Mergers in Indian

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MERGERS IN INDIANBANKING SECTOR MOTIVES AND BENEFITS]BY AKHIL BHANElectronic copy available at: http://ssrn.com/abstract=1467813

MERGERS IN INDIAN BANKING SECTOR MOTIVES AND BENEFITSAkhil BhanPage 2Table of Contents

Abstract..................................................................................................................... 4Introduction............................................................................................................... 4The Indian Banking System....................................................................................... 6Catalysis Initiating the Merger................................................................................... 8Reforms of 1991.................................................................................................... 8

Increasing Competition and Efficiency.................................................................. 9Stability............................................................................................................... 10Regulatory Requirement...................................................................................... 10Risk..................................................................................................................... 11Benefits of Consolidation........................................................................................ 12Consolidation in Global Banking sector................................................................... 13Methodology........................................................................................................... 16Data........................................................................................................................ 18Discussion and Analysis.......................................................................................... 20Centurion Bank and Bank of Punjab Deal............................................................ 20Centurion Bank and Lord Krishna Bank.............................................................. 21

ICICI Bank and Bank of Madura Limited............................................................ 21ICICI Bank and Sangli Bank............................................................................... 22MERGERS IN INDIAN BANKING SECTOR MOTIVES AND BENEFITSAkhil BhanPage 3

HDFC and Times Bank....................................................................................... 23Oriental Bank of Commerce and Global Trust Bank............................................ 23Federal Bank and Ganesh Bank of Kurundwad Ltd.............................................. 24Bank of Baroda and Benares State Bank Ltd........................................................ 24Conclusion.............................................................................................................. 28Annexure................................................................................................................. 29MERGERS IN INDIAN BANKING SECTOR MOTIVES AND BENEFITSAkhil BhanPage 4Abstract


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This paper gives you an insight into the motives and benefits of the mergers in Indian banking sector .This is done by examining the eight merger deals of the banks in Indiaduring the period of reforms from 1999 to 2006 .This paper also uses the empiricalmethods T-test to study the short term change in the returns of the banks due the merger and EVA (Economic Value added) method to study the efficiencies or benefits achieved

due to the merger .Through this paper and the sample taken for analysis it has beenconcluded that the mergers in the banking sector in the post reform period possessedconsiderable gains which was justified by the EVA of the banks in the post merger period.Key Words: Merger, Banking, Indian, EVA, Motives, BenefitsIntroduction

Bank in general terminology is referred to as an financial institute or a corporation whichis authorised by the state or central government to deal with money by acceptingdeposits, giving out loan and investing in securities . Bank word has been coined from theItalian word Banca which means a bench. The European money leader used to display

their coins for the customer on the benches and from there came the definition of a bank.In the present scenario Indian Banking sector has close to three quarters of the countriesfinancial assets and the banks have been growing at the rate of around 18 %.(All e n, R aje s h, De , 2007)

Indian banking sector can be divided into two important era the pre liberalisation eraand post liberalisation era since 1991.This sector has seen a tremendous amount of change in the post liberalisation era. In the recent times this sector has been undergoing alot of changes in terms of regulations and effects of globalisation .These changes haveaffected this sector both structurally and strategically. With the changing environmentmany different strategies have been adopted by this sector to remain efficient and to surgeahead in the global arena. One such strategy is through the process of consolidation viamerger and acquisition.MERGERS IN INDIAN BANKING SECTOR MOTIVES AND BENEFITSAkhil BhanPage 5

With the changing times Indian banking system is moving from a system with largenumber of small banks to a system where in there are small number of large banks. Thischanging market drives the mergers which have been part of the history process of change in the developed economies but in the emerging economies this concept isgaining pace in the recent times. For every change to accelerate some initiator isnecessary and for the Indian banking system economic policy liberalization, privatization,deregulation and other market reforms have acted as the catalysts. According to Mr. D.K.Mukerjee, managing director, IDBI Bank The new generation private sector banks aregoing through a critical phase of financial reformation.1

The Indian government and Reserve bank of India has been in favour of these mergerstaking place in the Indian Financial sector. Every merger wave has its own reasons and


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these reasons are closely related to the localised environment. The reasons for theconsolidation of banking sector in Europe may not be same as that of India or that of Japan .Each has its own localised factors which play a big role in this consolidation.

This paper has been written with this purpose in mind to understand these localised

factors. This merger wave which we see in the Indian banking sector in the present timesis the first merger wave and not much has been written about it. The banking industrywhose main function was only taking deposits and lending money has moved a long waywith banks today offering a large variety services such as Bank-assurance, remittancesand securities trading. To keep pace with the changing times and to remain competitive inthe global arena banks need to change in form and structure. With the lack of time athand the preferred route is inorganic growth and hence mergers and acquisitions for consolidation.

