merger and amalgamation of banks in india

---------Merger and Amalgamation of Banks in India-----

MERGER AND AMALGAMATION OF BANKS IN INDIA

SUBJECT: BANKING LAW – I

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TABLE OF CONTENTS

INDEX OF AUTHORITIES.....................................................................................................iv

TABLE OF STATUTES....................................................................................................iv

TABLE OF CASES...........................................................................................................iv

INTRODUCTION....................................................................................................................1

CHAPTER I: JUDICIAL PRONOUNCEMENTS ON THE CONCEPT OF

MANUFACTURE…………..4

CHAPTER II: IMPLICATIONS OF THE JUDICIAL PRONOUNCEMENT

CITED…………………...6

CHAPTER III: TEST OF A

MANUFACTURE………………………………………………….9

CHAPTER IV: MANUFACTURE AND

DUTIABILITY………………………………………...12

CHAPTER V: PRODUCTION, MANUFACTURE AND PROCESS

DISTINGUISHED……………...13

CHAPTER VI:

CONCLUSION……………………………………………………………….22

BIBLIOGRAPHY…………………………………………………………………………...23

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INDEX OF AUTHORITIES

TABLE OF STATUTES

1. The Banking Regulation Act, 1949

TABLE OF CASES

1. Somayajula v Hope Prudhomme & Co Ltd..............................................................5

2. Bank of Madura Shareholder Welfare Association v Governor, RBI......................6

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INTRODUCTION

Banking sector in India is being transformed with an increasing number of banks

realizing the benefits offered by globalization. However, in addition to benefits, several

risks are also associated with the opportunities proffered by globalization. By the year

2009, Indian Financial Markets would be set free, allowing foreign banks to operate in

India, thereby exposing Indian Banks to an even more stiff competition and possible

threat of takeovers by the overseas banks.1

The Narasimham committee on banking reforms has recommended that the establishment

of three large banks with international structure, eight to ten national banks and a large

number of regional and local banks . This, the committee has suggested, can be done

through mergers.2

Under the existing law, the amalgamation of two banks requires approval of the scheme

of amalgamation by two-thirds in value of the shareholders of each of the banks followed

by the approval of the RBI. At the outset, we note that, under Indian law, an

amalgamation occurs when two or more companies are joined to form a third entity, that

is, the amalgamating companies disappear and a new company comes into existence

subject to all the duties and obligations of the constituent companies3. A merger, in

contrast, results in the disappearance of only one of the companies to the transaction, not

both. Generally in India mergers and amalgamations are treated as synonymous.

1 Bank consolidation to pick up in India, says ASSOCHAM study. Wednesday, October 04, 2006, www.assocham.org/prels/shownews.php?id=728 – 29k

2 SUDHA MAHALINGAM, ‘BANKING REFORMS- Radical prescriptions’, The Frontline, Vol. 15 ; May 22, 1998

3 Somayajula v Hope Prudhomme & Co Ltd [1963] 2 Comp. L.J. 61

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RESEARCH METHODOLOGY

The project has been compiled in Chanakya National Law University. A brief

study was done on the project. A number of sources of information were collected such

as, books from the library, online sources and World Wide Web. Doctrinal method of

research is adopted depending on the nature of the topic.

This project is entirely original and no part of it has been plagiarized.

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CHAPTER I: WHY MERGERS

M&A in the Indian banking sector is an opportunity and an imperative

M&A has to be based on a business rationale and effective execution – there is

not enough track record of that in the Indian banking sector

India may have to follow a managed transition model to ensure a stronger banking

sector

IMPERATIVES FOR M&A FOR BANKING IN INDIA

Stability

Fragmentation poses increasing risk in the Indian banking sector

Returns to shareholders

While shareholders have had good returns over the last few years, valuations are

well short of other markets

Benefits to customers

Intermediation costs remain high

Access to quality products and services is restricted to a small part of the market

Value added in the sector

The banking sector is a big employer; large parts of the workforce may be left

without requisite skills if there is not skill transfer through M&A.

