Mergers in Indian Banking: An Analysis[dagger]

This paper analyzes some of the critical issues of consolidation in Indian banking with special emphasis on the views of two important stakeholders viz., shareholders and managers. First, we review the trends in consolidation, in global and Indian banking. Then to ascertain the shareholders' views, we conduct an event study analysis of bank stock returns which reveals that in the case of forced mergers, neither the bidder nor the target banks' shareholders have benefited. However, in the case of voluntary mergers, the bidder banks' shareholders have gained more than those of the target banks. In spite of absence of any gains to shareholders of bidder banks, a survey of bank managers strongly favors mergers and identifies the critical issues in a successful merger as the valuation of loan portfolio, integration of IT platforms, and issues of human resource management. Finally, we support the view of the need for large banks by arguing that imminent challenges to banks such as those posed by full convertibility, Basel-II environment, financial inclusion, and need for large investment banks are the primary factors for driving further consolidation in the banking sector in India and other Asian economies. INTRODUCTION Globally, mergers and acquisitions have become a major way of corporate restructuring and the financial services industry has also experienced merger waves leading to the emergence of very large banks and financial institutions. The key driving force for merger activity is severe competition among firms of the same industry, which focuses on the economies of scale, cost efficiency, and profitability. The other factor behind bank mergers is the "too big to fail" principle followed by the authorities. In some countries like Germany, weak banks were forcefully merged to avoid the problem of financial distress arising out of bad loans and erosion of capital funds. Several academic studies (see for example Berger et al. (1999) for an excellent literature review) examine merger related gains in banking and these studies have adopted one of the two following competing approaches. The first approach relates to evaluation of the long-term performance resulting from mergers by analyzing the accounting information such as return on assets, operating costs and efficiency ratios. A merger is expected to generate improved performance if, the change in accounting-based performance is superior to the changes in the performance of comparable banks that were not involved in merger activity. An alternative approach is to analyze the merger gains in stock price performance of the bidder and the target firms around the announcement event. Here, a merger is assumed to create value if the combined value of the bidder and target banks increases on the announcement of the merger and the consequent stock prices reflect potential net present value of acquiring banks. Our objective here is to present a panoramic view of merger trends in India, to ascertain the perceptions of two important stakeholders viz., shareholders and managers and to discuss dilemmas and other issues on this contemporary topic of Indian banking. We believe that the currently available merger cases do not form a sufficient data set to analyze the performance of mergers, based on corporate finance theory because almost all the mergers are through regulatory interventions and market driven mergers are very few. In this paper, the perception of shareholders is ascertained through an event study analysis that documents the impact of bank mergers on the market value of equity of both the bidder and target banks. The perception of bank managers is ascertained through a questionnaire-based survey that brings out several critical issues on bank mergers, with insights and directions for the future. Finally, we present arguments on why Indian banks should go for mergers. These arguments are also applicable to other Asian countries which have bank consolidation on their agenda. …