In the subsequent paragraphs of literature review we will focus of Indian BankingSystem, the catalysts which are initiating these mergers and motives behind these

mergers, the benefits of this consolidation, main deals which have taken place in the present days, consolidation in global banking sector and future of Indian banking sector.1 Indian express Newspaper ArticleMERGERS IN INDIAN BANKING SECTOR MOTIVES AND BENEFITSAkhil BhanPage 6The Indian Banking System

At the top of the Indian banking system is the Central bank of India known as ReserveBank of India. The Reserve Bank of India is responsible for the Indian Banking systemsince 1935.The commercial banks in India are segregated into public sector banks,

private banks and foreign banks. All these banks fall under Reserve Bank of India (RBI)classification of Scheduled Commercial Banks (SCBs). PSBs, Private and Foreign Banksare known as Scheduled Commercial Banks as they are included in the SecondScheduleof theReserveBank of India

Act, 1934(Gourlay,Ravishankar,Jones,2006). The pubic sector was wholly owned by thegovernment of India before the reforms. The PSBs are the biggest players in the Indian

banking system and they account for 70 % of the assets of SCBs in India.2

Indian banking was highly regulated before the reforms of 1991 .In our discussion wesegment the Indian banking into an era of pre reforms that is before 1991 and post 1991reforms which was the reforms era .During the pre reforms era banks where instructed to


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maintain a high reserve ratio, the interest to be given out by the banks on the deposits andthe interest to be charged on loans was also guided by government. Government hadcreated priority sectors and banks had to lend out money to these priority sectors as per the guidelines which was 40 % of the total credit .This had lead to the growth of the PSBand PSBs accounted for 90.8% of aggregate deposits of SCBs(Gour lay , Rav is hank ar,

J one s, 2006). This was the period of low profitability, increasing number of Non performing assets and operational inefficiencies .In the post reform era, after the reformswere brought out on the recommendations of the Narasimham Committees I and II, theIndian banking sector started to grow leaps and bounds .This was the time of growth of the private banks like ICICI ,Axis Bank ,HDFC bank . It is not that merger did nothappen in the pre reforms era ,they did happen but most of these mergers where directed

by RBI .These were generally the mergers were in a weak bank which was about to goflat on its tummy was taken over by a strong bank on the directions of RBI .There wherearound 55 pre reform era2 Report on Trends and Progress of Banking in India, 2005.A newspaper article of Businessline.

MERGERS IN INDIAN BANKING SECTOR MOTIVES AND BENEFITSAkhil BhanPage 7

mergers .But the underlying motives of the mergers have changed in the present daycontext. The competitive market dynamics are driving the present day mergers .Author will describe in detail about the motives of mergers in the below given paragraphs.Globalisation is showing its impact on the Indian Banking system .Another importantdevelopment which is going to take place is when in 2009 government will open the

banking sector in India .This will bring in large number of foreign player into the sector which will increase the competition.MERGERS IN INDIAN BANKING SECTOR MOTIVES AND BENEFITSAkhil BhanPage 8Catalysis Initiating the Merger

Some working papers argue if the merger wave in the Indian banking sector will continueand are there really any benefits of the merger. In the empirical analysis section we willanalyse the benefits of these mergers if any, using the data of the mergers happening inIndian banking sector in last 8 years .The argument given in these working paper is thatthe Indian banking system is under- banked. Some paper also argue that instead of consolidation we need expansion .Still in rural India 50 % of the people do not have

banks3. But these all arguments can be countered by following argument .In the paper present by P.L Beena in 2004 clearly shows the present trend of mergers in the Indiancorporate sector since the reforms of 1991.Mergers have been on a increase and theyhave really benefited the organisations . For any substantial change to occur there has to

be the effect of some catalysts which play a big role .Same has been the case of theIndian Banking sector. Adaptability of the system to change is the only way of survival.


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Reforms of 1991

The banking reforms which where taken in 1991 where mainly done to make the bankingsector more competitive and fundamentally sound. These reforms also required that theIndian banking system should be in line with the international standards.

Due to the reforms of 1991 , there was a big surge in the number of private banksentering into the Indian banking sector and due to this there has been drop in the spreadearned by the pubic banks .Over the period of time the banks tried to sustain their growth

by expanding in various segments but now things have become so competitive thatconsolidation is the way forward .There is a clear indication that the forces of competition are playing into the Indian banking sector as well .To safe guard themselvesand to remain in the market the banks have started to capture their emergingcompetitors .And this has started the first merger wave in the banking industry in India.3 Are Bank Mergers in India Entering a New Era?- Article published by IndianKnowledge at

WhartonMERGERS IN INDIAN BANKING SECTOR MOTIVES AND BENEFITSAkhil BhanPage 9Increasing Competition and Efficiency

Currently, India has 88 scheduled commercial banks (SCBs) - 28 public sector banks, 29 private banks and 31 foreign banks. They have a combined network of over 53,000 branches and 17,000 ATMs4. To remain competitive in such a market space the banksneeded to go to the basics of profitability which is increase in the revenue and decrease inthe cost. There are two hypotheses regarding the competitiveness effect due to the

banking consolidation which lead to the increase in revenue and reduction in cost. Thetwo hypotheses are Structure conduct performance paradigm given by Mason (1939)and Bain (1956), and other one is efficient structure hypothesis related to Demsetz (1973)and Peltzman (1977). (Carletti, Hartmann, Spagnolo,2002)

A merger has two effects on the industry: First, it the market share of the merged firms isincreased and as the market share increases so does the power; second, it leads to gains inthese efficiency which in turn results in reduction in the costs of the merged firms andincrease in the revenue. The first effect leads increase in prices. As you are the marketleader so it creates a monopoly for you in the market and you can charge high spread for the products from the customer for the services which you provide. Like if a bank isoffering 10 products, after merging with a bank which complements its product range itcan offer many more products to the customer. And for these services it can charge highvalue to the customer. In some cases it can even become the monopoly player and thisleads to increase in revenue and becomes one of the important catalysts in the for themerger .But banks do not merge only with the increase in revenue in mind as the law of the land protects the monopoly state to occur and thus restricts the high growth inrevenue.


