different

from most other emerging market economies. It has been a measured, gradual,

cautious, and steady process, considering many add-ons that can be observed in other

countries. It is clear that reform in the financial sector and monetary policy framework

was a key component of the overall reforms that provided the foundation of increase

in price and financial stability. Reforms in these sectors have been well sequenced,

taking into account the state of the markets in the various segments. The main

objective of the financial sector reforms in India initiated in the early 1990s was to

create an efficient, competitive and stable financial sector that contributed in greater

measure to stimulate growth. India included in its reform a program for complete

revival of the banking system and the capital markets.

The banking sector reforms also showed a special indigenous touch in contrast to

other developing countries, especially in the policy towards public sector banks that

dominated the banking system. The government has announced its intention to reduce

its equity share to 33.33 percent, but this was to be done while retaining government

control. Therefore, efficiency improvements of the banking system depended on the

ability to step up the efficiency of public sector banks.

Banking sector reforms included7 (a) measures for liberalization, like dismantling the

complex system of interest rate controls, eliminating prior approval of the Reserve

Bank of India for large loans, and reducing the statutory requirements to invest in

government securities; (b) measures designed to increase financial soundness, like

introducing capital adequacy requirements and other prudential norms for banks and 6 Ahuwalia, Montek, ‘India’s Economic Reforms: An Appraisal, ‘in Jeffrey Sachs and Nirupam Bajpai’s (eds.), ‘India in the Era of Economic Reform, Oxford University Press, New Delhi, p-5. (2000) 7 Ibid,p-8

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strengthening banking supervision; (c) measures for increasing competition like more

liberal licensing of private banks and freer expansion by foreign banks. These steps

produced some positive outcomes. There has been a sharp reduction in the share of

non-performing assets in the portfolio and more than 90 percent of the banks now

meet the new capital adequacy standards.

Still one can doubt that whether government control can be made consistent with

efficient commercial banking because bank managers are bound to respond to

political directions if their career advancement depends upon the government. Even if

the government does not interfere directly in credit decisions, government ownership

means managers of public sector banks who are held responsible to standards of

accountability. It discourages with rules and procedures, and therefore it rolls down

innovative decision and make the regulatory control difficult to exercise. As the

public sector banks cannot be closed, those performing poorly are regularly re-

capitalized which weakens market discipline, as more efficient banks are not able to

expand market share. Privatization, though feasibly political, is at least necessary to

consider intermediate steps that could spur efficiency within a public sector

framework.8 Another key factor limiting the efficiency of banks is the legal

framework, which makes it very difficult for creditors to protect their claims. The

government introduced legislation to establish a bankruptcy law that will be much

closer to accept international standard. Though this would be an important

improvement but it needs to be followed by reforms in court procedures to cut the

delays which is a major weakness of the legal system at present.

The focus on stock market reforms was given due to a stock market scam9 of 1992,

which shed light on serious weaknesses in the regulatory mechanism. The government

established a statutory regulator and formed rules and regulations governing various

types of participants in the capital market. Also the activities like insider trading,

takeover bids, electronic trading to improve transparency in establishing prices, and

dematerialized shares to eliminate the need for physical movement and storage of

paper securities were introduced. Effective regulation of stock markets requires the

development of institutional expertise, which necessarily require time, but a good start

8 Ahuwalia S Montek, ‘Economic Reforms in India since 1991: Has Gradualism Worked, “Journal of Economics perspectives, Vol 16, 3”p.67-88 London, (2002) 9 The Hindu, “Press Report on Stock Market Scam” (Harshad Mehta), Bombay stock exchange and http://sify.com/finance/fullstory.php?id=14509816,p-1 (1992)

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has been made and India’s stock market is much better regulated today than in the

past.

At the onset of reforms, the insurance sector (including pension schemes) was a

public sector monopoly, and an expert committee10 recommended the need to open

the sector for private insurance companies in 1994. However, there was a strong

political resistance. It was only in 2000 that the law was finally amended to allow

private sector insurance companies, with foreign equity and allowed up to 26 percent,

now proposed to be 49 percent to enter the field. An independent Insurance

Development and Regulatory Authority (IDRA) has been established. So, the

development of an active insurance and pensions industry offering attractive products

tailored to different types of requirements could stimulate long-term savings and add

depth to the capital markets. However, these benefits will only become evident over

the time.

3.3 Indian Banking Sector: An Overview The banking system in India is significantly different from that of other Asian nations

because of country’s unique geographic, social, and economic characteristics. India

has a large population and land size, a diverse culture, and extreme disparities in

income, which are marked among its regions. There is high level of illiteracy among a

large percentage of its population but, at the same time, the country has a large

reservoir of managerial and technologically advanced talents. About 30 and 35

percent of the population resides in metro and urban cities and the rest is spreaded in

several semi-urban and rural centers. The country’s economic policy framework

combines socialistic and capitalistic features with a heavy bias towards public sector

investment. India has followed the path of growth-led exports rather than the “export

led growth” as compared to other Asian economies, with emphasis on self-reliance

through import substitution.11

There was a slowdown in the balance sheet of scheduled commercial banks (SCBs)

with some slippages in their asset quality and profitability. Bank credit posted a lower

growth of 16.6 per cent in 2009-10 on a year-on-year basis but showed signs of 10 Ministry of Finance, “Committee on Insurance Sector in India”, (Chairman R N Malhotra), Government of India, New Delhi, January, (1994) 11 Deolalkar, G. H, ‘The Indian Banking Sector on the road to progress’, Study commissioned by ADB for RETA 5770, (1998). retrieved from http://aric.adb.org/pdf/aem/external/financial_market/India/india_bnk.pdf

125

recovery from October 2009 with the beginning of economic turnaround. Gross

nonperforming assets (NPAs) as a ratio to gross advances for SCBs, as a whole,

increased from 2.25 percent in 2008-09 to 2.39 per cent in 2009-10. Notwithstanding

some weakening of asset quality, the Capital to Risk Weighted Assets Ratio (CRAR)

of Indian banks in terms of Basel II norms at 14.5 per cent as at end March, 2010 was

much higher than the regulatory prescription. However, the profitability of Indian

banks as reflected by the Return on Assets (ROA) was lower at 1.05 per cent in 2009-

10 than 1.13 per cent during the previous year. Notwithstanding some knock-on

effects of the global financial crisis, Indian banks withstood the shock and remained

stable and now compare favorably with banks on metrics such as growth, profitability

and loan delinquency ratios. In general, banks had a track record of innovation,

growth and value creation. However, this process of banking development needs to be

taken forward to serve the further needs of financial inclusion through expansion of

banking services.12

The Banking system of India was started in 1770 and the first Bank was the Indian

Bank known as the Bank of Hindustan. Later on some more banks like the Bank of

Bombay-1840, the Bank of Madras-1843 and the Bank of Calcutta-1840 were

established under the charter of British East India Company. These Banks were

merged in 1921 and formed new bank known as the Imperial Bank of India. For the

development of banking facilities in the rural areas the Imperial Bank of India

partially nationalized on 1 July 1955, and named as the State Bank of India along with

its 8 associate banks (at present 7). Later on, the State Bank of Bikaner and the State

Bank of Jaipur merged and formed the State Bank of Bikaner and Jaipur.