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CHAPTER II: MAIN MOTIVES OF THE MERGER

There are many reasons why banks may wish to merge. According to the literature

on motives for merging in the banking: (i) cost reduction (scale and scope economies);

rationalisation of branch networks; economies in investment for new technologies and

processes; (ii) income increase (e.g. improvement of the ratio of net interest and non-

interest income to assets); (iii) risk reduction due inter alia to diversification; and (iv)

strengthening of the strategic position (e.g. increase of market power resulting from

greater market share of merged institutions). Rapid access to new product and/or

geographic market may also be an important motive for merging. However, considering

the motives mentioned above, the following considerations have to be made.

First, these motives may also be an explanation for strategic alliances. According to

the theory of transaction costs, it is important to consider that these motives encourage

firms when the ratio of transactions costs to control costs is quite high, to induce firms

to minimise transaction costs through mergers and takeovers, rather than through

strategic alliances in cases where internal growth is costly, risky and/or too slow.

Secondly, the motives mentioned above have to be placed within a strategic position

of the market that the partners want to reach. Do they want to be among the main

leaders on the national market, or on the international market as well?

Thirdly, given the fact that the target regarding the strategic position on the market

is clearly established, it is possible to classify the motives mentioned into three major

types of advantage for the merging partners:4

1) Mergers can improve cost-efficiency by increasing scale efficiency, scope

(product mix) efficiency and X-efficiency (management efficiency).

2) Mergers may increase profits through improvement in profit efficiency that

involve superior combinations of inputs and outputs.

3) Mergers may improve profits through the exercise of additional market power

in setting prices.

4 DBOD.No.PSBS..BC 89/16.13.100/2004-05, May 11, 2005.

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Studies on cost efficiency have generally found that the potential for cost-efficiency

improvement was not achieved for most mergers.5 This may lead one to consider that

the increase of profit through improvement in profit efficiency and through exercise of

market power should be the stronger motives for merging.

Fourthly, motives for mergers may be different depending on the time of the

merger,6 the region where the merger takes place and, in some instances, whether the

operation is a domestic or a cross-border merger.7

Fifthly, motives are always particular to each case and are not always the same for

all partners of a specific merger. As far as the new UBS is concerned, the major motives

for merging may be placed in three categories: first, to strengthen the partners' global

position in national and particularly in international markets in core businesses; second,

to benefit from a greater strategic efficiency in the use of their specific assets; third, to

increase profitability. The last is based mainly on a cost/revenue analysis while the

second relies on a strategic/organisational consideration.

5 For a detailed analysis of the RBI "Roadmap", see A. Viswanathan, [2005] J.I.B.L.R. 333.6 Somayajula v Hope Prudhomme & Co Ltd [1963] 2 Comp. L.J. 61.7 Banking Regulation Act 1949, s.44A(3).

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CHAPTER III: THE GOVERNING LAW- THE BANKING REGULATION ACT, 1949

The Banking Regulation act, 1949 was enacted to consolidate and amend the law relating

to banking. The Merger of banking companies are not done under the companies act but

under the Banking Regulation Act, 1949. The Amalgamations of Banking Companies is

contained in section 44A which appears under Part III of the act.It is under this section

that the banking companies are amalgamated. In the case of Bank of Madura Shareholder

Welfare Association Vs Governor, RBI8, it was held by the court that the provision

contained in the banking regulation act namely section 44A is a complete code on the

amalgamation of banking companies.

RELEVANT PROVISIONS OF BANKING REGULATION ACT, 1949

Section 44 A –Procedure for amalgamation of banking companies

Section 44 B -Restriction on compromise or arrangement between banking

company and creditors

Section 45 -Power of Reserve Bank to apply to Central Government for

suspension of business by a banking company and to prepare scheme of

reconstitution of amalgamation.

