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Competition from foreign banks: Foreign banks will be soon allowed to spread their business in Indiawhich will create intense competition for Indian banks. The RBI Report on Currency and Finance presentsthe view that mergers are the only way to face competition from foreign banks. High cost of intermediation:Intermediation cost (operating expenses as a proportion of total assets), an indicator of competitiveness, ishigher in India as compared to international levels. High level of fragmentation: There is a high level offragmentation, especially among cooperative banks, as compared to some of the advanced economies ofthe world, which poses a serious threat to their profitability and viability in conducting business. About

1,00,000 entities in the cooperative sector share just 4 percent of the total banking assets in the economy.

Lack of product differentiation: The financial products offered by banks in India are similar across theindustry with no distinctive features, thereby leading to unhealthy competition.

Low penetration: There is an uneven distribution of banking services in the country. It is limited to fewcustomer segments and geographies only. Of the total 611 districts in the country, 375 districts are under-banked. There is a need for banks to open branches at these locations and establish connectivity with thehelp of a core banking solution. According to a report on banking sector consolidation by Ernst & Young, thecountry would require 11,600 branches by 2013 and an additional 20,300 branches by 2018 in order toachieve the desired penetration levels of 74 per cent and 81.5 per cent in 2013 and 2018 respectively.

No competition at international level: Indian banks are not able to compete globally in terms of fundmobilisation, credit disbursal, investment and rendering of financial services. The main reason behind it isthe size of the industry. State Bank of India (SBI), is the worlds 57th largest bank in the list of the top 1,000banks in the world carried in the July 2009 issue of The Banker based on its tier-I capital, or equity andreserves, for the fiscal year ended March 2008. Similarly, in terms of assets, SBI is now the worlds 70thlargest bank. On the other hand, ICICI Bank Ltd, the largest private sector lender has attained the 150thposition. Based on assets, ICICI Banks world ranking is 148th. None of the other Indian banks featuredamong the top 200 banks in the world-in terms of tier-I capital. In 2008, there was only one Indian lender -SBI, at eighth place among the top 25 Asian banks. Industrial and Commercial Bank of China, the biggestAsian bank and the worlds eighth biggest bank, is four times bigger than SBI, both in terms of tier-I capitalas well as assets. Another recent study Report on Currency and Finance released by the RBI reveals thatthe combined assets of the five largest Indian banks - SBI, ICICI Bank, Punjab National Bank, Canara Bankand Bank of Baroda are just about half the asset size of the largest Chinese bank, Bank of China. The bank

is 3.6 times larger than SBI in terms of assets, branches and profits.

Advanced technology: New generation private sector banks and foreign banks are technologically moreadvanced in terms of management information systems, delivery mechanisms, etc. These systems andprocesses require substantial investments which may be possible after consolidation. Cutting-edgetechnology may lead to acceleration of service delivery and broadening of customer relationships.Basel norms: Basel II requires banks to meet tougher and higher capital adequacy norms such as capitalallocation towards operational risk, in addition to credit and market risks. Many Indian banks, especiallypublic sector banks, cooperative banks and regional rural banks are unprepared for this implementation dueto capital inadequacy. According to the report, every category of bank has to arrange additional capital fromits own internal sources. To maintain the 51 per cent minimum government share, PSBs cannot collectadditional capital directly from the public and with this view it promotes bank mergers. Consolidation may bea route for smaller banks to infuse funds to strengthen their capital base.

Cost cutting: Many branches and ATMs of various banks are congregated in the same areas leading topointless outlay on premises, manpower and maintenance facilities. Consolidation may lead to redeploymentand rationalisation of such infrastructure, human resources and other administrative facilities therebyundercutting the cost factor. Consolidation will lead to cost efficiency which will enhance profitability.Enhancement in risk absorption ability: The risk management capabilities of the banks may improve. Largersize improves the risk bearing capacity of a bank and strengthens its balance sheet. Bigger organisationshave inherent advantages and they are too big to fail.

Enlarged customer base: The combined customer base may increase the volume of business. Theenhanced rural branch network may lead to increase in microfinance activities and lending to the agriculturesector. M&A may be a far-sighted conclusion to increase the market share. The time required to expand

inorganically may be less than that of an organic route.

Geographical spread: Banks can diversify the risk of concentrated lending through mergers. They can alsohave a greater market access thereby widening the deposit base. The RBI has imposed strict licensing

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norms for opening of new branches and hence via consolidation, the acquirer will have access to readyphysical infrastructure. Pan-India presence of the combined entity may enhance convenience for thecustomers.

Improvement in operational efficiency: The operational efficiency of banks may improve owing to bigger

size. There may be increase in financial capability greater resource/deposit mobilisation, output and betterpricing of products.

Product diversification: Merger creates the opportunity to cross-sell products and leverage alternativedelivery channels. Old generation banks can merge with the new generation private sector banks and foreignbanks to diversify their credit profile. They can sell technology-based innovative products.

Tax shields: In case of bailout mergers, the accumulated losses and unabsorbed depreciation of theamalgamating bank can be carried forward and set off against the future profits of the amalgamated bank.

ThreatsAlignment of technology: The technology infrastructure, system platforms (Finnacle, Flexcube, etc),

network architecture, database vendors and IT-enabled synergies (customer service, payroll, back officeoperations, risk management, etc) should be compatible in banks desiring to merge. Most of the publicsector banks are at different stages of technology implementation. It would pose a stiff challenge to suchmerging entities to integrate their technology and working platforms. The cost of integrating diverse systemsand processes should be paid due attention. Bancassurance is one of the areas where merging entities may

face problems.

Customer dissatisfaction: The change in the nature and quality of financial products may dissatisfy thecustomers, even if the products are better. In some cases customers may be deterred by the acquiringcompany for various reasons which may affect brand loyalty of the combined entity.

Integration of people: The acquirer bank may have to absorb the entire workforce of the target bank whichmay push up the wage cost. It also requires the integration of the heterogeneous work cultures. The views of

the employees towards various aspects of the new organisation, management styles, training, leadership,etc are to be considered in a critical manner. The varied aspects of the work environment, if not handled

properly, may lead to resentment and shrinkage in productivity.

Marginalisation of small customers: Larger entities may neglect small customers and concentrate on

affluent customers or High Networth Individuals (HNIs).

Regulatory hurdles: Some of the legal barriers need to be removed to make PSBs, which still control about68 per cent of the Indian banking sector, active participants in the consolidation process. It will help realisethe true benefits of consolidation. These hurdles include bringing down the government ownership from thestatutory 51 per cent and amending certain clauses in acts governing these banks to facilitate their merger.On the cooperative banking side too, issues of dual control should be resolved to facilitate a smootherconsolidation exercise.

Rise of monopolistic structures: Mergers are an impediment to perfect competition. They may give rise tomonopolistic structures and lower competition. Monopolistic entities may charge higher fees for servicesrendered in case there is no effective competition. The motive should be to increase the size but not inisolation. Size should be measured in terms of efficiency with which interests of various stakeholders areadequately met. In order to leverage the benefits of bigger size, geographic expansion, huge loan portfolios,improved technology, product diversification and reduced transaction costs, Indian banks are gradually butsurely moving from a cluster of large number of small banks to small number of large banks. Consolidationwill positively amplify the business prospects of the industry in the domestic as well as international marketplace.