The Indian banking sector can be divided into two eras, the pre liberalization era and

the post liberalization era. In pre liberalization era government of India nationalized

14 Banks on 19 July 1969 and later on 6 more commercial Banks were nationalized

on 15 April 1980. In the year 1993 government merged The New Bank of India and

The Punjab National Bank and this was the only merger between nationalized Banks,

after that the numbers of nationalized Banks reduced from 20 to 19. In post

liberalization regime, government initiated the policy of liberalization and licenses

were issued to the private banks which lead to the growth of Indian Banking sector.

The Indian Banking Industry showed a sign of improved performance and efficiency 12 ‘Reserve Bank of India Annual Report on Banking’, (2009-2010), retrieved from http://rbi.org.in/scripts/AnnualReportPublications.aspx?year=2010

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after the global crisis in 2008-09. The Indian Banking Industry is having far better

position than it was at the time of crisis. Government has taken various initiatives to

strengthen the financial system.13At present 27 commercial Banks in public sector are

working in the country.

Out of these banks, 19 banks are nationalized banks (earlier this number was 20 but

New Bank of India was merged with PNB leaving this number to 19), 6 State Bank

group (SBI and 5 associates) and one IDBI Ltd. and 1 recent Bhartiya Mahila Bank.

At the time of banks nationalizations (i.e., July 1969) there were 8262 branches of

various commercial banks (1860 in rural areas and remaining 6402 branches in urban

areas). In other words, in 1969 only 23% of the total bank branches were working in

rural areas. But on June 30, 2012, total number of bank branches was increased to

98,536. Presently, 36.9% of the total branches are working in rural areas. At present

there is one bank branch working for 15,000 populations while there was one branch

for 64000 populations in 1969.State Bank of India is the largest public sector bank in

the country. On June 30, 2012, 18992 branches of SBI & associates were working in

the country. SBI Group also includes associates banks other than State Bank of India.

Earlier SBI had only 7 associate banks that constituted the state bank group,

originally, belonged to princely states until the government nationalized them

between October 1959 and May 1960. In tune with the first five year plan,

emphasizing the development of rural India, the government integrated these banks

into the State Bank of India system to expand its rural outreach. There has been a

proposal to merge all the associate banks into SBI to create a ‘Mega Bank’ and

streamline operations. The first step towards unification occurred on August 13, 2008

when State Bank of Saurashtra merged with SBI, reducing the number of State Banks

from 7 to 6. Then on June 19, 2009 the SBI Board approved the merger of its

subsidiary, state bank of Indore, with itself. SBI holds 98.3% in state Bank of Indore.

(Individuals who held the shares prior to its takeover by the government hold the

balance of 1.77%). The acquisition of state Bank of Indore added 470 branches to

SBI’s existing network of 12,448 and over 21,000 ATMs. Also, following the

acquisition, SBI’s total assets will inch very close to the Rs 10 lakh crore marks. Total

assets of SBI and the State Bank of Indore stood at Rs 9, 98,119 crores as on March

13 Khan, Azeem Ahmad, ‘Merger and Acquisitions (M&As) in the Indian Banking Sector in Post Liberalization Regime’, International Journal of Contemporary Business Studies, Vol: 2, No: 11. November, (2011) Ohio, (USA) ISSN 2156-7506 Available online at www.akpinsight.webs.com

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2009. The process of merging of state Bank of Indore was completed by April 2010

and the SBI Indore Branches started functioning as SBI branches on August 26,

2010.14 Presently number of Banks working in India see table 3.3.1.

3.4 Banking sector Reforms since Economic Liberalization in India There is an close interlink between finance and growth. Bank credits to productive

sectors of the economy have a critical role in sustaining the growth process. While the

spread of banking network is a continuous process and the effectiveness of the

banking network depends on the expansion in the scale of operations and the

availability of credit facilities. As the economy grows, it becomes more sophisticated,

the banking sector has to develop in a manner that it supports and stimulates such

growth. With increasing global integration, the Indian banking system and financial

system have to be strengthened so as to be able to compete. India has passed more

than a decade of financial sector reforms and faced substantial transformation and

liberalization of the whole financial system. It is, therefore, an appropriate time to

take stock and assess the effectiveness of the approach. It is to evaluate how the

financial system has performed in an objective quantitative manner. This is important

because India’s path of reforms has been different from most other emerging market

economies: it has been a measured, gradual, cautious, and steady process, devoid of

many flourishes that could be observed in other countries. The following two phases

can be seen in the total financial sector reforms, especially banking sector reforms.

First Phase of Banking Sector Reforms (1991 to 1997)

Both the economic crisis faced by the government and the crisis developed in the

national banking sector come simultaneously, towards the end of the 1980s. Thus the

government, just after implementing reforms in the economic front, undertook

comprehensive reforms in the financial and banking sector.

Financial institutions and commercial banks come under direct functional and

regulatory control of the Reserve Bank of India. Up to 80 percent of the banking is

owned by the Government of India, but the Finance Ministry exercises a significant

control over the Public Sector banks. And reforms that require amendment to existing

14 Pratiyogita Darpan, ‘General Studies of Indian Economy’ (2013), pp.168

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banking law or enactment of new legislation are only within the ambit of the

Government of India (e.g. constitution of Debt Recovery Tribunal).

Decontrol and Competition

Initial efforts for banking reforms witnessed very slow pace in its implementation as

well as in its public acceptance. Decades of non-commercial orientation, directed

lending, loan waivers and increasing non-performing assets had made banks difficult

to adjust to the reform culture and a market environment had strict prudential norms.

However, the emerging results suggest that banks are beginning to adapt the

competitive environment and face challenges. And now, they have to learn

assessment of their problems and its resolution through direct initiatives and efforts,

without depending on RBI and Government of India.

In the period 1995-96, many steps were taken to reduce control and remove

operational constraints in the banking system in order to provide operational freedom

and to develop a competitive spirit. These include interest rate decontrol,

liberalization and selective removal of Cash Reserve Ratio (CRR) stipulation,

freedom to fix foreign exchange open position limit and to enhance refinance facilities

against government and other approved securities. Direct Steps initiated by RBI,15

during the period 1992-95, under the spirit of the policy of deregulation represented

the same spirit as that of the Banking Reforms.

The Narasimham Committee Report (I)

The financial sector reform started in 1991 followed the Narasimham committee

recommendations16, which chiefly dealt with the banking sector. Mean while, the

banking sector reforms were initiated in 1992, and in the first phase it provided

necessary platform to the banking sector to operate on the basis of operational

flexibility and functional autonomy. That resulted in enhancing efficiency,

productivity and profitability. These reforms further brought out structural changes in

the financial sector, eased external constraints in their working, introduced

transparency in reporting procedures, restructuring and recapitalization of banks and

15 Reserve Bank of India, ‘Press Release’, RBI- Publication Division, New Delhi (2006) 16 Government of India, ‘Report of Committee on Indian Financial System’, (Chairman M Narasimham), Ministry of finance, New Delhi. (1991)

129

have increased the competitive element in the market. The salient features of these

reforms include:

Phasing out the statutory pre-emption – The SLR requirement have been

brought down from 38.5 percent to 25 percent and CRR requirement from

7.50 percent to 5.75 percent. (at present 5 percent)

Deregulation of Interest rates – All lending rates, except for lending to small

borrowers and a part of export finance, were de-regulated. Banks determine

interest on all deposits except on saving deposits.