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The second effect tends to reduce prices. This is because as the size increases theefficiency of the system also increases. This is the effect of economies of scale. Thenumber of branches can also increase which helps the banks increase their spread .Likefor example the case of the HDFC and Centurion Bank merger .Centurion Bank is strong

with around 390 branches in North and South of India. And HDFC with4ht tp :// www .w ikipedi a.o rg/MERGERS IN INDIAN BANKING SECTOR MOTIVES AND BENEFITSAkhil BhanPage 10

around 11005branches mainly in north and western India will give the new entity a muchwider spread. Also efficiency comes in the system due to wider choice of better suitablehuman resource for the purpose of doing the job. In fact efficiency at all the 3 levels of

people, process and product can be achieved through merger .This lead to decrease in

cost which may be passed to the customer so as to increase the customer base.These standard results in industrial organisation apply of course to banking markets aswell. This is another reason for the merger of the banks.Stability

Indian banking system is highly fragmented. Even Indias largest bank does not have theany standing among the top banks in the world .Only four banks have been able to crossthe market capitalisation of Rs.50 billion including the Bank of Baroda, State of India,ICICI, and HDFC. Moreover the trend has also shown that the top 5 banks have beeneroding in wealth and it is getting spread among other banks which are an indication thatthe stability of the top banks is in question. Even though it may be good to have afragmented banking state for the customers because of low cost due to lack of any one

bank having the monopoly .But for the financial stability of the country it is not good thatits banking system is not stable This is another catalyst for the merger of the banks inIndiaRegulatory Requirement

Indian economy is growing at the rate of 8 10 % to maintain such amount of growthIndian banking system needs Rs. 590 billion6. An obvious way to meet this requirementwould be by industry consolidation.

Basel II which is going to be implemented in all the banks operating in India aims atdetermining the capital requirement based on risk weighted average of the capital of the

bank. As per the Basel II norms banks have to meet the requirements of the capital5 Are Bank Mergers in India Entering a New Era?- Article published by IndianKnowledge atWharton6Banks may need Rs.60,000cr more capital, The Hindu Business Line, 24th October 2005)MERGERS IN INDIAN BANKING SECTOR


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MOTIVES AND BENEFITSAkhil BhanPage 11

for the operational risk as well .As a result of these regulatory requirements the banks

will have to increase their capital base to support their assets and as per the estimates theadditional requirements of capital will be 2-3% of the risk based assets of banks(Unnikrishnan, 2007). Thus, this need to keep the additional capital to meet Basel IInorms and to maintain the needs of the growing economy, consolidation of the banksfor larger credit pool is also one of the catalysts.

The report of Tarapore Committee on Fuller Capital Account Convertibility has drawn a pathway for the bringing the Indian financial sector at par with the global levels andnorms. Also the trade barriers are getting removed under WTO and Indian BankingSystem is going to open up for the global competitors by 2009 .As a result of this lot of foreign banks will enter into Indian markets . When these banks will enter India, to keep

pace with the fast running financial sector in India these banks will try and grow throughinorganic means of merger and acquisition in Indian arena .As a result many Indian bankswhich are weak are going to be soft target of these foreign banks. Also big banks in Indiawill have a stiff competition from these foreign banks and to be prepared for suchcompetition the bigger banks in India will fasten the pace of merger and acquisition inIndian banking sector.Risk

As per the study by Hannan and Pilloff,2006 the merger also helps the banks to reducethe bankruptcy risk if the merger is carried over in a controlled manner . Craig and Santosalso in their research paper have validated that risk gets reduced due to the diversificationin the merger of the banks .This has been validated by the z score test done on default

probability and by stock return volatilityMERGERS IN INDIAN BANKING SECTOR MOTIVES AND BENEFITSAkhil BhanPage 12Benefits of Consolidation

In Business the benefit achieved from the thing is the most important than any thing else.Any bank goes in for the merger or acquisition due the benefits which are associated withit .Many papers talk about the benefits achieved, we will check empirically if the benefitsof the merger in Indian banking sector are really achieved and are they realised over ashort period of time. The details for this are given in the empirical methods section below.We have already talked about the motives of the banks to merger and on the lines of these motives, the benefits achieved by the banks after merger are perceived to be as1. As the single line of business after the merger can be expanded and thus thecost effectiveness is achieved


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2. After the merger the bank will have large number of branches and its visibility will beat more places which will help it to build the brand image. Brand plays a big role inincreasing the revenue of the bank