8 (2001)3 Comp LJ 212 Mad

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CHAPTER IV: ROLE OF THE BOARD OF DIRECTORS

A draft scheme of amalgamation between two banks must be approved by a special

resolution of the shareholders of each bank, that is, by a resolution passed by a majority

representing two-thirds in value of the shareholders present in person or by proxy at a

meeting called for the purpose. Before convening the shareholders' meeting, the draft

scheme of amalgamation must be approved by the board of directors of the two banking

companies. There is "crucial role" of the boards in the process, and provide that the

decision of merger should be approved by a two-thirds majority of the total board

members and not those present alone. This is an important change in the law governing

board resolutions because Indian company law does not provide for such "super

majority" or three-fourths vote of board members for any matters. Instead, a two-thirds

vote or "special resolution" exists only for shareholder resolutions.

Nowadays there is considerable importance on the responsibility of the board in such

merger decisions, and require directors who participate in such meetings to be signatories

to a deed of covenant as recommended by the Ganguly Working Group on Corporate

Governance.9 According to the Ganguly Report, in order to be eligible to be a director of

a bank, the director must satisfy the fit and proper criteria, namely, formal qualification,

experience, track record, and integrity. Moreover, banks should require the directors to

execute a covenant binding them to discharge their responsibilities to the best of their

abilities, individually and collectively. Execution of a deed of covenant adds contractual

force to the existing obligation of the directors under law to exercise due care and act in

the best interests of a company. By requiring the directors of banks who approve a

scheme of amalgamation to be signatories to a deed of covenant, the Guidelines are

strengthening the fiduciary obligations of directors in law while not altering the common

law legal standard.

The factors which must be taken into consideration by the board members in approving

the draft scheme of amalgamation, including the following:

• The value of the assets, liabilities and reserves of the amalgamated company that are

incorporated into the books of the amalgamating banking company and whether such

9 RBI Circ. No.BC 116/08.139.001/2001-02, June 20, 2002

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incorporation will result in a revaluation of assets upwards or credit being taken for

unrealised gains.

• Whether a due diligence exercise has been undertaken in respect of the amalgamated

company.

• The nature of the consideration paid by the amalgamating bank to the shareholders of

the amalgamated company.

• Whether the swap ratio has been determined by independent valuers having required

competence and experience and whether in the opinion of the Board such swap ratio is

fair and proper.

• The shareholding pattern in the two banking companies and whether as a result of the

amalgamation and the swap ratio the shareholding of any individual, entity or group in

the amalgamating banking company will violate the Reserve Bank guidelines or require

its specific approval.

• The impact of the amalgamation on the profitability and the capital adequacy ratio of

the amalgamating banking company.

• The changes which are proposed to be made in the composition of the board of directors

of the amalgamating banking company, consequent upon the amalgamation and whether

the resultant composition of the Board will be in conformity with the Reserve Bank

guidelines in that behalf.10

10 According to the RBI regulations (Annexure to Road Map for Presence of Foreign Banks in India, February 28, 2005), the composition of a board of directors of a bank must satisfy the following requirements: (a) at least 50% must be Indian nationals resident in India; (b) a minimum of one-third of the directors should be totally independent of the management of the subsidiary in India, its parent and associated companies; (c) the directors must confirm to the "fit and proper" criteria as laid down in the RBI's guidelines dated June 25, 2004; (d) RBI approval of the directors must be obtained as per the procedure adopted in the case of the erstwhile Local Advisory Board of foreign bank branches.

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CHAPTER V: RIGHTS OF DISSENTING SHAREHOLDERS

The s.44A of the Banking Regulation Act requires that at least two-thirds of the

shareholders must approve the draft scheme of amalgamation. A dissenting shareholder is

entitled, in the event of the scheme being approved by the RBI, to claim from the

concerned bank, the value of his shares as determined by the RBI when sanctioning the

scheme.11 Such determination by the RBI as to the value of the shares to be paid to the

dissenting shareholders will be final for all purposes.

The documents which must be provided by the amalgamating bank to the RBI to enable it

to determine such value. These documents include a report on the valuation of the shares

of the amalgamated company by the valuers appointed for the determination of the swap

ratio and, if the shares of the amalgamated company are publicly traded, the details of the

monthly high and low of the quotation on the stock exchange over the preceding six

months. The RBI attempts to make transparent the procedure for compensating dissenting

shareholders while continuing to vest the sole discretion over the same in the RBI.

