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Principles and Practices of Banking: A Project Report On
Principles and Practices of Banking: A Project Report On
Principles and Practices of Banking: A Project Report On
Project Report
On
SCOPE OF MERGES IN INDIAN BANKING SECTOR
2011
1
INDEX
Acknowledgement 3
Executive summary 4
Introduction 5-6
6 35 - 40
After merger changes in ICICI
Conclusion
41 - 42
2
ACKNOWLEDGEMENT
This project work would never have been an achievable task, had I not been under the great shelter of
guidance of respected Mr. P. K. JAIN, His simplified teaching technique based on examples has
helped me gain more understanding of the subject.
The very essence of the project work is the linguistic precision which has an impact of conveying
more details in least possible words. An ample use of various reference readings has been very
frequently made while compiling data for this project. Such rich reading has been made available at
hand by the treasure-like well-maintained library of the National Law University, Jodhpur. I am very
much grateful to the library staff of the university for their unfailing co-operation.
I am very much under obligation to mention here, the contributions of my batch mates who have,
knowingly or unknowingly, provided me the competitive edge which is the driving force of the whole
labour and extra labour put into the project.
I would also take an opportunity to thank all the respondents, who have taken pains in answering the
questions and filled the place of true representatives for deciding the nature of the problem.
………………Anjulata Songara
3
Executive Summary
Economies of the world have experienced a revolutionary change in the environment of banking
sector. One of the radical changes that have taken place in the banking industry at global level is the
increased competition among banks. Increased competition has compelled the banking industry to
improve their efficiency and productivity. The banking industry has also to face competition from
the non-banking companies such as insurance, investment banks, and saving banks that also
encouraged the banks to improve their efficiency and productivity.
The strategic priority in the banking industry has changed over the last two decades. Presently,
more emphasis has been put on efficiency, soundness, value creation, and productivity rather than
on growth. To achieve all these goals, the government and regulatory authorities have adopted
various policies and measures, out of which consolidation of the banks emerged as one of the most
preferable strategy. There are several ways to consolidate the banking sector; the most commonly
adopted by the banks is mergers. Merger and acquisition of the banking sector was one of the
outcomes of the deregulation, liberalization, and technological progress. Merger of two weaker
banks or merger of one healthy bank with one weak bank can be treated as the faster and less costly
way to improve profitability than spurring internal growth.
One of the main motives behind the mergers and acquisitions in the banking industry is to achieve
economies of scale. Scale economies arise when banks increase their scale of production and size
by merging with other banks. With this consideration in mind, the project attempted to study the
effect of mergers on efficiency of Indian banks that have participated in the merger activity during
1990-2010. The remainder of this paper is organized as follows: section 2 provides brief overview
of the Indian banking sector. Next section deals with the review of empirical studies related with the
impact of mergers on efficiency.
4
INTRODUCTION
Bank Mergers are happening in the world economy in a rapid rate for the past few years. Obviously
there are reasons behind this numerous bank mergers. In the Banking Sector of any economy, the
most crucial concern is the Risk Management. Banks of every country are supposed to make a
proper risk analysis in order to balance the deposit and credit portfolios. Mergers can diversify these
risks to a significant extent. Drastic increase in market competition, innovation of new financial
products and consolidation of regional financial systems and national financial systems are the other
reasons, for which banks are going for mergers, around the world. Merger can be proved really
useful in fighting market competition, as merger has the capability to generate economies of scale.
These Economies of scale can help the banks in lowering their servicing cost and in this way can
provide a competitive edge to them. Moreover, when Mergers happen, Transfer of Skills takes place
between the two banking organizations and this transfer of skills lead to higher efficiency on the
part of the merged bank. Banking Sectors of every economy of the world are becoming global
sooner or later. This globalization or economic liberalization has exerted a great impact on the Bank
Mergers With recession taking toll of many Indian businesses and the feeling of insecurity surging
over our businessmen, it is not surprising when we hear about the immense numbers of corporate
restructurings taking place, especially in the last couple of years. All our daily newspapers are filled
with cases of mergers, acquisitions, spin- offs, tender offers, & other forms of corporate
restructuring. Thus important issues both for business decision and public policy formulation have
been raised. No firm is regarded safe from a takeover possibility. On the more positive side Mergers
& Acquisition’s may be critical for the healthy expansion and growth of the firm. Successful entry
into new product and geographical markets may require Mergers & Acquisition’s at some stage in
the firm's development.
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Considerable amount of brainstorming would be required by the managements to reach a
conclusion. E.g. A due diligence report would clearly identify the status of the company in respect
of the financial position along with the net worth and pending legal matters and details about
various contingent liabilities. Decision has to be taken after having discussed the pros & cons of the
proposed merger & the impact of the same on the business, administrative costs benefits, addition
to shareholders' value, tax implications including stamp duty and last but not the least also on the
employees of the Transferor or Transferee Company.