3. Due to the merger the banks get an access to large amount of capital base which in

effect leads to the greater avenues for the bank to invest money and earn higher rate of return and this increases the bottom line of the banks

4. Also due to the increase in the scale of the deposits the banks can get higher amount of credit at a lower value .The banks credit worth ness also is increased due to the largedeposit size

5. The large amount of fixed cost which is required for collecting the data of thecustomers is rationalised by the increase number of the products sold to the customer

base by the merged entity .Thus the per product fixed cost gets reduced6. Also cross selling of the products to the existing customer base can also help

increase the revenue7. This also helps in the diversifications of the products which help to reduce the risk aswell. This is very well explained in their papers by Boyd ad Runkle (1993) and Hughes,Lang,Mester and Moon(1999)MERGERS IN INDIAN BANKING SECTOR MOTIVES AND BENEFITSAkhil BhanPage 13Consolidation in Global Banking sector

In the global arena the deregulation of the banking sector had a wide impact on the banking sector .This process started in from 1980s in United States .The deregulationresulted in price competition in the banking sector and also dis-intermediation .As a resultof this profit of the banks suffered heavy brunt. They started to look at the avenues toincrease their returns and one of the ways was consolidation. In the global bankingscenario the Merger and Acquisition has been used for cutting costs and increasing therevenue This trend took pace from 1998 onwards when more than fourth of the merger deals involved banks .(The Economist ,1999).

Even thought this trend started in US but now it has spread to other economics of theworld. The reasons for the consolidation in US banking sector were mainly the regulatorychanges which allowed interstate ownership of the banks, this gave the banks an avenueto scale up their branches and reap the benefits of the economies of scale andgeographical diversification. As the legislature allowed the banks to have other investment services as well, this resulted in increased competition and this was also a

prime reason of mergers and acquisition in the US banking sector.

In Japan the reasons of consolidation were driven by technology .The banks wanted toscale up their technology and it did not make sense to buy a very costly technology for


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only a single small operation bank. This drove the banks to consolidation and whichrationalised their purchase of the costly technology .Also this was kind of the safe wallcreation to safe guard themselves from the competition which the foreign banks wouldcreate when they enter into the Japanese markets.

In the European markets the banking sector is highly concentrated and as the result theEuropean banks are doing a lot of cross border Mergers. From the period from 1stJanuary 1996 to 31 Dec 2005 European banks spend around 682bn for M & A activitiesaround the world.7 The European banks are growing in trend of acquiring the banks inWestern Europe .Consolidation is a key word in the banking sector in all economies withsome what varying reasons or motives of consolidation .7 Banking Consolidation Report - PWCMERGERS IN INDIAN BANKING SECTOR MOTIVES AND BENEFITSAkhil BhanPage 14

Future Growth of Indian banking Sector Till now Indian banking sector has remained safeguarded at number of occasions fromthe crisis in the financial markets, be it the 1997 Asian Crisis or be the resent Sub PrimeCrisis where the exposure of the Indian banks as of now seems to be negligible. Indian

banking is entering into a new orbit and it is going to change a lot in the next 3 years.During the period of 5 years from 2000 to 2005 the assets of the banking sector grew by$255 billion and the profits grew to $ 5 billion .It is estimated through the news paper reports that the total profits will be between $ 10 to $12 billion by 2010(Si nha, 2006).After 2009 when the Indian banking system opens for the markets player from across theglobe things are moving and will starting moving even faster in the Indian banking sector .According to the report by Mckinsey there are 3 potential scenarios which will emerge inthe Indian banking sector ,which are :- First a high performance scenario where in theregulatory bodies will not intervene in the working of the banks and leave themindependent .The regulatory body will intervene only when it has to safeguard theinterests of the customers and maintain the stability of the system .Second scenario whichthe paper talks about which may evolve is that it will be pro market but it will also be alittle cautious in working for reforms . In this market driven scenario the success of themanagement of the banks will depend on the upgrading capabilities of the bank whichmatch the market dynamics , Growth and expansion through Merger and acquisition anddeveloping business models to tap the untapped markets8.This will be the evolution

phase and the sector will emerge as an important driver of economy and wealth by2010.After the opening up of Indian banking sector in 2009 the foreign backs will catch

pace with the fast growing markets in India and will lead the merger wave .The thirdscenario which may occur is the stage of stagnation where in policy maker will employlot of restrictive conditions on the banks and the consolidation activity instead of beingdriven by market condition will be restrictive .This will impede the growth of the banks .