11 Banking Regulation Act 1949, s.44A(3).

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CHAPTER VI: AMALGAMATION OF AN NBFC WITH A BANK

While the Banking Regulation Act 1949 confers on the RBI the power to approve an

amalgamation between two banks, it does not have such power with respect to an

amalgamation between a NBFC and a bank. Instead, such amalgamations have to be

approved by the High Court as is the case with all other amalgamations between two

companies. In the case of an amalgamation of an NBFC into a banking company, the

banking company should obtain the RBI approval after the scheme is approved by the

board of directors, but before it is submitted to the High Court for approval. Therefore,

the RBI will now have the power to approve amalgamations involving an NBFC and a

banking company as well.

In determining whether to accord it approval, the board of directors should take into

consideration the factors set forth in the first section, above. In addition, it should

examine whether:

• the NBFC has violated/is likely to violate any of the norms of the RBI or the Securities

Exchange Board of India ("SEBI");

• the NBFC has complied with the "Know Your Customer" norms for all the accounts

which will become accounts of the banking company after amalgamation;

• the NBFC has availed of credit facilities from banks/financial institutions and, if so,

whether the loan agreements mandate the NBFC to seek consent of the bank/financial

institution concerned for the proposed merger/amalgamation.

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CHAPTER VII: INSIDER TRADING

In a radical move, the RBI make the “spirit” of the SEBI (Prohibition of Insider Trading)

Regulations 1992, which apply only to listed companies, applicable to unlisted banks and

companies. Now even unlisted banks and companies are required to follow the Insider

Trading Regulations in spirit and to the extent applicable.

The Insider Trading Regulations define price sensitive information as "any information

which relates directly or indirectly to a company and which if published is likely to

materially affect the price of the securities of the company". The Insider Trading

Regulations provide that no insider shall-

(1) either on his own behalf or on behalf of any other person, deal in securities of a listed

company on the basis of any unpublished price sensitive information, or

(2) communicate any unpublished price sensitive information to any person except as

required in the ordinary course of business or under any law, or

(3) counsel or procure any other person to deal in securities of any company on the basis

of unpublished price sensitive information. An “insider” in turn means any person who is

or was connected with the company and who is reasonably expected to have access, by

virtue of such connection, to unpublished price-sensitive information in respect of

securities of the company.

The RBI Guidelines thus seek to prevent promoters or officers of amalgamating banks

from disclosing and trading on information relating to share swap ratios or other

information regarding valuation during the period prior to the amalgamation.

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CHAPTER VIII: RESERVE BANK OF INDIA APPROVAL

The list of information and documents which must be furnished to the RBI for its

approval along with the scheme of amalgamation. Notably, the RBI call for detailed

information regarding the approval of the scheme by the shareholders by requiring

submission of the following information signed by each of the officers presiding at the

meeting:

• a copy of any resolution passed;

• the number of shareholders present in person or by proxy;

• the number of the shareholders who voted in favour of and against the resolution and

the aggregate number of shares held by them;

• the number of shareholders whose votes were declared invalid and the aggregate

number of shares held by them;

• the names and ledger folios of the shareholders who voted against the resolution and the

number of shares held by each such shareholder;

• the names and designations of the scrutineers appointed for the purpose of counting the

votes together with certificates from such scrutineers.

The RBI is also seeking detailed information regarding the names, addresses and

occupation of directors of the amalgamating banking company as proposed to be

reconstituted after the amalgamation and details as to compliance with RBI regulations

on the composition of the board of a bank..12 In addition, details of the proposed Chief

Executive Officer of the amalgamating banking company after amalgamation must be

furnished.