Capital Adequacy – CAR of 9 percent prescribed with effect from March 31,

2000

Other prudential norms – Income recognition, asset classification and

provisioning norms has been made applicable. The provisioning norms are

more prudent, objective, transparent, and uniform designed to avoid

subjectivity.

Debt Recovery Tribunal -22 DRTs and 5 DRATs have already been set up.

Comprehensive amendment in the Act has been made to make the provisions

for ad jurisdiction, enforcement and to make recovery effective.

Transparency in Financial statements – Banks have been advised to disclose

certain key parameters, such as CAR, percentage of NPAs net value of

investment, return o Asset, profit per employee and interest income as

percentage to working funds.

Entry of the new private sectors banks- 9 new private sector banks were set up

with a view to induce greater competition and for improving operational

efficiency of the banking system. Competition was introduced in a controlled

manner and today there are nine new private sector banks and 36 foreign

banks in India competing with the public sector banks both in retail and

corporate banking

• Functional autonomy - The minimum prescribed Government equity was brought to

51 percent. Nine nationalized banks raised Rs. 2855 crores from the market during

1994-2001. Banks Boards have been given more powers in operational matters, such

as, rationalization of branches, credit delivery and recruitment of staff.

• Hiving off of regulatory and supervisory control - Board for financial supervision

was set up under the RET in 1994, classifying the regulatory and supervisory

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functions. Indian banking sector has achieved significant progress in recent years. It is

almost at par with international counterparts in prudential norms, accounting and

disclosure standards and risk management practices. The financial soundness and

enduring supervisory practices evident in India’s level of compliance with the Basle

Committees, Core Principles for Effective Banking Supervision have made the

banking stem resilient to global shocks. The need for further refinements in the

regulatory and supervisory practices has been recognized and steps are taken by RBI

to move towards the goal in an organized manner without destabilizing the system.

Success of the second phase of reforms will depend primarily on the organizational

effectiveness of banks, for which the initiatives should come from banks itself.

Imaginative corporate planning combined with organizational restructuring is a

necessary pre-requisite to achieve desired results. And banks need to address urgently

the task of organizational and financial restructuring for achieving greater efficiency.

Following are the reforms adopted in the rural and co-operative banking sector, which

have far reaching effects:

• All banks - public, private or foreign — have achieved the overall target of priority

sector for the last 3 years.

• NABARD’s resource base has been considerably augmented and its paid- up capital

has been increased from Rs.100 crore in 1991-92 to Rs. l000 crore at present, while its

overall resource position is enhanced substantially by other means as well. NABARD

has sanctioned disbursed Rs. 19849cr and Rs. 10078cr respectively to various State

Governments under RIDF I to VII, as on 30th September 2001.

• Share of commercial banks, cooperatives and RRBs in the production credit

amounted to 38 percent, 55 percent and 7 percent respectively

• There are 196 RRBs functioning in 26 States (including 3 newly created states)

covering 495 districts with a network of 14311 branches. Number of profit making

RRBs increased from 44 to 172 during 1996-1997 to 2000 to 2001 and the amount of

profit of RRBs increased from Rs. 69.68 crores to Rs. 681 crores during the same

period.

Second Phase of Reforms (1997 Onwards) -‘--

The major achievement of second phase of financial sector reforms is the setting up of

Narasimham committee on banking sector in 1997, submitted the report soon after the

establishment with a set of recommendations for the affluence of banking sector. This

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played an important role in elimination of further government control and

deregulation.

The Narasimham Committee Report (II)

The second committee on banking sector reforms headed by Mr. Narasimham

presented its report to the Government in April 1998. Many of its recommendations

have been accepted and are under implementation process.

Term of reference of the committee;17

• to review the progress of reform process in the banking sector over the past six years

with particular reference to the recommendations made by the Committee on the

Financial Sector Reforms in 1991, and

• to check out a programme on Financial Sector Reforms in order to strengthen India’s

financial system and make it internationally competitive taking into account the vast

changes in the international and financial markets, technological advances and the

experience of other developing countries in adapting such changes and to make

detailed recommendations regarding the banking policy, institutional, supervisory,

legislative and technological dimensions. The report recommended the following:

a) Government should divest its Equity in PSBs.

b) Net NPA to be pegged down to the level of 5 percent by 2000 and 3 percent soon

thereafter.

c) The problem of high interest rates

d) Debt recovery

e) Recovery of NPAs - Creation of Asset Recovery Fund (ARF)

f) The Rural Credit System is in a shambles

g) Regulatory Authorities

Ii) Universal Banking

I) Challenges posed by Global Financial Integration

j) Lending to Corporate Customers and Financing Local Trade, Small Industry and

Agriculture

k) Functional Autonomy to Ensure Greater Operational Flexibility

The main objective of banking sector reforms was to promote a diversified, efficient

and competitive financial system with the ultimate goal of improving the efficiency of 17 Government of India and Reserve Bank of India “ Report of Committee on Banking Sector” (Chairman M Narasimham), Ministry of finance, New Delhi (1997)

132

allocating resources through operational flexibility, improved financial viability and

institutional strengthening. The reforms have focused on removing financial

repression through reductions in statutory controls, while stepping up prudential

regulations at the same time and interest rates on both deposits and lending of banks

have been progressively deregulated.

As the Indian banking system had become predominantly government owned by the

early 1990s, banking sector reforms essentially took a two pronged approach. 1) The

level of competition was gradually increased within the banking system while

simultaneously introducing best international practices in prudential regulation and

supervision tailored to Indian requirements. In particular, special emphasis was placed

on building up the risk management capabilities of Indian banks while measures were

also initiated to ensure flexibility, operational autonomy and competition in the

banking sector. 2) Active steps were taken to improve the institutional arrangements

including the legal framework and technological system. The supervisory system was

also revamped in view of the crucial role of supervision in the creation of an efficient

banking system. YV Reddy’18 opined that the approach towards financial sector

reforms in India has been based on five principles, (i) cautious and appropriate

sequencing of reform measures, (ii) introduction of mutually reinforcing norms, (iii)

introduction of complementary reforms across monetary, fiscal and external sectors

(iv) Development of financial institutions, and (v) development of financial markets.

It will be interesting to enumerate the unique features of the progress in financial

sector reforms.