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The best scenario to occur is the market driven banking sector growth under the watchfuleyes of the regulators .By watchful eye of the regulators the author of this paper meansthat the managed consolidation and not letting it in the hands of market8 Indian Banking 2010 by MckinseyMERGERS IN INDIAN BANKING SECTOR

MOTIVES AND BENEFITSAkhil BhanPage 15

players completely .As the Indian economy still needs to develop ,the banks should leadthe way in the development .The Pubic sector banks should to some extend support thedevelopment and growth of the rural sector in Indian and to bring them on level playingground with the private banks or foreign banks some initiatives should be brought aboutto maintain their profitability . It is universally acknowledged that the key drivers of the

banking sector in the future will be competition, consolidation and convergence9.9 Budget Speech of Mr. P.C. Chidambaram,

MERGERS IN INDIAN BANKING SECTOR MOTIVES AND BENEFITSAkhil BhanPage 16Methodology

After doing the literature review and understanding the motives of the merger of banks inIndia and benefits achieved there by. The author of this paper validates with help of thedata if the benefits of the merger are there in the Indian banking sector .For this author has chosen the time period from 1999 to 2006 .The data for 8 significant deals whichhave happened during this period has been collected as the time series data. In all thedeals which have been selected between the banks a caution has been taken so that onlythose deal are selected for which only 2 banks are involved in the merger. After collection of data various empirical methods have been applied on the data to validate or refute the arguments stated in the literature review section and then giving the conclusionon the basis of the observed results .The data required for the analysis is:

1. Returns of the stock of the banks2. Expected Rate of return for the stock 3. Cumulative abnormal return

Returns of the stock have been calculated by comparing the closing stock price on the tday (Day zero) to the closing stock price of the stock on t-1 day. The expected rate of thereturn is calculated using the using the capital asset pricing model.The expected return is calculated as follows:Expected return = + * RM

+ : these are aspects which are related to a individual stock,RM return of market alpha is an intercept of minimum rate of return.


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is a beta which implies the systematic risk of a stock. & are calculated by running a linear regression and then we calculatethe Abnormal returnsAbnormal Return = Actual stock Expected Return on Stock

After we run a T-TEST at confidence level of 95% to verify if there is any significantchange in the CAR calculated.It is this which will indicate the effect of the merger. Alsoanother test which has been applied to check the financial performance of the


banks is the EVA method .Economic Value Added is a measure of the financial performance of the banks .EVA method is the invention of the Stern Steward and Co

which was launched in 1989.How do we calculate the EVA?EVA is a methodology which links the finance to the competitive strategy framework.It is also an indicator of the value which is created in the stocks of the company.EVA = Net operating profit of the company (NOPAT) (Cost of the capital * Totalcapital employed)

This formula will give us a positive or a negative EVA number. Positive EVA number means that the company is going to create value for its shareholders and negative EVAnumber means that it is destroying the value of the shareholder .The concept it is buildupon is that till the time the business does not give out profits which are more that thecost of the capital till that time business is not profitably and it is making losses. We firstcalculate the NOPAT which has been calculated as

NOPAT = EBIT * (1- tax rate)Cost of the capital has been calculated as WACC which is weighted averagecost of capital. This is the weighted sum of the cost of debt and cost of equity.Total Capital Employed has been calculated as the total debt and total equity.MERGERS IN INDIAN BANKING SECTOR MOTIVES AND BENEFITSAkhil BhanPage 18Data

This paper till now talks about the merger and its benefits in Indian context .To check how many mergers have been profitable to the banks in India the paper has short listed 8deals which have happened in the Indian banking sector from the period 1999 to 2006.The deals which have happened in 2007 have not been included because it would not be


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possible to study the effect of merger due to the less number of time periods availableafter 2006 .that is post merger years. Also only deals where only two banks have beeninvolved have been selected.Target NameAcquirer Name

PaymentTypeDateBANK OF PUNJAB LIMITEDCENTURION BANK OF PUNJABLTDStock

20-06-2005BANK OF MADURALIMITED

ICICI BANK LTDStock 11-12-2000LORD KRISHNA BANK LTDCENTURION BANK OF PUNJABLTDStock 04-09-2006SANGLI BANK LTDICICI BANK LTDStock 09-12-2006TIMES BANK LTDHDFC BANK LIMITEDStock 26-11-1999GANESH BANK OFKURUNDWAD LTDFEDERAL BANK LTDUndisclosed 25-01-2006GLOBAL TRUST BANK ORIENTAL BANK OFCOMMERCEUndisclosed 26-07-2004BENARES STATE BANK LTDBANK OF BORODAUndisclosed 24-01-2002


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After selecting the deals we applied two empirical methods on it. To study the short termimpact we applied the t-test and for long term impact we applied EVA (Economic valueadded method).T-Test

To study the T-Test on the data we selected a time series data of the closing prices of thestock from 1999 to 2007 and then found the return of these stocks. We found theintercept and the slope of these stocks and by applying the CAPM formula we found theexpected return on the stocks. Then this expected return was subtracted from the actualreturn to arrive at the abnormal return .Over the period of 30 days pre and post merger theabnormal returns where found and t-test was applied on these abnormal returns .If thevalue given by the t-test is less than .05 then the hypothesis which isMERGERS IN INDIAN BANKING SECTOR MOTIVES AND BENEFITSAkhil BhanPage 19

that the data sets are similar over the period of study is rejected and we conclude thatthe significant effect of merger is prevalent.

To study the long term effect of merger another indicator is the EVA. We calculated theEVA pre merger, in the year of merger and post merger which gives us the idea of theefficiency of the merger. All the data has been analysed from the acquiring banks

perspective.