6
CHAPTER1 MERGERS, ACQUISITIONS
AND TAKEOVERS
Merger
Merger is defined as combination of two or more companies into a single company where one
survives and the others lose their corporate existence. The survivor acquires all the assets as well as
liabilities of the merged company or companies. Generally, the surviving company is the buyer,
which retains its identity, and the extinguished company is the seller.
Merger is also defined as amalgamation. Merger is the fusion of two or more existing companies.
All assets, liabilities and the stock of one company stand transferred to Transferee Company in
consideration of payment in the form of:
Acquisition
Acquisition in general sense is acquiring the ownership in the property. In the context of business
combinations, an acquisition is the purchase by one company of a controlling interest in the share
capital of another existing company.
Methods of Acquisition:
a) Agreement with the persons holding majority interest in the company management like members
of the board or major shareholders commanding majority of voting power;
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b) Purchase of shares in open market;
c) To make takeover offer to the general body of shareholders;
d) Purchase of new shares by private treaty;
e) Acquisition of share capital through the following forms of considerations viz. Means of cash,
issuance of loan capital, or insurance of share capital.
Takeover:
Takeover differs from merger in approach to business combinations i.e. The process of takeover,
transaction involved in takeover, determination of share exchange or cash price and the fulfillment
of goals of combination all are different in takeovers than in mergers. For example, process of
takeover is unilateral and the offeror company decides about the maximum price. Time taken in
completion of transaction is less in takeover than in mergers, top management of the offeree
company being more co-operative.
De-merger or split or divisions of a company are the synonymous terms signifying a movement in
the company.
The purpose for an offeror company for acquiring another company shall be reflected in the
corporate objectives. It has to decide the specific objectives to be achieved through acquisition. The
basic purpose of merger or business combination is to achieve faster growth of the corporate
business. Faster growth may be had through product improvement and competitive position.
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2. To obtain economies of purchase in the form of discount, savings in transportation costs,
overhead costs in buying department, etc.;
3. Expanding Market and aiming at consumers satisfaction through strengthening after sale
Services;
4. To obtain improved production technology and know-how from the offered company
5. To reduce cost, improve quality and produce competitive products to retain and Improve
market share.
3. To obtain new product for diversification or substitution of existing products and to enhance the
product range;
5.To reduce advertising cost and improve public image of the offeree company;
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(4) Financial strength:
2. To dispose of surplus and outdated assets for cash out of combined enterprise;
3. To enhance gearing capacity, borrow on better strength and the greater assets backing;
1. To improve its own image and attract superior managerial talents to manage its affairs;
The purpose of acquisition is backed by the offeror company’s own developmental plans. A
company thinks in terms of acquiring the other company only when it has arrived at its own
development plan to expand its operation having examined its own internal strength where it might
not have any problem of taxation, accounting, valuation, etc. But might feel resource constraints
with limitations of funds and lack of skill managerial personnel’s. It has to aim at suitable
combination where it could have opportunities to supplement its funds by issuance of securities,
secure additional financial facilities, eliminate competition and strengthen its market position.
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(7) Strategic purpose:
The Acquirer Company view the merger to achieve strategic objectives through alternative type of
combinations which may be horizontal, vertical, product expansion, market extensional or
otherspecified unrelated objectives depending upon the corporate strategies. Thus, various types of
combinations distinct with each other in nature are adopted to pursue this objective like vertical or
horizontal combination.
Although it is rare but it is true that business houses exhibit degrees of cooperative spirit despite
competitiveness in providing rescues to each other from hostile takeovers and cultivate situations of
collaborations sharing goodwill of each other to achieve performance heights through business
combinations. The combining corporate aim at circular combinations by pursuing this objective.
Mergers and acquisition are pursued to obtain the desired level of integration between the two
combining business houses. Such integration could be operational or financial. This gives birth to
conglomerate combinations. The purpose and the requirements of the offeror company go a long
way in selecting a suitable partner for merger or acquisition in business combinations.
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CHAPTER 2: TYPES OF MERGERS AND
IT’S ADVANTAGES
Types of Mergers
Merger or acquisition depends upon the purpose of the offeror company it wants to achieve. Based
on the offerors’ objectives profile, combinations could be vertical, horizontal, circular and
conglomeratic as precisely described below with reference to the purpose in view of the offeror
company.
A company would like to takeover another company or seek its merger with that company to
expand espousing backward integration to assimilate the resources of supply and forward
integration towards market outlets. The acquiring company through merger of another unit attempts
on reduction of inventories of raw material and finished goods, implements its production plans as
per the objectives and economizes on working capital investments. In other words, in vertical
combinations, the merging undertaking would be either a supplier or a buyer using its product as
intermediary material for final production.
The following main benefits accrue from the vertical combination to the acquirer company i.e.
1. It gains a strong position because of imperfect market of the intermediary products, scarcity of
resources and purchased products;
12
It is a merger of two competing firms which are at the same stage of industrial process. The
acquiring firm belongs to the same industry as the target company. The mail purpose of such
mergers is to obtain economies of scale in production by eliminating duplication of facilities and
the operations and broadening the product line, reduction in investment in working capital,
elimination in competition concentration in product, reduction in advertising costs, increase in
market segments and exercise better control on market.