1) Financial sector reforms were undertaken early in the reform cycle. 2) The reform

process was not driven by any banking crisis, nor was it the outcome of any external

support package, 3) The design of the reforms was crafted through domestic expertise,

taking on board the international experiences in this respect. 4) The reforms were

carefully sequenced in respect to instruments and objectives. Thus, prudential norms

and supervisory strengthening were introduced early in the reform cycle, followed by

interest rate deregulation and gradually lowering of statutory obligations. The

financial liberalization process has been very useful in India towards improving the

18 Y.V Reddy, ‘ Lectures on “Economic and Financial Sector Reforms in India”, Oxford University Press, New Delhi, p-237, (2002)

133

functioning of markets and institutions19. 1) With the development of appropriate

market regulation and associated payment, settlement systems and the greater

integration into global markets, the financial markets have witnessed rapid growth and

robustness. A range of instruments in domestic and foreign currency is traded in

financial markets. In addition, the market in corporate bonds has been spurred with

increased use of external credit ratings. Further, derivative products covering

forwards, swaps and options and also structured products are transacted enabling

corporates and banks to manage their risk exposures. The market in securitized paper,

both mortgage-backed and asset-backed securities, has also grown significantly with

the support of a well-developed credit rating industry. 2) Liberalization in financial

sector has led the emergence of financial conglomerates as banks have diversified

their activities into insurance, asset management securities business 3) Prudential

regulations and supervision have imposed the combination of regulation, supervision

and a better safety net has limited the impact of unforeseen shocks on the financial

system and the role of market forces in enabling price discovery has also enhanced.

The dismantling of the erstwhile administered interest rate structure has permitted

financial intermediaries for lending and deposit taking based on the commercial

considerations and their asset- liability profiles. The financial liberalizations process

has also enabled reduction in the overhang of non-performing loans which entailed

both a stock (restoration of net worth) solution as well as a flow improving future

profitability solution. On the other hand, legal processes that were implemented over a

period of time.

3.5 Growth and Development of Commercial Banks in India The growth of branch expansion in the Indian Banking sector during the period 2006-

2011 exhibited in table 3.5.1. In the year 2010, the branch expansion for the scheduled

commercial bank was 88,155 crores which move 93,027 crores in the year 2011; all

scheduled commercial banks recorded a growth 5.5 percent during the year 2010-

2011. The percentage share of SBI group registered a growth of 3.5 and the state

owned banks of India registered an increase of 5.4 percent during 2010-11. While,

Indian private sector banks, foreign banks and regional rural banks registered a

19 Key note, ‘Speech at the International Centre for the Monetary and Banking studies, Geneva, May 9 (2006)

134

growth 3.6, 2.9, and 1.9. The non scheduled commercial bank record shows a growth

of 10.4 percent in the year 2010-11. Mobilization is the integral part of banking

activity and for improving economy also. The basic purpose of branch expansion is to

increase deposits and generate saving habit among the people of rural as well as urban

areas. There were the substantial increases in the bank deposits after the branch

expansion of commercial banks which is shown in table 3.5.2. It is seems that banks

deposits increased in the commercial banks of India. In the year 2010 State Bank of

India and its associates banks had deposits 1108086 crores and for the year 2011 it

had 12545862 which are 12.4 percent high when it is compared with 2010. The

nationalized banks of India recorded an increase of 21.0 percent during 2010-11.

However India’s public sector banks and old private sector banks registered a growth

18.4 and 15.0 percent. New private sector banks, private sector banks and foreign

banks escalate a growth 24.5, 22 and 3.7 percent during 2010-2011. Therefore, all

scheduled commercial banks registered a growth 18.3 per cent during 2010-2011. On

the other hand the growth of Advances increased in all scheduled commercial Banks

was 23.0 per cent during 2010-2011.

The credit from the bank is an important input in the production function of the

agriculture, industry, commerce and allied productive activities for socio economic

development of the country. The bank credits, its development, composition and

direction are equally important in realizing the country’s various macroeconomic

goals. The channelization of bank credit in proper direction is a necessity otherwise;

there will be the adverse effect on the economy of the country. The percentage share

of State Bank of India and its associate banks recorded a growth of 15.9 during 2010-

2011. The nationalized bank of India shows an increase of 25.4 percent during 2010-

11. India’s public sector banks, old private sector banks, new private sector banks,

private sector banks and foreign banks recorded a growth 22.3, 19.9, 28.1, 26.1 and

19.8 per cent during 2010-2011.Table 3.5.3 depicts the growth rate of Investment in

the Banks, the share of State Bank of India and its associate banks traced a growth of

5.6 during 2010-2011. The nationalized banks of India recorded an increase of 26.4

per cent. India’s public sector banks, old private sector banks, new private sector

banks, private sector banks and foreign banks escalated a growth 19.0, 15.3, 15.6,

15.5 and 22.1 per cent during 2010-2011. However, all scheduled commercial banks

registered a growth 18.6 per cent during 2010-2011 on the other hand the growth of

Bank Assets provided the sustainability of banks development. The table also showed

135

that the percentage share of state bank of India and its associate banks registered a

growth of 13.1 percent in total assets and the nationalized banks of India recorded an

increase of 22.0 per cent during 2010-11. India’s public sector banks and old private

sector banks showed a growth rate of 19.2 and 15.0 which are satisfactory. New

private sector banks, private sector banks and foreign banks registered a growth 23.5,

21.5 and 12.9 per cent in total asset during 2010-2011. But the overall growth of

scheduled commercial banks recorded 19.2 percent during 2010-2011.20

20 Khan, Nafees .A and Fozia, ‘Growth and Development in Indian Banking Sector’, International Journal of Advanced Research in Management and Social Sciences, Vol. 2 , No. 2 February (2013) retrieved from www.garph.co.uk

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Table: 3.3.1 Number of Banks in India

2006 2007 2008 2009 2010 2011

SBI Group 8 8 8 7 7 6

State-Owned Banks 20 20 20 20 20 20

Private Sector Banks 28 25 23 22 22 21

Foreign Banks 29 29 28 31 32 34

Regional Rural Banks 133 96 91 86 82 82

Non-Scheduled Commercial Banks 4 4 4 4 4 4

Scheduled Commercial Banks 218 178 170 166 163 163

Source: Statistical Tables Relating To Banks in India, RBI

Table: 3.5.1 Group Wise Number of Branches of Commercial Banks from 2006 to 2011

2006 2007 2008 2009 2010 2011

SBI Group 14310 14673 15848 16894 18186 18823

State-Owned Banks 35858 37415 39235 40937 43467 45850

Private Sector Banks 6835 7424 8324 9240 10452 12001

Foreign Banks 259 272 279 295 310 319

Regional Rural Banks 14807 14822 15054 15484 15740 16034

Non-Scheduled Commercial Banks 41 47 47 47 48 53

Scheduled Commercial Banks 72,069 74,696 78,740 82,850 88,155 93,027

Source: Master Office File (Latest updated version) on banks, Department of Statistics & Information Management, RBI, Statistical Tables Relating to Banks in India, RBI 2010-2011 Retrieved from http: //dbie.rbi.org.in Note: 1. Data is as per information reported by banks. 2. Population group classification based on 2001 census. 3. Data on branches exclude administrative offices.