EVA gives us a clear understanding of the values which the banks create over a period of time .It connects the theories of Finance with the strategy of competitive markets given

by Michael Porter. For the operations of the banks the EVA is used as a commonmeasure by many banks like Citi Bank, Barclays etc .Many Indian banks also use EVA tocalculate their profits by EVA method like ICICI Bank, HDFC etc which in itself justifiesthe reason of using EVA for our methodology for calculating the profits of the banks.When ever the benefits of the decisions taken by the banks are more than the costinvolved in its structure, it creates the value for the Bank. Most of the strategies of the

banks create value for the bank over a period of some time which may be in distant futureand thus when ever profitability of the banks merger is to be calculated it should be donethrough EVA method. There are two sensitive drives of the value creation in the banks.Firstly how fast the funds are moved and how much of these funds create further valuewhich is more than the cost factor of generating these funds which clearly given by theEVA of the banks Another important thing to be understood in terms of the mergers of the banks is difference between the projects and strategies. For projects it is best tocalculate the NPV or IRR to check for the feasibility of the projects .For strategies oneshould check the EVA and the decision of the merger should be based on the EVAcalculated from estimation of the strategies of the merger.Limitation of ratios

Many accounting fundaments such as Price Earnings ,Return of Equity ,Return of Net,Book Value do not give a clear understanding of the major variables which are the value


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drives .These all ratios are prone to window dressing by the mischievous management.Also these measures use the historical data to arrive at the conclusions .EVA also very

beautifully raises the point of how the shareholders of the bank expect a certain rate of return for taking the risk of investing in the bank MERGERS IN INDIAN BANKING SECTOR

MOTIVES AND BENEFITSAkhil BhanPage 20Discussion and AnalysisCenturion Bank and Bank of Punjab Deal

Bank of Punjab in order to meet the credit requirements sold 15 % of its shares and thisled to a sharp decrease in the stock price of Bank of Punjab .This happened in Feb. 2005.As the basic concept of the merger when ever the companys stock prices drop downdrastically then it becomes the target for a acquisition .In this case finally the Centurion

bank which wanted to expands its arms in northern part of India and more so in the

agricultural belts of Punjab acquired the Bank of Punjab in June,2005 .The combinedentity was known as Centurion bank of Punjab and it had 235 outlets with a customer base of 2.2 million .This deal was perceived by the market as the good deal because of the cost factor and the synergies of merger in terms of geographical expansion .Tomeasure the benefits of this deal we ran the t test on this deal with the time period of t+30 ,t-30 ,t .This was to check the effect of the merger before and after using the CAPMand t-test and to establish that has merger shown any effect over a short period of time.As per t-test which was done on a sample from time period 1999 2007 .The value of t-test for this deal for t+30 ,t-30 is coming out be .96 which is quite high and accepts our hypothesis that the merger has not had a significant effect on the abnormal returns of the

bank pre merger and post merger . Cumulative abnormal returns have also not changedover a period of time interval t + 30 and t-30.This shows that over a short period of timemerger did not effect the returns .Then we studied effect of merger over a long period of time that is one year .This was done through the method of EVA .The deal took place in2005 so we calculate the economic value added by the merger in the year 2004 ( the year

before the merger ) ,2005 the year of the merger and 2006( the post merger year ) .As per the data observed in Table -1 for the Centurion bank which is acquirer bank had an EVAvalue of negative 50.49. .In the year of the merger its value increase to 154.61 which is aclear indication that the even the news of the merger of the two banks did create anupsurge it its profitability. To see the long term effect of the merger we observed that the1 year post merger the value of EVA was 421.31. This was a tremendous increase in theEconomic value of the bank which had an intermingled effect of merger news with LordKrishna Bank which the bank was going to go through. The positive effects of thismerger was validated even by the stock market with increase in its stock price by 2.1

percent when the news of merger broke out .This is an indication that merger wassuccessful.MERGERS IN INDIAN BANKING SECTOR MOTIVES AND BENEFITSAkhil BhanPage 21


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Centurion Bank and Lord Krishna Bank

The merger between the lord Krishna bank and Centurion bank was more of a RBI drivenmerger to safe guard the interests of the depositors .This deal took place finally on 04-09-2006. As has been talked about in this paper above that many mergers in Indian banking

scenario also happen due to the managed M & A activity by legislature or more clearlyRBI .In this case as well we studies the effect of the merger on returns by t-test for time period t, t+ 30 and t-30 days where in t stand for the date of the merger. The value whichwe get from the t-test is .305 .As the t-test has been done on 95 % confidence level thisaccepts the hypothesis that the merger did not show any significant effect on the banksreturns.For the significant returns to be shown and to reject the null hypothesis of t-testwe should get the value of .05 or below for the t-test. Also the cumulative abnormalreturns 30 days prior to and post merger did not show any change .This shows that thewithin a short period of 30 days the merger did not show any signs .Also the news of themerger did not create any significant ripples in the market .To understand the effect of thesynergy derived over a long period of time we applied the EVA test on this merger as

well .The EVA for the year before the merger that is 2005 is 154.61 for the year of themerger it is 421.31 which is a very high value .Even though the banks spend the moneyfor the merger and the economic value should have ideally either remained same or marginally increased .But in this case we see a very high value of EVA .This iscontributed due to dual effect .The market had very well accepted the merger with LordKrishna bank and this increased the credit worthiness of the merged entity .But the mainfactor for such an increase in the EVA was the post merger gain with the Bank of Punjabwhich had started to show the effect .This compound effect really pulled the EVA valuehigh for Centurion bank .The Centurion Bank become the 4 th largest bank after the dealsand in the post merger year 2007 its EVA continued to be good and upwards which is anindication that the merger was successfulICICI Bank and Bank of Madura Limited