Companies producing distinct products seek amalgamation to share common distribution and
research facilities to obtain economies by elimination of cost on duplication and promoting market
enlargement. The acquiring company obtains benefits in the form of economies of resource sharing
and diversification.
It is amalgamation of two companies engaged in unrelated industries like DCM and Modi
Industries. The basic purpose of such amalgamations remains utilization of financial resources and
enlarges debt capacity through re-organizing their financial structure so as to service the
shareholders by increased leveraging and EPS, lowering average cost of capital and thereby raising
present worth of the outstanding shares. Merger enhances the overall stability of the acquirer
company and creates balance in the company’s total portfolio of diverse products and production
processes.
[4]Advantages of Mergers
Mergers and takeovers are permanent form of combinations which vest in management complete
control and provide centralized administration which are not available in combinations of holding
company and its partly owned subsidiary. Shareholders in the selling company gain from the
merger and takeovers as the premium offered to induce acceptance of the merger or takeover offers
much more price than the book value of shares. Shareholders in the buying company gain in the
long run with the growth of the company not only due to synergy but also due to “boots trapping
earnings”.
13
Mergers and acquisitions are caused with the support of shareholders, manager’s ad promoters of
the combing companies. The factors, which motivate the shareholders and managers to lend support
to these combinations and the resultant consequences they have to bear, are briefly noted below
based on the research work by various scholars globally.
Investment made by shareholders in the companies subject to merger should enhance in value. The
sale of shares from one company’s shareholders to another and holding investment in shares should
give rise to greater values i.e. The opportunity gains in alternative investments. Shareholders may
gain from merger in different ways viz. From the gains and achievements of the company i.e.
Through
(d) Acquisition of human assets and other resources not available otherwise;
One or more features would generally be available in each merger where shareholders may have
attraction and favour merger.
Managers are concerned with improving operations of the company, managing the affairs of the
company effectively for all round gains and growth of the company which will provide them better
deals in raising their status, perks and fringe benefits. Mergers where all these things are the
guaranteed outcome get support from the managers. At the same time, where managers have fear of
14
displacement at the hands of new management in amalgamated company and also resultant
depreciation from the merger then support from them becomes difficult.
Mergers do offer to company promoters the advantage of increasing the size of their company and
the financial structure and strength. They can convert a closely held and private limited company
into a public company without contributing much wealth and without losing control.
Impact of mergers on general public could be viewed as aspect of benefits and costs to:
(c) General public affected in general having not been user or consumer or the worker in the
companies under merger plan.
(a) Consumers
The economic gains realized from mergers are passed on to consumers in the form of lower prices
and better quality of the product which directly raise their standard of living and quality of life. The
balance of benefits in favour of consumers will depend upon the fact whether or not the mergers
increase or decrease competitive economic and productive activity which directly affects the degree
of welfare of the consumers through changes in price level, quality of products, after sales service,
etc.
The merger or acquisition of a company by a conglomerate or other acquiring company may have
the effect on both the sides of increasing the welfare in the form of purchasing power and other
miseries of life. Two sides of the impact as discussed by the researchers and academicians are:fir
stly, mergers with cash payment to shareholders provide opportunities for them to invest this money
15
in other companies which will generate further employment and growth to uplift of the economy in
general.Secondly, any restrictions placed on such mergers will decrease the growth and investment
activity with corresponding decrease in employment. Both workers and communities will suffer on
lessening job Opportunities, preventing the distribution of benefits resulting from diversification of
production activity.
Mergers result into centralized concentration of power. Economic power is to be understood as the
ability to control prices and industries out monopolists. Such monopolists affect social and political
environment to tilt everything in their favour to maintain their power ad expand their business
empire. These advances result into economic exploitation. But in a free economy a monopolist does
not stay for a longer period as other companies enter into the field to reap the benefits of higher
prices set in by the monopolist. This enforces competition in the market as consumers are free to
substitute the alternative products. Therefore, it is difficult to generalize that mergers affect the
welfare of general public adversely or favorably. Every merger of two or more companies has to be
viewed from different angles in the business practices which protects the interest of the
shareholders in the merging company and also serves the national purpose to add to the welfare of
the employees, consumers and does not create hindrance in administration of the Government
polices.
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CHAPTER 3: MERGERS IN INDIAN BANKING
SECTOR,
In India, the Reserve Bank of India acts as a central bank of the country. Banking system has a wide
mix, comprising of scheduled and non-scheduled banks, cooperative sector banks, post office
saving banks, foreign and exchange banks. Table below provides a brief detail of the structure of
Indian commercial banks. The number of commercial banks is 79 comprise of 28 PSBs, 23 private
sector banks and 28 foreign banks. It is evident from the table that public sector banks dominate the
commercial banks in India. It has been observed that the market share of public sector banks in
terms of investment, advances and assets is near about 70 percent. The Public sector banks are the
biggest players in the Indian banking system and they account for 70 percent of the branches of
commercial banks in India. Private sector banks accounts for nearly 21.7 percent while foreign
banks constitutes 8.41 percent share in total assets of commercial banks. During last few decades,
the environment under which Indian banking sector has operated witnessed a remarkable changes.
