Bank Merger Reason, Advantage and Limitations.

Why Bank Merger ?

Achieving Cost Reduction

  1. Cost reduction through economy of Scale- Consolidation helps in scaling in up operations, thereby reducing per unit cost.
  2. Cost reduction through economy of Scope- This is achieved through synergy involved in the ability to offer multiple products using the same infrastructure. Example: Banks can offer insurance and investment products using their branch network and thereby achieve economy of scope.
  3. Cost reduction through rationalization of man power. The merged entity will be able to identify the right persons to man critical functions from a larger pool of human resources.
  4. Reduction in risk. The merged entity will be able to reduce credit risk through spreading it across wider geographies or product range.
  5. Cost reduction through possible reduction in tax obligations
  6. Cheaper sourcing of inputs with increased bargaining power with vendors and suppliers.
  7. Ability to enter new business areas with reduced initial cost as compared to a new set up.

 Increasing Revenue

  1. A bigger entity will be able to serve a large customer better. By offering more services and taking bigger share in the business of the customer the bank will be able to increase the revenue per customer
  2. Product diversification will facilitate ‗one stop shopping ‘by the bank‘s customers.
  3. A larger customer base will generate more revenue
  4. Greater visibility in the market place will enhance the ability to attract new customers.
  5. A bigger size and share in the market will boost the bank ‘s ability to raise product prices without losing customers
  6. The merged entity will be able to take bigger risk and reap its rewards.

Reasons of mergers -

  1. Competition among firms: This is the key driving force behind the merger activity. It is this severe competition among firms of the same industry which puts focus on different factors like, economies of scale, cost efficiency and profitability. This is also attributed to the fact, that the government started this consolidation of banks in the form of nationalisation, and then furthered it to the process of amalgamation of banks which has been seen in previous days.
  1. Too big to fail principle: The other factor behind bank merger, is this principle which is followed by the authorities. It is very much visible in the form of the RBI’s classification of domestic-systematically important banks(D-SIBs). It is believed that these banks are too large to fail, and that any disturbance in any of these might disrupt the banking channels all across the country. Thus, mergers help in creating large entities, which can be better taken care of in terms of regulation and vigilance.
  1. Improved Credit delivery: Improvement of operational and distribution efficiency, of public sector banks, has always been an issue for discussion for the Government of India, in consultation with the RBI. Because, in India, mergers happen only after policy intervention by the RBI, and not due to the requirements of the markets, it becomes imperative for the government and RBI to make a wise call. It was in this specific context, Narsimhan committee report of 1991 and 1998, gain prominence, for these two reports strongly moot mergers, both in the public as well as as the private sector.
  1. Solve the twin balance sheet problem: In recent years, due to slump in economy, the loans advanced to corporates for investment in infrastructure, have been turning sour, and gradually becoming NPAs. Thus, to combat this issue, the banks in India are merged to form larger entities, so that they can manage the NPAs in an efficient and effective manner, apart from that, the merger would also lead to financial strength, which would further boost the liquidity situation of the market.
  1. Align with the global banking practices: The Basel-3 norms, which demand, enhanced minimal capital and liquidity requirements, in addition, they also enumerate provisions for enhanced risk disclosure and market discipline, compel the Indian banking sector to go for mergers and acquisitions, as the small banks do not possess the financial capacity to comply with these norms. Mergers somewhere would help the anchor as well as the amalgamating banks to fulfil the compliance, and thus, bring Indian banking industry at par with the international banking practices.
  1. Protect the interests of depositors: Many banks of smaller size have been merged with the large ones, keeping the interest of depositors at forefront. It is when, a specific bank shows symptoms of sickness such as huge NPAs, erosion in net worth or huge decline in the capital adequacy ratio, it is then that the RBI is forced to impose section 45(1) of Banking Regulation Act, 1949, so as to initiate the proceedings for merging the small banks with the large ones.
  1. Voluntary mergers of banks: Of all the mergers in the Indian banking industry, only few have them have happened with expansion, diversification and overall growth as the primary objectives. In the private sector as well, mergers have been driven by the problem of low profitability, high NPAs, and lack of alternate avenues to increase capital adequacy. E.g Acquisition of Times bank by HDFC bank, Bank of Madura’s acquisition by ICICI bank, etc, have all been motivated by the above-mentioned reasons.
  1. Universal Banking model and integration of financial services: Over a period of time, developmental financial institutions (DFIs) which were formed to allocate investments into different sectors of the economy, became redundant. It was attributed to the fact that RBI provided flexibility to the banks in terms of credit delivery, banks have widened their loan portfolio to project finance, long term loans and other specialized sectoral financing. It was in this lieu, that RBI, working group in 1998, recommended universal banking model, by exploring different set of possibility of gainful mergers. E.g. ICICI merged with ICICI bank Ltd, IDBI incorporated as PSB acquired private sector bank IDBI Bank in 2004 etc.