This deal too place in the month of December 2000 .At that time ICICI bank did not havevery strong holdings in southern part of India .This deal was done to increase the

presence of ICICI in southern India. ICICI bank paid $70 mn min in share swap to buyBank of Madura limited .This deal made ICICI bank 33 percent bigger than HDFC ,itsrival .This deal provided ICICI bank with the synergies that enhanced its brand image,branches and gave it additional 2.6 million customer and 263 branchesMERGERS IN INDIAN BANKING SECTOR MOTIVES AND BENEFITSAkhil BhanPage 22

in southern India. The author of this paper checks the short term gains and to gauge themarket reaction using the t-test over short period .The t test give us a value of .27 whichagain accepts our hypothesis that the merger did not show gains over a short period of 30days pre and post merger and that the abnormal returns where almost similar .Eventhough the value of the t-test is coming out to be .27 which is low and some variation isabnormal returns can be seen but it is not significant enough in term of merger point of


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view. Also the cumulative returns given in the table -3 below shows that the values havenot changed much which is an indication that within short period of 30 days there was noabnormality of returns pre and post merger. But the gains from the merger were high over the long period of time.ICICI Bank and Sangli Bank

The deal between ICICI Bank and Sangli Bank took place in Dec 2006 which is exactly 6years after the deal of ICICI bank with Bank of Madura Limited .Sangli Bank was a nonlisted bank .The deal structure was in the ratio of 1 share of ICICI for 9.25 shares of Sangli Bank .By the market value the deal size was 302 crores .Sangli bank was held 30% by Bhate family of Sangli . On the analysis of the returns of 8 years and applying t test we get a value of .772 which accepts our hypothesis that the merger has did notcreated any change in the returns over a short period of 30 days .The cumulative returnsover a short period of 30 days turned negative from positive value which was pre merger.Details of which can be seen in table -3

To study the effort over the long period of time through the calculation of the EVA for the given deal pre merger , on the year of the merger ,post merger and which is shown intable -1 which is 3191.919 for the pre merger year ,2688.00 for the merger year and5293.31 for the post merger year .This EVA gives us a clear understanding how the valuehas been created for the ICICI by this merger over a long period of time .Synergies fromthis deal have realised over a period of 1 year .During the year of merger the EVA hadgone down due the extra shares which the company had to release and money spend over the deal which had effected the bottom-line of the bank and over the period of the oneyear the economics of scale benefits where realised and the EVA jumped up to5293.31.This was due the inroads which the ICICI could get into the interior of Maharastra state in India through the branches of Sangli bank where had a major customer base in these places. This merger of the Indian bank was also a success and the

benefits talked about in the beginning sections of this paper have been achieved whichhave resulted in adding the economic value for the bank.MERGERS IN INDIAN BANKING SECTOR MOTIVES AND BENEFITSAkhil BhanPage 23HDFC and Times Bank

This was the first deal which took place in the Indian banking sector which was marketled .Total market value of the deal was 5775.75 Million Rs and it was a total stock deal .As this deal was a friendly deal and was market led so the market perceived it to bea very good deal which would benefit HDFC in a big way .On analysis of the data wecheck that the deal has created value and shown the effect of the merger even within theshort period of 30 days .We studied the stock returns from a period 1999-2000 andapplied the t-test on the data to check the abnormal return pre merger and post merger and the value of the t-test came out to be .055 which is indication that the hypothesis isrejected that the pre merger and post merger the abnormal returns have been the same andthus merger has created a significant change in abnormal return .Also t-30 days


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cumulative abnormal return is- 0. 14 46 2 and t+ 30 days the value of the cumulativeabnormal return is0.4 512 92 which is clear indication of the value added due to themerger over a short period of time .The abnormal returns turn out to be from negative to

positive.Oriental Bank of Commerce and Global Trust Bank

This take over of the Global Trust Bank by Oriental Bank of Commerce took place in lastweek of July .Before this the Global trust banks operations where suspended by theCentral bank of India .The GTBs bad loans accounted for about fifty of its 32.7 billionrupees of deposits .This deal was driven by the Central bank .At that time OBC waslooking for merger options with other banks and RBI decided to merger GTB with OBCto safeguard the interests of the depositors. So at that time OBC took this opportunity anddecided to acquire GTB and turn it around in one and a half year .GTB had 103 branchesin southern part of India and has a strong retail products in the market which proved to bea value adds for the synergy of the deal .As stated by the bank authorities that the bank deal will have a impact on the bottom-line of the bank and they will turn around the bank