Detailed information regarding the share valuation must also be submitted, including

annual reports of each of the banking companies for the three previous financial years,

financial results published by the banking companies, and a pro forma balance sheet

showing computation of the following:

• Tier I Capital

12 Banking Regulation Act 1949, s.44A(3).

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• Tier II Capital

• Risk-weighted Assets

• Gross and Net NPAs

• Ratio of Tier I Capital to Risk-weighted Assets

• Ratio of Tier II Capital to Risk-weighted Assets

• Ratio of Total Capital to Risk-weighted Assets

• Tier I Capital to Total Assets

• Ratio of Gross and Net NPAs to Advances

Furthermore, information certified by valuers as is considered relevant to understand the

proposed swap ratio must be submitted to the RBI, including in particular:

• the method of valuation used by the valuers;

• information and documents on which the valuers have relied and the extent of

verification, if any, made by the valuers to test the validity and accuracy of such

information;

• details of the projected information on which the valuers have relied and the names and

designations of persons who have provided such information and the extent of

verification, if any, made by the valuers in relation to such information;

• detailed computation of the swap ratios in detail with explanations for any adjustments

made to the published financial information for the purpose of valuation. If these

adjustments are made based on valuations by third parties, details regarding the persons

who made such valuations about such third party;

• Capitalization factor and weighted average cost of capital used for the purpose of

valuation and the justification for the same;

• if the market value of shares have been considered in the computation of the swap ratio,

the market values considered and the source from which such values have been derived.

If there is more than one valuer, whether each of the valuers has recommended a different

swap ratio and, if so, the above details should be given separately in respect of each

valuer and it may be indicated how the final swap ratio is calculated.

A comprehensive set of information is to be furnished to the RBI so as to enable the RBI

to scrutinize the approval of the draft scheme by the board of directors, the basis for the

share valuation and swap ratio and the certification by the value’s.

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CHAPTER IX: CONCLUSION

In sum, the Merger Guidelines reveal the intense concern of the RBI, and the Ganguly

Committee on Corporate Governance, that boards of directors of banks exercise their

discretion in approving a scheme of amalgamation to the best of their abilities and in the

best interests of the bank concerned. The RBI has extended the deed of covenant

requirement introduced by the Ganguly Committee to directors making this decision,

thereby strengthening the common law obligations of directors with the contractual

obligations created under the deed of covenant. The RBI has moreover dictated the

factors to be considered by the directors in making this decision and introduced the

concept of a super-majority vote of directors, that is, approval of the scheme of

amalgamation by a two-thirds majority of the total strength of the board, not those

present alone. At the same time, the RBI has introduced transparency in the calculation of

the payment made to dissenting shareholders and brought amalgamations between NBFC

and banks within its purview. Moreover, the SEBI Insider Trading Regulations have, for

the first time, been made applicable to unlisted companies by requiring the promoters of

banks buying and selling shares to comply with these regulations at least in spirit and to

the fullest extent possible. Departing at full speed ahead after its "Roadmap" for the

presence of foreign banks in India announced in February, the RBI appears intent on

ensuring consolidation in the banking sector in a manner which is in the interests of the

stability of the financial sector as a whole.

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BIBLIOGRAPHY

BOOKS REFERRED

1. P.N. Varshney, “Banking Law and Practice”, third edition, 2009, Sultan Chand &

Sons, New Delhi.

2. M.L.Tannan, “Tannan’s Banking Law and Practice in India, Lexis Nexis

Butterworths Wadhwa Nagpur, 22nd edition, 2008

3. K.P.Kandasami, S.Natarajan & R.Parameswaran, “Banking Law and

Practice”,Revised edition 2007, S. Chand, New Delhi

4. Know Your Banking – I Basics of Banking, Indian Institute of Banking and

Finance, 2005 ed., Taxman Publications Pvt. Ltd., Haryana

5. Legal Aspects of banking Operation, Indian Institute of Banking and Finance,

Macmillan India Ltd., New Delhi, 2005 ed.

6. J.C.Verma, Corporate Mergers Amalgamations & Takeovers, 5th ed, 2008,

Bharat Publications, New Delhi

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merger and amalgamation of banks in india

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