 

Advantages of Mergers:

  • Prevents financial distress of weak banks: Guided by the central bank, most often this is the primary motive behind the mergers in the Indian banking industry, and it actually shields the weak banks from getting liquidated, in turn, becoming insolvent, for in populous nation like India, a majority of people are still not connected with the financial sector, and any setback to depositors in these weak banks, which are mostly regional in nature, would deter the people to further shy away from bank.
  • Rationalization of Branches: With bank mergers, comes the advantage of more branches in more areas, it also leads to the reduction of branches, in those areas where it might see multiple branches, and thus it helps in better planning and management of resources, deployment of humans at workplaces etc.
  • Increased customer base and resources: The primary resources for any bank is the deposit that it gets, and thus with mergers, the customer base and the market share automatically gets increased, in addition, the merged entity also acquires the client portfolio of the amalgamated unit.
  • Improved financial Inclusion: In the mergers, as we have seen, the amalgamating banks are usually the regional banks, which have larger rural and suburban outreach, in comparison to the anchor bank, which is usually stationed in metropolitans. Thus, these banks help in including a large number of people, which would have otherwise stayed from availing banking benefits of these large banks, thus improving the fold covering the Indian populace.
  • Better NPA and risk management: The merged entities see reduced operating costs, lower funding cost, and strengthened risk management practices apart from increasing the scale. The asset-liability mismatch of the amalgamating banks can better be handled at a consolidated level. It is also attributed to be one the core reasons as to the government going in for merging small banks into larger public sector banks.
  • Minimization of scale of efficiency: The weaker banks also have a problem of inefficiency, which becomes a paralyzing one in the long run, leading to its systematic failure. With merger, comes in standardized management practices which for the base of the anchor bank, it is this dissemination of these practices which leads to minimizing the prevailing efficiency of the weaker banks.
  • Diversification of products: With improved capital base, and geographical outreach, the banks are in better position to identify customer needs in different areas, and thus offer customized products suiting to the requirement of a particular bloc. It also helps in improving the competitive edge, as with larger units, it becomes easy to monitor the progress of product from multiple levels.
  • Prevents financial distress of weak banks: Guided by the central bank, most often this is the primary motive behind the mergers in the Indian banking industry, and it actually shields the weak banks from getting liquidated, in turn, becoming insolvent, for in populous nation like India, a majority of people are still not connected with the financial sector, and any setback to depositors in these weak banks, which are mostly regional in nature, would deter the people to further shy away from bank.
  • Rationalizations of Branches: With bank mergers, comes the advantage of more branches in more areas, it also leads to the reduction of branches, in those areas where it might see multiple branches, and thus it helps in better planning and management of resources, deployment of humans at workplaces etc.
  • Increased customer base and resources: The primary resources for any bank is the deposit that it gets, and thus with mergers, the customer base and the market share automatically gets increased, in addition, the merged entity also acquires the client portfolio of the amalgamated unit.
  • Improved financial Inclusion: In the mergers, as we have seen, the amalgamating banks are usually the regional banks, which have larger rural and suburban outreach, in comparison to the anchor bank, which is usually stationed in metropolitans. Thus, these banks help in including a large number of people, which would have otherwise stayed from availing banking benefits of these large banks, thus improving the fold covering the Indian populace.
  • Better NPA and risk management: The merged entities see reduced operating costs, lower funding cost, and strengthened risk management practices apart from increasing the scale. The asset-liability mismatch of the amalgamating banks can better be handled at a consolidated level. It is also attributed to be one the core reasons as to the government going in for merging small banks into larger public sector banks.
  • Minimization of scale of efficiency: The weaker banks also have a problem of inefficiency, which becomes a paralyzing one in the long run, leading to its systematic failure. With merger, comes in standardized management practices which for the base of the anchor bank, it is this dissemination of these practices which leads to minimizing the prevailing efficiency of the weaker banks.
  • Diversification of products: With improved capital base, and geographical outreach, the banks are in better position to identify customer needs in different areas, and thus offer customized products suiting to the requirement of a particular bloc. It also helps in improving the competitive edge, as with larger units, it becomes easy to monitor the progress of product from multiple levels.
  • Prevents financial distress of weak banks: Guided by the central bank, most often this is the primary motive behind the mergers in the Indian banking industry, and it actually shields the weak banks from getting liquidated, in turn, becoming insolvent, for in populous nation like India, a majority of people are still not connected with the financial sector, and any setback to depositors in these weak banks, which are mostly regional in nature, would deter the people to further shy away from bank.
  • Rationalization of Branches: With bank mergers, comes the advantage of more branches in more areas, it also leads to the reduction of branches, in those areas where it might see multiple branches, and thus it helps in better planning and management of resources, deployment of humans at workplaces etc.
  • Increased customer base and resources: The primary resources for any bank is the deposit that it gets, and thus with mergers, the customer base and the market share automatically gets increased, in addition, the merged entity also acquires the client portfolio of the amalgamated unit.
  • Improved financial Inclusion: In the mergers, as we have seen, the amalgamating banks are usually the regional banks, which have larger rural and suburban outreach, in comparison to the anchor bank, which is usually stationed in metropolitans. Thus, these banks help in including a large number of people, which would have otherwise stayed from availing banking benefits of these large banks, thus improving the fold covering the Indian populace.
  • Better NPA and risk management: The merged entities see reduced operating costs, lower funding cost, and strengthened risk management practices apart from increasing the scale. The asset-liability mismatch of the amalgamating banks can better be handled at a consolidated level. It is also attributed to be one the core reasons as to the government going in for merging small banks into larger public sector banks.
  • Minimization of scale of efficiency: The weaker banks also have a problem of inefficiency, which becomes a paralyzing one in the long run, leading to its systematic failure. With merger, comes in standardized management practices which for the base of the anchor bank, it is this dissemination of these practices which leads to minimising the prevailing efficiency of the weaker banks.
  • Diversification of products: With improved capital base, and geographical outreach, the banks are in better position to identify customer needs in different areas, and thus offer customised products suiting to the requirement of a particular bloc. It also helps in improving the competitive edge, as with larger units, it becomes easy to monitor the progress of product from multiple levels.