India embarked on a strategy of economic reforms in the wake of a serious balance of payment
crisis in 1991.In Indian banking sector, the policy makers adopted a cautious approach for
introducing reform measures on the recommendation of Narishmam Committee I (1991),
Narishmam Committee II (1997) and Verma Committee (1999). The main objective of the banking
sector reforms was to improve the efficiency of banks and to promote a diversified and competitive
financial system. One of the outcomes of such reforms was the consolidation of the banking
industry through mergers and acquisitions. Technological progress and financial deregulation have
played an important role in accelerating the process of merger and acquisition in Indian banking
industry. Due to technological progress, the scale at which financial services and products are
produced has expanded which provide an opportunity for the banks to increase their size and scale
of production. At that, time mergers of banking institutions emerged as an important strategy for
growing the size of banks. Size of the bank plays a significant role to enter the global financial
market.
17
INDIAN BANKING SECTOR
18
V. Total 79 78666 1177330 1177330 2476936 4326166 5320062
commercial banks
Market share (%) 100% 100% 100% 100% 100% 100%
Mergers occurs by adding the active (bidder ) banks assets and liabilities to the target (Passive)
bank’s balance sheet and acquiring the bidder ‘s bank name through a series of legal and
administrative measures. Mergers and acquisitions in Indian banking sector have initiated through
the recommendations of Narasimham committee II. The committee recommended that merger
between strong banks/ financial institutions would make for greater economic and commercial
sense and would be a case where the whole is greater than the sum of its parts and have a “force
multiplier effect”. Table below provides a list of banks that have been merged in India since post-
liberalization in the country. Impact of Mergers on the Cost Efficiency of Indian Commercial Banks
www.banknetindia.com/banking/bop.htm
19
1999 Union Bank of Sikkim Bank Ltd. To achieve scale Forced Merger
India and scope
To achieve scale
and scope
To achieve scale
and scope
Economies
2000 Times Bank To achieve scale To achieve scale Voluntary
and scope and scope Merger
economies Economies
2001 ICICI Bank Bank of Madura To achieve scale Voluntary
and scope Merger
Economies
2002 Bank of Baroda Benaras State Bank Restructuring of bank Forced
Ltd. Weak Merge
Bank
20
2006 Federal Bank Ganesh Bank of Restructuring of Forced merger
Kurandwad weak bank
State Bank of India (SBI), August 26.2010 the merger of State Bank of Indore with itself .
21
Change in scenario of Banking Sector
1. The first mega merger in the Indian banking sector that of the HDFC Bank with Times Bank, has
created an entity which is the largest private sector bank in the country.
2. The merger of the city bank with Travelers Group and the merger of Bank of America with
Nation Bank have triggered the mergers and acquisition market in the banking sector world wide.
3. Europe and Japan are also on their way to restructure their financial sector thought merger and
acquisitions. Merger will help banks with added money power, extended geographical reach with
diversified branch Network, improved product mix, and economies of scale of operations. Merger
will also help banks to reduced them borrowing cost and to spread total risk associated with the
individual banks over the combined entity. Revenues of the combine entity are likely to shoot up
due to more effective allocation of bank funds.
4. In India mergers especially of the PSBS may be subject to technology and trade union related
problem. The strong trade union may prove to be big obstacle for the PSBS mergers. Technology of
the merging banks to should complement each other NPA management. Management of efficiency,
cost reduction, tough competition from the market players and strengthen of the capital base of the
banks are some of the problem which can be faced by the merge entities. Mergers for private sector
banks will be much smoother and easier as again that of PSBS.
CHAPTER 4: PROCEDURE
OF BANK MERGER,
22
Procedure of Mergers & Acquisitions
Public announcement: To make a public announcement an acquirer shall follow the following
procedure:
The acquirer shall appoint a merchant banker registered as category – I with SEBI to advise him on
the acquisition and to make a public announcement of offer on his behalf.
Public announcement shall be made at least in one national English daily one Hindi daily and one
regional language daily newspaper of that place where the shares of that company are listed and
traded.
3. Timings of announcement:
Public announcement should be made within four days of finalization of negotiations or entering
into any agreement or memorandum of understanding to acquire the shares or the voting rights.
4. Contents of announcement:
➢ The procedure for merger either voluntary or otherwise is outlined in the respective state
statutes/ the Banking regulation Act. The Registrars, being the authorities vested with the
responsibility of administering the Acts, will be ensuring that the due process prescribed in the
Statutes has been complied with before they seek the approval of the RBI. They would also be
ensuring compliance with the statutory procedures for notifying the amalgamation after obtaining
the sanction of the RBI.
23
➢ Before deciding on the merger, the authorized officials of the acquiring bank and the merging
bank sit together and discuss the procedural modalities and financial terms. After the conclusion of
the discussions, a scheme is prepared incorporating therein the all the details of both the banks and
the area terms and conditions.