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Table: 3.5.2 Group Wise Deposits and Advances of Scheduled Commercial Banks in India - 2010 and 2011

(Amount in crore) (As on March 31)

Deposits Advances

2010 2011 Increase % 2010 2011 Increase %

State banks of India & its Associates 1108086 1245862 12.4 857937 994157 15.9

Nationalized 2583934 3127122 21 1843082 2311478 25.4

Public sector 3692019 4372985 18.4 2701019 3305632 22.3

Old private 229897 264157 15 154085 184647 19.9

New private sector banks 592904 738602 24.5 478356 612886 28.1

Private sector banks 822801 1002759 22 632441 797539 26.1

Foreign banks 232099 240689 3.7 163260 195539 19.8

All scheduled commercial banks 4746920 5616432 18.3 3496720 4298704 23

Source: Annual accounts of banks, Statistical Tables Relating to Banks in India, RBI 2010-2011

Retrieved from http: //dbie.rbi.org.in

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Table: 3.5.3 Group Wise Investment and Total Assets of Scheduled Commercial Banks in India - 2010 and 2011

(Amount in crore) (As on March 31)

Source:- Annual accounts of banks, Statistical Tables Relating to Banks in India, RBI 2010-2011

Retrieved from http: //dbie.rbi.org.in

Investment Total Assets

2010 2011 Increase % 2010 2011 Increase %

State banks of India & its Associates 357627 377658 5.6 1412253 1597684 13.1

Nationalized 655042 828125 26.4 3028574 3696133 22

Public sector 1012666 1205783 19 4440827 5293817 19.2

Old private 72393 83499 15.3 268905 309011 15

New private sector banks 234139 270618 15.6 881831 1089165 23.5

Private sector banks 306531 354117 15.5 1150736 1398176 21.5

Foreign banks 130354 159286 22.1 435362 491528 12.9

All scheduled commercial banks 1449551 1719185 18.6 6026925 7183522 19.2

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3.6 Merger and Amalgamation: Reports of Committees on Banks The reports of three committees appointed by the RBI are relevant in relation to the

restructuring of Banks. These are: Report of the Narasimham Committee on Banking

Sector Reforms, Report of the Working Group for Harmonizing the Role and Operations

of DFIs and Banks, and the Report of the Working Group on Restructuring of Weak

Public Sector Banks. These three reports reveals the idea of the trends and future of Bank

restructuring in India.

1. Narasimham Committee

The Narasimham Committee on Banking Sector Reform was set up in December, 1997.

This Committee’s terms of reference include; review of progress in reforms in the

banking sector over the past six years, charting of a programme of banking sector reforms

required for making the Indian banking system more robust and internationally

competitive and framing of detailed recommendations in regard to banking policy

covering institutional, supervisory, legislative and technological dimensions. The

Committee submitted its report on 23 April, 1998 with the following suggestions:

Merger with strong banks, but not with the weak.

Two or three banks with international orientation, eight to 10 national banks and a

large number of local banks.

Rehabilitate weak banks with the introduction of narrow banking

Confine small, local banks to States or a cluster of Districts.

Review the RBI Act, the Banking Regulation Act, the Nationalization Act and the

State Bank of India Act.

Speed up computerization of public sector banks.

Review the recruitment procedures, training and remuneration policies of PSU banks.

De-politicization of appointments of the bank CEOs and professionalization of the

bank Boards.

Strengthen the legal framework to accelerate credit recovery.

Increase capital adequacy to match the enhanced banking risk.

Budgetary support non-viable for recapitalization.

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No alternative to the asset reconstruction fund.21

2. Khan Group

The Group was set up by the RBI in December, 1997, under the Chairmanship of Shri

S.H. Khan, the Chairman of IDBI. This was to review the role and structure of the

Developmental Financial Institutions and the Commercial Banks in the emerging

environment and to recommend measures to achieve coordination and harmonization of

Lending policies of financial institutions before they move towards Universal Banking.

Some of the recommendations of this Group are given below:

i) A progressive move towards universal banking and the development of an enabling

regulatory framework for the purpose.

ii) A full banking license may be eventually granted to DFIs. In the interim, DFIs may be

permitted to have a banking subsidiary (with holdings up to 100 per cent), while the DFIs

themselves may continue to play their existing role.

iii) The appropriate corporate structure of universal banking should be an internal

management/shareholder decision and should not be imposed by the regulator.

iv) Management and shareholders of banks and DFIs should be permitted to explore and

enter into gainful mergers.

v) The RBI/Government should provide an appropriate level of financial support in case

DFIs are required to assume any developmental obligations.22

3. Verma Group

The Reserve Bank of India set up a Working Group on Restructuring Weak Public Sector

Banks, under the Chairmanship of Shri M.S. Verma, former Chairman, State Bank of

India, to suggest the measures for revival of weak Public Sector Banks. The group went

deep into the issue and analyzed the problem fully and made specific suggestions. This

group also identified some core principles for incorporation into the future restructuring

strategies for weak banks.23

21 ‘Bank Mergers and Acquisitions’, Retrieved from http://www.egyankosh.ac.in/handle/123456789/9039 22 Ibid.pp-14 23 Ibid.pp-15

141

Future restructuring strategies for weak banks must incorporate the following core

principles:

a) Manageable Cost: The restructuring effort that is embarked upon has to be at the least

cost possible. However, the fact that injudiciously chosen lower cost alternatives may

lead to much higher costs in the long term. So, it must not lost sight of.

b) Least Possible Burden on the Public Exchequer: As far as practicable is concerned,

the cost of restructuring must come out of the unit being restructured. Even if its

contribution to the cost of restructuring is not available upfront, it should be possible to

recover this later, out of the value that can be created by restructuring. The need to

minimize the burden of such cost, is certainly obvious and cannot be overstated. And, any

plan for restructuring which does not clearly result in value addition at the end of the

exercise, is not worth attempting.

c) All Concerned must Share Losses: The restructuring strategy, as the instruments

employed in the implementation of this strategy should to make a clear statement about

the manner in which the losses already incurred and to be incurred have to be shared. The

principle of sharing of losses will have to remain fully operative in both operational and

financial restructuring envisaged for a bank. Such a plan for sharing losses will include

reduction in staff as well as for all other administrative cost of operations.

d) Changes for Strong Internal Governance: The internal governance of the banks and

their operations at all levels has to be strengthened and fully sensitized to the needs of

protecting against all foreseeable future problems. Restructuring always involves some

amount of destabilization in the organization and during this period, management and all

its operatives have to make sure that the intended benefits of the restructuring plans are

not allowed in any way to be frittered away or lost due to delays and lack of diligence in

its implementation.

e) Effective Monitoring and Timely Course Corrections: Individual restructuring plans

are to be implemented by the banks concerned internally and their success will depend

upon the quality of governance and organizational commitment to the proposed

restructuring. However, for a successful restructuring, it is important that there is an

independent agency which will own it and in the process of driving it forth, constantly

monitor its progress. This role can be played by the owner but such an arrangement has