Limitation of mergers:

It must be understood that limitations arising out of mergers are more of social or emotional in nature, than being technical or managerial, it is in these specific areas that the management has to ensure coordination and co-operation.

  • Compliance and Risk taking ability: Each bank follows a specific set of rules, and thus the decision making of that bank rests on these rules, with mergers arises the problem of compliances of rules which the merged entity has to set and follow, usually it’s the anchor bank which dominates, and thus it creates a rift and tension amongst the employees which causes a problem. Similar is the situation with risk bearing ability of banks, different banks based on different metrics have different risk appetite. Thus, it becomes very critical to set the rules in such a manner so as to ensure that maximum decision makers are on-board, else it may result in a fallout.
  • Human Resources Issues: This is the most complicated organisational issue in mergers. HR issues like reward strategy, service conditions, employee relations, pension provisions, trade union actions, etc. are critical for the deal and the merger plan. Change management is the only way out which prepares the employees for the change, and so, in a similar manner it opens a channel for them to address their grievances to the merged entity.
  • Cultural Issues: Culture is at the center to the institutional environment in which people have to work. ‘Cultural friction’, is again very difficult to analyze, as it becomes visible in problems like poor productivity, high turnover rates, delays in integration, this disturbs the whole synergy of the deal, and so again restrict the success of a merger.
  • Integration of Information Technology: Given each bank works on a technology platform, and that employees are attuned to working on that technology, in addition, the customers of that banks also operate on that technology, in such a scenario, it becomes difficult for the employees and customers of the newly amalgamated banks to suite them with the new change, it is again a time-consuming process, and if went unhandled without any patience, it may again post a serious concern for the merged entity in the long run.
  • Customer Retention: Though customers are pivotal stakeholders of the bank, usually they are kept out of the merger discussions. It is in this context, that the communication with the customers of the newly acquired bank becomes important, and they are the ones who should be dealt with care. In scenarios, wherein the customer feels disconnected with the culture of the new entity, they are most likely to fly away to a competitor, and it is just not this specific customer, it happens with big lot; thus, banks need to take care of this aspect with caution.

SWOT Analysis

Bank Merger Reasons, advantage and limitations article by Aditya Vishwakarma

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