➢ Once the scheme is finalized, it is tabled in the meeting of Board of directors of respective
banks. The board discusses the scheme thread bare and accords its approval if the proposal is found
to be financially viable and beneficial in long run.
➢ After the Board approval of the merger proposal, an extra ordinary general meeting of the
shareholders of the respective banks is convened to discuss the proposal and seek their approval.
After the board approval of the merger proposal, a registered valuer is appointed to valuate both the
banks. The valuer valuates the banks on the basis of its share capital,market capital, assets and
liabilities, its reach and anticipated growth and sends its report to the respective banks.
➢ Once the valuation is accepted by the respective banks , they send the proposal along with all
relevant documents such as Board approval, shareholders approval, valuation report etc to Reserve
Bank of India and other regulatory bodies such Security & exchange board of India(SEBI) for their
approval.
➢ After obtaining approvals from all the concerned institutions, authorized officials of both the
banks sit together and discuss and finalize share allocation proportion by the acquiring bank to the
shareholders of the merging bank (SWAP ratio)
➢ After completion of the above procedures , a merger and acquisition agreement is signed by the
bank
➢ With a view to facilitating consolidation and emergence of strong entities and providing an
avenue for non disruptive exit of weak/unviable entities in the banking sector, it has been decided to
frame guidelines to encourage merger/amalgamation in the sector. Although the Banking
2
www.rbi.org.in ›
24
Regulation Act, 1949 (AACS) does not empower Reserve Bank to formulate a scheme with regard
to merger and amalgamation of banks, the State Governments have incorporated in their respective
Acts a provision for obtaining prior sanction in writing, of RBI for an order, inter alia, for
sanctioning a scheme of amalgamation or reconstruction.
➢ The request for merger can emanate from banks registered under the same State Act or from
banks registered under the Multi State Co-operative Societies Act (Central Act) for takeover of a
bank/s registered under State Act. While the State Acts specifically provide for merger of co-
operative societies registered under them, the position with regard to take over of a co-operative
bank registered under the State Act by a co-operative bank registered under the central act.
➢ Although there are no specific provisions in the State Acts or the Central Act for the merger of a
co-operative society under the State Acts with that under the Central Act, it is felt that, if all
concerned including administrators of the concerned Acts are agreeable to order merger/
amalgamation, RBI may consider proposals on merits leaving the question of compliance with
relevant statutes to the administrators of the Acts. In other words, Reserve Bank will confine its
examination only to financial aspects and to the interests of depositors as well as the stability of the
financial system while considering such proposals.
1. Draft scheme of amalgamation as approved by the Board of Directors of the acquirer bank.
2. Copies of the reports of the valuers appointed for the determination of realizable value of assets
(net of amount payable to creditors having precedence over depositors) of the acquired bank.
3. Information which is considered relevant for the consideration of the scheme of merger including
in particular:-
A. Annual reports of each of the Banks for each of the three completed financial years immediately
preceding the proposed date for merger.
25
B. Financial results, if any, published by each of the Banks for any period subsequent to the
financial statements prepared for the financial year immediately preceding the proposed date of
merger.
C. Pro-forma combined balance sheet of the acquiring bank as it will appear consequent on the
merger.
Tier I Capital
Tier II Capital
Risk-weighted Asset
4. Information certified by the values as is considered relevant to understand the net realizable value
of assets of the acquired bank including in particular:-
B. The information and documents on which the values have relied and the extent of the
verification, if any, made by the values to test the accuracy of such
information
26
C. If the values have relied upon projected information, the names and designations of the persons
who have provided such information and the extent of verification, if any, made by the values in
relation to such information
5.Such other information and explanations as the Reserve Bank may require.
Event:
ICICI bank has approved an in principle merger with Bank of Rajasthan (BoR). The bank has
entered into agreement with certain shareholders of BoR consenting to the share swap ratio of
27
25:118 (25 shares of ICICI Bank for 118 shares of BoR), subject to necessary regulatory approvals.
The Tayal group is a dominant shareholder in BoR the bank with a declared stake of 28% 3.
• Bank of Rajasthan is an old private sector bank headquartered in Jaipur. Founded in 1943, the
bank has a customer base of over 2m.
• The Tayal group is the dominant shareholder of the bank with a declared stake of ~28% (as of
Mar- 10). However as per SEBI, Tayals hold 55% stake in the bank as of December 2009. Mr Tayal
is the representative of the dominant shareholder group on BoR’s board of directors. The board also
includes 13 non-executive independent directors out of which 4 directors have been appointed by
Reserve Bank of India.
• BoR has a network of 463 branches, 29 offsite ATMs and 82 onsite ATMs covering 22 states and
2 Union territories across the country. Most of BoR branches are located in northern and western
India and the bank has a strong hold in the state of Rajasthan with a network of 294 branches (~63
% of total branches).
BoR had an asset base of Rs172.2bn with a loan book size of Rs77.8bn. Retail loans constitute
~10.8% of the total loan book. The bank had delivered net profit of Rs1.18bn in FY09 and booked a
loss of Rs100m for 9mFY10. The bank has total deposits base of Rs151.9bn with a CASA ratio of
27.4%.