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limitations because of the conflict of interests that are likely to arise in such cases and the

lack of time and skill for the job, which the owner may suffer from. These conflicts are

more when the ownership of the banks is with the government. For obvious reasons, this

responsibility cannot be given to the regulator either. The regulator will no doubt have

interest in the success of the restructuring programme but direct efforts on its part to

ensure its implementation could result in conflict of interests. The objective can therefore

be best achieved by an independent agency, which with the express consent of the owner

will have full authority over the restructuring process and be in a position to effectively

monitor its progress. In this process, while this independent agency will monitor to

ensure that the restructuring process remains on course, wherever necessary it will also

take steps to facilitate due implementation of the plan. Such steps by this agency may

include devising corrective measures, ensuring that the banks concerned adopt these

measures.

f) Ease of Implementation: Above all there must be an all-round consensus on the

process of restructuring, its modalities and timing. The process itself and all the attendant

instruments and instrumentalities should to be simple and easy to employ. While setting

the core principles, which should govern any programmed of bank restructuring is not so

difficult, deciding upon precise modalities of restructuring, is indeed a vexatious and

difficult issue to settle. It can be seen from international experiences that various

modalities and quite a few variations of each of these modalities have been tried with

varying degrees of success. In their time, as given in socio-economic environment, each

of these options chosen had good logic behind them. Therefore, they have their

applicability and merit and these are certainly not transplantable where the prevailing

conditions are different.24

3.7 Merger and Amalgamation: Banking Regulation Act, 1949 Under Banking Regulation Act, presently there is no provision for obtaining approval of

the Reserve Bank of India for any acquisition or merger of any financial business by any

banking institution. In other words, if a banking institution desires to acquire non-banking

finance company there is no requirement of approval of the Reserve Bank of India. 24 Ibid.pp.15-16

143

Further, in case of merger of all India financial institution with own subsidiary bank,

there was no expressed requirement for obtaining the approval of Reserve Bank of India,

under the provisions of the Banking Regulation Act or the Reserve Bank of India Act.

Such approval is required only in the context of relaxation of regulatory norms to be

complied by a bank However, for a regulator, it is a matter of concern to ensure that such

acquisitions or mergers do not adversely affect the concerned banking institutions or the

depositors of such banking institutions. The Competition Commission of India will

approve M&A (Mergers and Acquisitions) in banks except in the case of banks that are

under trouble. In such cases, the RBI will have the final authority.25 So, Bank mergers in

India are often viewed as shotgun marriages. The merger of the banking companies in

India attract Section 44 A of the Banking Regulation Act 1949 unlike other companies

which are bound by Section / s 390 – 396 of Indian Companies Act 1956.26 The

guidelines on merger and amalgamation of banks announced by the Reserve Bank in May

2005, inter alia, stipulated the following:

• The draft scheme of amalgamation is approved individually by two-thirds of the total

strength of the total members of board of directors of each of the two banking companies.

• The members of the boards of directors who approve the draft scheme of amalgamation

are required to be signatories of the Deed of Covenants as recommended by the Ganguly

Working Group on Corporate Governance.

• The draft scheme of amalgamation is approved by shareholders of each banking

company by a resolution passed by a majority in number representing two-thirds in value

of shareholders, present in person or by proxy at a meeting called for the purpose.

• The swap ratio is determined by independent values having required competence and

experience; the board should indicate whether such swap ratio is fair and proper.

• The value to be paid by the respective banking company to the dissenting shareholders

in respect of the shares held by them is to be determined by the Reserve Bank.

25‘Indian legal impetus’, Sigh and associates advocates and solicitors, VOL. V, Issue XII December (2012) retrieved from http://singhassociates.in/UploadImg/NewsImages/Vol%20V%20Issue%20XII.pdf 26Tandon, Deepak , Vohra, Manish and Saluja, Meenaksh’, ‘Corporate Restructuring via Amalgamation in Private Sector Banks: A Case Study of HDFC Bank and Centurion Bank of Punjab’, (2009) retrieved from www.iilm.edu/downloadable-material/merger-acquisition-in-banks.pdf

144

• The shareholding pattern and composition of the board of the amalgamating banking

company after the amalgamation are to be in conformity with the Reserve Bank’s

guidelines.

• Where an NBFC is proposed to be amalgamated into a banking company in terms of

Sections 391 to 394 of the Companies Act, 1956, then it is required to obtain the approval

of the Reserve Bank before the scheme of amalgamation is submitted to the High Court

for approval.27

3.8 Major Merger and Acquisitions in Indian Banking Sector since

Economic Liberalization In India, consolidation of banks through Merger and Amalgamation is not a new

phenomenon, which has been going on for several years. Since the beginning of modern

banking in India, through the setting up of English Agency House in the 18th century, the

most significant merger in the pre- Independence era was that of the three Presidency

banks founded in the 19th century in 1935 to form the Imperial Bank of India (renamed as

State Bank of India in 1955). In 1959, State Bank of India acquired the state-owned

banks of eight former princely states. In order to strengthen the banking system,

Travancore Cochin Banking Enquiry Commission (1956) recommended for closure /

amalgamation of weak banks. Consequently, through closure/ amalgamations that

followed, the number of reporting commercial banks declined from 561 in 1951 to 89 in

June 1969. Merger of banks took place under the direction of the Reserve Bank during

the 1960s. During 1961 to 1969, 36 weak banks, both in public and private sectors, were

merged with other stronger banks.28 This way been several bank amalgamations were

seen in India in the post-reform period. In all, there have been 33 M&As since the

nationalization of 14 major banks in 1969. Of these mergers, 25 involved mergers of

private sector banks with public sector banks, while in the remaining eight cases, mergers

involved private sector banks. Out of 33, 21 M&As took place during the post-reform

period with as many as 17 mergers/ amalgamations taking place during 1999 and after

27 ‘Report on Currency and Finance’ retrieved from http://rbidocs.rbi.org.in/rdocs/Publications/PDFs/86735.pdf 28 ‘Competition and Consolidations’ pp.356, retrieved from http://rbi.org.in/scripts/publicationsview.aspxid=10495(2008)

145

(table 3.8.1). Apart from this, few more merger were occurred in the Indian banking

sector (table 3.8.2), the HDFC Bank acquired the Centurion Bank of Punjab on 23 May

2008. In the year 2010, on 13th August, the process of M&As in the Indian banking

sector passed through the Bank of Rajasthan and the ICICI Bank. The Reserve Bank of

India sanctioned the scheme of merger of the ICICI Bank and the Bank of Rajasthan.

After the merger, ICICI Bank replaced many banks to occupy the second position after

the State Bank of India (SBI) in terms of assets in the Indian Banking Sector. And in the

last ten years, ICICI Bank and HDFC bank in the private sector and Bank of Baroda

(BOB) and the Oriental Bank of Commerce (OBC) in the public sector involved

themselves as bidder banks in the Merger and Acquisitions (M&As) in the Indian

Banking Sector.29

Table: 3.8.1 Banks Amalgamated since Nationalization of Banks in India Sr. No Name of Transferor Bank /

Institution

Name of Transferee Bank /

Institution

Date of Amalgamation

1 Bank of Bihar Ltd State Bank of India November 8, 1969

2 National Bank of Lahore Ltd State Bank of India February 20, 1970

3 Miraj State Bank Ltd Union Bank of India July 29, 1985

4 Lakshmi Commercial Bank Ltd Canara Bank August 24, 1985

5 Bank of Cochin Ltd State Bank of India August 26, 1985

6 Hindustan Commercial Bank Ltd Punjab National Bank Dec 19,1986

7 Traders Bank Ltd Bank of Baroda May 13, 1988

8 United Industrial Bank Ltd Allahabad Bank October 31, 1989

9 Bank of Tamilnadu Ltd Indian Overseas Bank February 20, 1990

10 Bank of Thanjavur Ltd Indian Bank February 20, 1990

11 Parur Central Bank Ltd Bank of India February 20, 1990

12 Purbanchal Bank Ltd Central Bank of India August 29, 1990

13 New Bank of India Punjab National Bank September 4, 1993

14 Kashi Nath Seth Bank Ltd State Bank of India January 1, 1996

15 Bari Doab Bank Ltd Oriental Bank of Commerce April 8, 1997

16 Punjab Co-operative Bank Ltd Oriental Bank of Commerce April 8, 1997

17 BareiIly Corporation Bank Ltd Bank of Baroda June 3, 1999

29 Retrieved from http://articles.economictimes.indiatimes.com/news/27610821_1_state-bank-indore-order-indore-branches, 2010-08-25

146

18 Sikkim Bank Ltd Union Bank of India December 22. 1999

19 Times Bank Ltd HDFC Bank Ltd February 26, 2000

20 Bank of Madura Ltd. ICICI Bank Ltd March 10, 2001

21 ICICI Ltd ICIC I Bank Ltd May 3, 2002

22 Benares State Bank Ltd Bank of Baroda Juno 20, 2002

23 Nedungadi Bank Ltd Punjab National Bank February 1, 2003

24 South Gujarat Local Area Bank

Ltd

Bank of Baroda June 25, 2004

25 Global Trust Bank Ltd Oriental Bank of Commerce August 14, 2004

26 IDBI Bank Ltd IDBI Ltd April 2, 2005

27 Bank of Punjab Ltd Centurion Bank Ltd October 1, 2005

28 Ganesh Bank of Kurundwad Ltd Federal Bank Ltd September 2, 2006

29 United Western Bank Ltd IDBI Ltd October 3, 2006

30 Bharat Overseas Bank Ltd Indian Overseas Bank March 31, 2007

31 Sangli Bank Ltd ICICI Bank Ltd April 19, 2007

32 Lord Krishna Bank Ltd Centurion Bank of Punjab Ltd August 29, 2007

33 Centurion Bank of Punjab Ltd HDFC Bank Ltd May 23, 2008

Source: Report on Trend and Progress, RBI, Various Issues

Table 3.8.2 Last three Merger and Amalgamations took place in the Indian

banking sector.

34 State Bank of Saurashtra State Bank of India 13 August 2008

35 State Bank of Indore State Bank of India 19 June 2009

36 The Bank of Rajasthan ICICI Bank Ltd August 13, 2010

Source: Compiled from CMIE Prowess and Economic Times Retrieved from

http://articles.economictimes.indiatimes.com/2010-08-25/news/27610821_1_state-bank-

indore-order-indore-branches

Prior to 1999, the amalgamations of banks were primarily triggered by the weak

financials of the bank being merged, whereas in the post-1999 period, there have also

been mergers between healthy banks, driven by the business and commercial

considerations. Recently the process of M&As in the Indian banking sector is generally

market driven. As given in the policies and objective of mergers, most of the mergers

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have taken place voluntarily for strategic purposes. The Reserve Bank of India has been

encouraging the consolidation process for the small banks that are facing difficulty to

compete with large banks which enjoy enormous economies of scale and scope. Most of

the amalgamations of private sector banks in the post nationalization period were induced

by the Reserve Bank in the larger public interest, under Section 45 of the Act. In all these

cases, the weak or financially distressed banks were amalgamated with the healthy banks.

The over-riding principles governing the consideration of the amalgamation proposals

were: (a) protection of the depositors’ interest; (b) expeditious resolution; and (c)

avoidance of regulatory forbearance. The amalgamations of the erstwhile Global Trust

Bank and United Western Bank with public sector banks are the recent examples of such

mergers. Even in such cases, commercial interests of the transferee bank and the impact

of the amalgamation on its profitability were duly considered. The mergers of many weak

private sector banks with the healthy ones have brought the Indian banking sector to a

credible position, as the CRAR of all private sector banks in the country was more than

the minimum regulatory requirement of nine per cent as at end-March 2007.30

Mergers in India have also been used as a tool for strengthening the financial system.

Through a conscious approach, the weak and small banks have been allowed to merge

with stronger banks to protect the interests of depositors and to avoid possible financial

contagion that could result from individual bank failures and also to reap the benefits of

synergy. Thus, the Indian approach has been different from that of many other EMEs,

wherein the government was actively involved in the consolidation process. For instance,

in East-Asia, after the banking crisis in 1997, the government led the process of bank

mergers in order to strengthen capital adequacy and the financial viability of many

smaller and often family-owned banks.31 In these crisis ridden countries, the involvement

of the government was inevitable, as viable but distressed institutions were hardly in a

position to attract potential buyers without moving some non-performing loans to an asset

management company and/or receiving temporary capital support. Such intervention also

proved more cost-effective than taking the bank into public ownership. However, with

30 Competition and Consolidations’ Op.Cit.pp.357-358 31 Competition and Consolidations’ Op.Cit.pp.358

148

the intensification in competition through deregulation, privatization and entry of foreign

banks in the emerging markets, consolidation is becoming more market-driven.

In recent years, the consolidation process in the banking sector in India in recent years

was confined to mergers in the private sector and some consolidation in the state-owned

sector. After nationalization of banks in 1969, India did not allow entry of private sector

banks until January 1993, when these barriers were removed; India also liberalized the

entry of foreign banks in the post-reform period. And further these liberalized measures

resulted in entry of many new banks (private and foreign). Accordingly, the number of

banks increased during the initial phase of financial sector reforms. However, the pace of

consolidation process gathered momentum from 1999-2000, leading to a marked decline

in the number of private and foreign banks (Table 3.8.3). In February 2005, a

comprehensive framework of policy was provided relating to ownership and governance

in private sector banks, the Reserve Bank prescribed that the capital requirement of

existing private sector banks should be on par with the entry capital requirement for new

private sector banks prescribed on January 3, 2001, according to which, banks required to

have capital initially of Rs. 200 crore, with a commitment to increase to Rs.300 crore

within three years from commencement of business. In order to meet this requirement, all

banks in the private sector should have a net worth of Rs. 300 crore at all times. Thus,

post-2005 period, amalgamations/mergers resulted partly from these guidelines. The

number of scheduled commercial banks (SCBs) declined to 82 at end-March 2007 from

100 at end-March 2000 due to merger of some old private sector banks. In recent years,

the only option available with the Reserve Bank was to compulsorily merge troubled

banks them with stronger banks under section 45 of the Banking Regulation Act, 1949.