In Dec-09, declared stake of the Tayals stood at 28%, while as per SEBI Tayals’ stake stood at
55%. Consequently, BoR had recently run into regulatory trouble as SEBI had banned the
promoters and other entities of the controlling Tayal family from dealing in the securities market on
account of incorrect disclosure of promoter’s holding in the bank.
• RBI had also levied a fine of Rs2.5mn on the bank for alleged violation of various norms
pertaining to transactions and misrepresentations of various documents. The regulator had then
www.vccircle.com/.../icici-bank-of-rajasthan-sign-merger-agreement
28
appointed Deloitte Haskins & Sells to conduct a special audit of the bank which has submitted its
interim report.
Mr. K.V. Kamath, CEO of ICICI Limited, has recently voiced the intentions of ICICI Limited
towards banking and ICICI Bank. ICICI Limited is endeavoring to forge a closer relationship with
ICICI bank. ICICI Bank is a focused banking company coping with the changing times of the
banking industry. So it can be a lucrative target for other player in the same line of operations.
However, when merged with ICICI Limited the attraction is reduced manifold considering the
magnitude of operations of the ICICI limited. Secondly, besides credit, a customer may also want
from a bank efficient cash management, advisory services and market research on his product. Thus
the importance of fee based is increasing in comparison with the fund-based income.
The pre--merger status of ICICI Bank is as follows: it had liabilities of Rs.12,073 crore, equity
market capitalization of Rs.2,466 crore and equity volatility of 0.748. Working through options
reasoning, we find that this share price and volatility are consistent with assets worth Rs.13,249
crore with volatility 0.15. Thus, ICICI bank had assets which are 9.7% ahead of liabilities, which is
roughly consistent with the spirit of the Basle Accord, and has leverage of 5.37 times.
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History of ICICI Bank 4
The World bank the Government of India and representatives of Indian industry form ICICI
Limited as a development finance institution to provide medium-term and long-term project
financing to Indian businesses in 1955.
•1999 ICICI becomes the first Indian company and the first bank or financial institution from non-
Japan Asia to list.
•2001 ICICI acquired Bank of Madura (est.1943). Bank of Madurawas aChettiar bank, and had
acquired Chettinad Mercantile Bank (est.1933) and Illanji Bank (established1904) in the1960s.
•2002 The Boards of Directors of ICICI and ICICI Bank approve the merger of ICICI, ICICI
Personal Financial Services Limited and ICICI Capital Services Limited, with ICICI Bank. After
receiving all necessary regulatory approvals, ICICI integrates the group's financing and banking
operations, both wholesale and retail, into a single.
ICICI Bank has announced swap ratio of 1:4.72 for certain shareholders for the bank. The ratio
imputes a BoR’s valuation at ~Rs30.4bn – 4.8x estimated book value as of Dec-10. It was expected
the merger to be value accretive for ICICI Bank in the medium term. With respect to balance sheet
size, BoR is significantly smaller than ICICI Bank (of 5%). Consequently, it was not expected that
material impact on asset profile of ICICI Bank. However, BoR’s branch network at 463 branches
stands at 25% of ICICI Bank’s current network. Access to this large, underutilized branch network
with concentration in the CASA-rich northern region is a key positive for ICICI Bank. An
opportunity for significant value creation as ICICI Bank leverages BoR’s branch network by
improving productivity levels (cost to income ratio at 62% for 9mFY10 against 37.6% for ICICI
Bank for FY10).
4
www.icicibank.com
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On the other hand, given the widely-known issues regarding corporate governance at BoR, we
await clarity on BoR’s asset quality (Gross NPAs at 2.84% as of Q3FY10). However, it was not
expected losses, if any, to be material in nature for ICICI Bank.
5
bor-icici-bank-merger-raj-bank-pays-the-cost-of-poor-governance
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Value base on 24.5.2010 Rs. 19670 Rs. 20800
Merger benefit Bank survives, future growth Business expansion in north
potential , beneficial to all India, long term shareholders
stakeholders value
• The merger of ICICI Bank and BoR will augment the network of the combined entity to 2,463
(25% increase in ICICI Bank’s present branch network) further consolidating its position as largest
private sector bank by branches.
• The access to such a large and wide branch network augurs well for ICICI Bank as it enters a
growth phase in FY11.
• While BoR has pan-India presence, its network is significantly stronger in the northern states like
Rajasthan, Punjab, Haryana and Delhi (73% of total branches in these states). We expect the merger
to strengthen ICICI Bank’s presence in these areas.
• BoR’s balance sheet is significantly small with respect to ICICI Bank (5% of total assets).
• Consequently, had insignificant impact of this merger on overall advances profile of ICICI Bank.
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• BoR has 463 branches, which is significant for the present balance sheet size of the bank.
However, there is significant scope for improvement in utilization of the branch network, as branch/
employee productivity is still way below that for the peer group. So had huge opportunity for
productivity improvement for BoR, which would be a medium term positive for ICICI Bank.