This included amalgamation of Global Trust Bank with Oriental Bank of Commerce in

August 2004, Ganesh Bank of Kurundwad Ltd. with Federal Bank Ltd. In September

2006 and the United Western Bank with IDBI Ltd. in October 2006.

Mergers and amalgamations involved relatively smaller banks, the largest number of

mergers took place with ICICI Bank, Bank of Baroda and Oriental Bank of Commerce

(each one of them was involved in three mergers). ICICI Bank replaced many entities to

occupy the second position in the Indian banking sector after State Bank of India. In the

Banker’s list out of the top 1000 banks of the world (July 2007), there were 27 Indian

149

banks (as compared with 20 in July 2004). Of these, 11 banks were in the top 500 banks

(as compared with 6 in July 2004) given in table 3.8.4. Even within Asia, India’s largest

banks, viz., SBI and ICICI Bank held at 11th and 25th place, respectively as shown in

table 3.8.4. The combined assets of the five largest Indian banks, viz., State Bank of

India, ICICI Bank, Punjab National Bank, Canara Bank and Bank of Baroda, on March

31, 2006 were about 51.0 per cent of the assets of the largest Chinese bank, Bank of

China, which was roughly 3.6 times larger than State Bank of India. In the Asian context,

only one Indian bank, State Bank of India – figures in the top 25 banks based on Tier I

capital, even though Indian banks offer the highest average return on capital among Asian

peers.

Table 3.8.3: New Private Sector and Public Sector Banks and Bank Mergers in India

Year Number of Bank Mergers

New Banks Set Up

No. of Banks (at the end of

March) Private Foreign Public Sector Banks 1989-90 4 0 0 0 75 1990-91 1 0 2 0 74 1991-92 0 1 0 0 77 1992-93 0 0 0 0 77 1993-94 1 0 0 0 74 1994-95 0 8 4 0 86 1995-96 1 2 4 0 92 1996-97 0 1 8 0 101 1997-98 2 0 4 0 103 1998-99 0 0 8 0 105

1999-2000 3 0 1 0 100

2000-01 1 0 0 0 99 2001-02 0 1 4 0 98 2002-03 3 0 1 0 92 2003-04 0 1 1 0 90 2004-05 2 1 0 1* 88 2005-06 2 1 0 0 84 2006-07 3 0 1 0 82 Source: Competition and Consolidations retrieved from http://rbi.org.in/scripts/publicationsview.aspx?id=10495 *: After merger of IDBI Bank Ltd. with IDBI, IDBI Ltd. is classified as other public sector bank. Apart from mergers and setting up of new banks, change in number of banks over the years is also on account of closure of some banks.

150

The total assets of State Bank of India were less than 10.0 per cent of the top three banks

in the world. However, the size of State Bank of India was larger than the largest bank

operating in some emerging markets like in Korea and Brazil. In a way, this suggests that

the size of bank and the banking sector depends on the size of the economy (Table 3.7.5).

Table: 3.8.4 Ranking of Indian Banks among World’s Top 1000 Banks

(As on March 31, 2006)

Sr

.No.

Name of Bank Overall

Ranking

Assets (US$

Million)

1 State Bank of India * 70 186,988

2 ICICI Bank 147 56,258

3 Punjab National Bank 255 32,509

4 Bank of Baroda " 259 33,690

5 Canara Bank ' 281 38,069

6 IDBI 329 20,209

7 HDFC Bank* 335 20,945

8 Oriental Bank of Commerce 378 13,190

9 Bank of India 411 25,126

10 Indian Overseas Bank * 414 18,868

11 Union Bank of India 495 19,945

12 Corporation Bank 507 9,079

13 Andhra Bank * 533 10,905

14 Allahabad Bank 548 12,374

15 Central Bank of India 561 16,713

16 UTI Bank 580 11,129

17 Syndicate Bank 601 13,668

18 Indian Bank 623 10,660

19 UCO Bank 699 13,839

20 United Bank of India * 708 9,700

21 Jammu & Kashmir Bank 744 5,919

151

22 Vijaya Bank 722 7,057

23 Bank of Maharashtra 805 6,989

24 Federal Bank 904 4,620

25 Punjab & Sind Bank 916 4,262

26 Karnatak Bank 962 3,346

27 Dena Bank 988 5,941

Source: The Banker, July 2007.

*: Data pertain to March 2007.

Note: Ranking of the banks is by the size of Tier I capital.

The mergers of regional rural banks (RRBs) took place on a large scale in India since

September 2005. Mergers of RRBs were largely policy driven in pursuance of the

recommendations of the Committee on the “Flow of Credit to Agriculture and Related

Activities” (Chairman: Prof. V.S. Vyas).

Table 3.8.5: Relative Size of the Largest Bank of India vis-à-vis the Largest Banks in

Select Countries

Sr. No. Bank Country Assets

(US million)

Relative size of SBI vis-a vis Largest Banks in

other countries (percent)

1 UBS Switzerland 1,963,870 9.5 2 Barclays Bank UK 1,956,786 9.6 3 Citigroup US 1,882,556 9.9

4 Mitsubishi UFJ Financial Group Japan 1,579,390 11.8

5 Deutsche Bank Germany 1,483,248 12.7 6 ABN Amro Bank The Netherlands 1,299,966 14.4 7 ICBC China 961,576 19.4

8 National Australia Bank Australia 331,408 56.4

9 Kookmin Bank Korea 180,805 103.4

10 Banco Itau Holding Financeira Brazil 98,124 190.6

11 State Bank of India India 186,988 - Source: The Banker, July 2007.

152

The Committee Report submitted in June 2004 recommended restructuring of RRBs in

order to improve the operational viability of RRBs and take advantage of the economies

of scale. In order to reposition RRBs as an effective instrument of credit delivery in the

Indian financial system, the Government of India, after consultation with NABARD,

concerned State Governments and the sponsor banks to intimate initiated State-level

sponsor bank-wise amalgamation of RRBs to overcome the deficiencies prevailing in

RRBs and making them viable and profitable units. Consequent upon the amalgamation

of 154 RRBs into 45 new RRBs, sponsored by 20 banks in 17 States, effected by the

Government of India, the total number of RRBs declined from 196 to 88 as on May 1,

2008 (which includes a new RRB set up in the Union Territory of Pondicherry).32 The

structural consolidation of RRBs resulted in the formation of new RRBs, which are

financially stronger and bigger in size in terms of business volume and outreach and

enabled them to take advantage of the economies of scale and reduce their operational

costs.

3.9 Conclusion The chapter traces the growth and development of the Indian Banking Sector since

economic liberalization reforms 1991. The growth in the financial performance depicts

the steady increase in the performance of Banks. The major Mergers and Amalgamations

deals are also extensively dealt with. Having studied the background of the Indian

banking sector, the next chapter involves a detailed financial analysis of five mergers and

Amalgamations that have taken place in India. The impact of mergers and amalgamations

on the performance of the banks both pre and post amalgamations era has been

determined.

32 ‘Competition and Consolidations’ Op.Cit.pp.358-359