• Additionally, ICICI Bank and BoR have implemented the same software platforms, which was
believed would enable smoother integration with limited investments in infrastructure.
BoR’s asset quality has remained relatively healthy over 9mFY10 with Gross NPAs increasing
by Rs714m in absolute terms (0.9% of advances). It was believed that this increase is a reflection of
the phenomenon witnessed across the industry in the aftermath of the downturn and not specifically
a reflection of bank’s credit quality.
• Going forward, with revival in the economic environment, asset quality concerns are likely to
recede.
Given the regulatory hurdles, lack of access to growth capital (Tier-I at 6.19% as of Mar-09) had
constrained BoR’s growth trajectory in FY10 (5% advances growth over 9mFY10) and had resulted
into to an underleveraged franchise.
The merger provides ICICI Bank a lucrative opportunity to eke out productivity gains and create
value over the medium term. Announced swap ratio imputes BoR’s valuation at ~Rs30.4bn (4.8x
book value as of Dec-10), translating into aper share price of ~Rs188.3 – a premium of ~89% over
the CMP. An attempt to value the CASA franchise of BoR offers a plausible explanation for the
valuations offered by ICICI Bank. Assuming a nominal growth in CASA deposits (in line with
GDP growth), the interest gains made by ICICI Bank would result into a PV of ~Rs26-33bn, which
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amounts to over 85% of BoR’s valuation. Moreover, creation of such a wide branch network (with
a CASA/branch of ~Rs91m) would have consumed significant time and management bandwidth.
ICICI Bank's 2QFY11 PAT grew 19% YoY to Rs12.4b (v/s our estimate of Rs11.6b). Adjusted for
the merger impact, NII and PAT growth would be 3-4% higher than our estimates. Reported NII
grew 11% QoQ to Rs22b. There were no negative shocks on asset quality post merger of the
erstwhile BoR. Key highlights:
Loans were up 5.3% QoQ and 1.8% YoY at Rs1.9t; adjusted for the merger, growth was
1.8% QoQ.
Margins improved 10bp QoQ to 2.6%; domestic margins improved 20bp QoQ to
3% while margins on international business remained stable at 0.8%.
CASA grew 34.5% YoY to Rs981b (adjusted growth of 33.9% YoY). While SA
deposits grew 28% YoY (12% QoQ), CA deposits grew 48% YoY (24% QoQ). On
an average daily basis, CASA ratio stood at 39% for 2QFY11.
Fee income grew 14.6% YoY driven by higher income from the corporate and
international segments, which grew 20%+. Management expects fee income growth to be
in line with asset growth.
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Credit cost was down to 1.35% v/s 1.75% in 1QFY11. Provisions charge was Rs6.4b, of
which Rs4b was used for improving coverage ratio to 70%. With PCR at 69% and asset
quality improving, NPA provisions should decline.
Valuation and view: Up gradation in earnings estimates by 4% for FY11/12 to factor in BoR
merger and lower credit cost. Adjusted for the Rs258/share value of subsidiaries, the stock trades at
2.2x FY12E ABV and 15.6x FY12E EPS. We expect ICICI Bank to report core RoE of ~14% by
FY12, with tier-I capital strong at 12%.
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No negative shocks from merger of Bank of Rajasthan
During the quarter, BoR was merged with ICICI Bank and the reported results include the impact
of the merger for a period of 49 days. While there was skepticism about quality of assets acquired
from BoR, the merger accounting does not reflect any negative surprise. Adjustments were made in
Sterms of provisions for employee benefits, move to 70% provision cover on NPAs and deferred
tax asset reversal in e-BoR books prior to merger.
Fee income growth picks up; C/I ratio target remains intact at 40%
Fee income grew 14.6% YoY, driven by higher income from the corporate and international
segments, which grew 20%+. The management believes that fee income growth going ahead
would be in line with the asset growth. Trading loss stood at Rs1.4b v/s a profit of Rs1b a quarter
ago and Rs3b a year ago.
Operating expenses increased 6% QoQ to Rs6.2b. Going ahead, management expects opex to
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increase in absolute terms to reflect the full impact of branch addition over the last two quarters
and merger related expenses. However, as a part of its '5C strategy' it expects to contain the cost
to income (C/I) ratio at the current levels of ~40%. We believe the bank's focus of cutting excess
operating cost has already yielded the desired results; for the next phase growth, investment in
people and brand building is a must. With pick up in loan growth, other operating expenses are
also likely to rise; we model in 20% opex growth over FY10-12.
Gross NPA increases QoQ (merger impact), credit cost declines, PCR reaches 69%
Reported gross NPAs increased 3% QoQ to Rs102b (retail GNPAs of Rs68b). During the
quarter, net additions to gross NPAs were on account of merger with BoR. In terms of ICICI
Bank's books, net addition to GNPAs was almost nil. During the quarter, the bank has written off
assets worth Rs1.3b. Credit cost was down to 1.35% v/s 1.75% in 1QFY11. With PCR at 69%
and asset quality on an improving trend, NPA provisions will decline going ahead. (RBI has
allowed ICICI to raise its PCR to 70% by 4QFY11). Management is targeting to lower credit cost
to 1% and expects it to stabilize at those levels, thereafter. Provisions charge during the quarter
stood at Rs6.4b, of which Rs4b was used for improving coverage ratio to 70%. Restructured assets
showed sharp improvement, with outstanding assets declining to Rs26b (1.1% of the customer
assets) compared to Rs37b (1.7% of the customer assets) at the end of 1QFY11.
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Adequately capitalized, tier-I ratio at 13.8%
ICICI Bank's capitalization remains one of the best in the industry, with tier-I ratio at
13.8%; as loan growth is likely to remain at 16%+ and earnings momentum should be strong
(~28% CAGR over FY11-12), we expect the bank to maintain its superior tier-I ratio (12%+ in
FY12).
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CONCLUSION
From the above study it is concluded that, ICICI bnak and bank of rajasthan has shown significant
difference in the shareholders‘ wealth before merger and after merger. In other words, shareholders‘
wealth has been appreciated corresponding to merger. For shareholders, it is believed that the
merged entity would provide value to shareholders in medium to long run.So far as share exchange
(swap ratio) is concerned, the present shareholders of BOR tend to gain in money terms considering
the present price or even the price on the date of announcement in the board meetings of two banks.
The share price of BOR has been jumping by 20 percent since then and even then at present prices,
it gives a monetary gain.
For ICICI bank, the benefits will start accruing immediately as there is going to be no cash outflow
(only share exchange will take place) and benefits from operational performance will be immediate
adding to top line as well as bottom-line. Since BOR now also operates on modern technology,
some capital expenditure on information technology may be required to align it with that of ICICI.
The customers of BOR may now enjoy would class personal banking experience, but of course, at a
cost. While ‘personal touch’ of BOR may be missing, one can then feel ‘professional touch’ in
banking relationships. ICICI lays emphasis on personal banking relationships where as customer
loyalty has been a USP of Bank of Rajasthan. Those loyalties will have to be tested now. Those
customers who are averse to dealing with private banks may shift to other public sector banks, and
in this back drop, bank like state bank of Bikaner and Jaipur may have an edge, given its size and
presence in the state of Rajasthan. The fixed deposits may also witness some shift. Undoubtedly,
customers will have rich choice of innovative as well as customized products and corporate
customers shall immensely gain out of such products adding to their efficient cash management.
BOR has considerable business of state government corporations and bodies (eg, roadways, JDA,
University, RIICO etc). While ICICI would benefit out of this, a question may arise in these
corporations to continue banking relations with a new generation private bank or switch over to any
other public sector bank.
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The most sensitive part of this merger would be handling of human relations. The employees of
BOR will resist such a merger for obvious reasons as it makes them in secure, fragile and brings in
fear of relocation, branch closure and rationalization besides discrimination in treatment, positions,
packages etc. The most challenging task before BOR employees would be to adjust to new target
oriented professional work culture where performance is rewarded and every team member has to
contribute in tangible terms to organizational growth. Those who are able to change would survive
and also rediscover their talent and those who won’t would find such merger really difficult to cope
with. The writing is on the wall and this change (merger) seems to be inevitable. The softer part of
the merger is not yet out but it would be desirable for ICICI Bank to value the BOR’s brand as well
as human resource when the final valuation exercise is done and finally approved by the
shareholders of both banks.
Given the market value of immovable properties and other assets (brand, goodwill) it is a win-win
situation for both the banks- a value buying for ICICI and a graceful face saving for Bank of
Rajasthan. However, a seven decade old bank would loose its identity and name for ever- the cost it
paid for the governance. The BOR- ICICI merger is perhaps a live example of what poor corporate
governance can cost to the organization.
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BIBILOGRAPHY
Allen, D. and Boobal, B. (2002), "The Role of Post-crisis Bank Mergers in Enhancing
Efficiency Gains to the Public in the Context of a Developing Economy: available at
http://www.mssa nz.org.au/modsim05/papers/allen-2pdf.
Avkiran, N. K. (1999), "The Evidence on Efficiency Gains: The Role of Mergers and the
Benefits to the Public," Journal of Banking and Finance, 23, pp. 1013.
Berger, A. N., Demsetz, R. S. and Strahan, P. E. (1999), "The Consolidation of the
Financial Service Industry: Causes, Consequences and Implications for the Future" Journal
of Banking and Finance, 23 (2-4), pp. 135-94.
Chatterjee, G. (1997), "Scale Economies in Banking--Indian Experience in Deregulated
Era", Reserve Bank of India Occasional Papers, Vol. 18: No. 1, pp. 37-59.
Denizer C. A., Dine M., Tarimcilar M. (2007), "Financial Liberalization and Banking
Efficiency: Evidence from Turkey Analysis," Journal of Productivity, Vol. 27, pp. 177-195.
Websites:-
www.icicibank.com
www.bankofrajasthan.com/
http:// www.google.com
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