in the one and a half years time .This was checked by the author of this paper by usingthe t-test over a period of 30 days i.e. t - 30 and t + 30 .The cumulative abnormal returnsturned from 0.159725 ,30 days pre merger, to -0.15102 post merger 30 days .The marketsreaction immediately to the deal was not good and they thought that it will effect the

bottom-line of Oriental Bank of Commerce .On doing a t-test the merger did not showany gains in the short period run .To understand the gain over a long period and to see if the Oriental Bank was able to turn around the bank in the stated period of time and enjoythe benefits of theMERGERS IN INDIAN BANKING SECTOR MOTIVES AND BENEFITSAkhil BhanPage 24

merger author calculated the EVA 1 year before merger ,in the year of merger and 1 year after merger and the values as given in table 1 are 654.42, 618.27 and 850.27 .The EVAof the Oriental bank of commerce is a clear indication that due to the merger its EVA hadsuffered due to the losses of the GTB .But the bank was successful to turn around itsacquired bank GTB with in a short period of time and started to reap the benefits of the

profit made from the merger due to which its EVA increased to 850.27.This is also aclear indication that banks do benefit over a long period of time from merger.Federal Bank and Ganesh Bank of Kurundwad Ltd

This was a small merger in the Indian banking context .The Ganesh Bank of Kurundwadwas a bank of Maharashtra which was under moratorium to safeguard the investorsmoney.So at that time Federal Bank which was a private bank asked the RBI to permitthem to merge Ganesh Bank of Kurundwad with it .Even though Ganesh Bank of Kurundwad had only 32 branches but this was a strategic decision for Federal bank as itgave federal bank in roads into the agricultural belt of Maharashtra.In the short run theFederal Bank did not have any change or gain from the merger as could be seen by the t-test done over t-30 and t + 30 days whos value is coming out to .735 .This suggests that


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the hypothesis is accepted that the bank has not benefited over a short period of time .Tosee the effect of the merger over a long period of time we could see that the merger wasreally very effective .The Federal bank could capitalise on the inroads which it got fromthe Ganesh Bank of Kurundwad in the agricultural sector of Maharastra and its Economicvalue one year prior to merger ,in the year of the merger and post merger was 185.18 ,

259.30 and 406.52. Merger is beneficial if it is sustained and in this case it was sustainedas well .The data shows clearly the benefit of the merger and the value added.Bank of Baroda and Benares State Bank Ltd

This deal between the banks took place in 2002. Benares State Bank Ltd was a bank inUttar Pradesh in India with the 105 branches and 2.35 billion rupees .As at that point of time most banks in India where trying to expand their customer base and there byincrease the consumer banking business. Benares State Bank helped Bank of Baroda inthis aspect.On Analysis of the deal to understand the benefits of merger of these banks author of this paper carried out the t-test which gave a value of .277 which is indication that the


hypothesis has been accepted and the merger has not shown any benefits over a short period of time .On doing a long term analysis of the merger of the bank by calculating theEVA of the banks before the year of merger ,during the year of merger and after the year of merger which can be seen from the table below as 906.92,1181.21,1063.83respectively which is the indication that even though some benefits where achieved dueto the merger process but they could not be sustained as the benefit of the merger seenthrough EVA value has dropped down .TABLE -1ICICI BANK Year

NOPATWACCTotal CapitalEVA20058,576.09 0.036811513146263.23 3191.919200612,137.52 0.041782221226161.07 2688.008200719,468.72 0.04625992206429.48 5293.316Federal Bank Year


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NOPATWACCTotal CapitalEVA2005

778.84 0.03529655916820.96185.11820061061.940.0387893820692.12 259.305520071377.69 0.03858319125170.64 406.5264OBC

Year NOPATWACCTotal CapitalEVA20032546.88 0.05566224233998.86 654.427220042530.81 0.04663968541006.56618.27720052774.290.0355841354069.45 850.2757Centurion Bank Year

NOPATWACCTotal CapitalEVA200498.68 0.407160788366.38 -50.49562005193.32 0.041479367933.17 154.61272006492.24 0.036978665


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1918.11 421.31092007820.33 0.0380692362996.47 706.2567BOB

Year NOPATWACCTotal CapitalEVA20014094.16 0.05033369963322.04 906.927520024622.03 0.04852359170910.07 1181.219

20034766.97 0.04845481276424.58 1063.831MERGERS IN INDIAN BANKING SECTOR MOTIVES AND BENEFITSAkhil BhanPage 26TABLE -2SUMMARY SHEET

FOR ABNORMALRETURNST-30T+30THDFC-0.144620.4512920.076485FEDERAL BANK -0.01892-0.06511-0.01082OBC0.159725-0.151020.014852CBOP + LORD KRISHNA0.16


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-0.06-0.01CBOP + BANK OF PUNJAB0.060.07

0.05ICICI0.098617-0.01545-0.00276ICICI0.2972820.00-0.02085BOB-0.02468

0.204561-0.01087TABLE -3SUMMARY SHEETT-Test ScoreHDFC0.055042036FEDERAL BANK 0.73585137OBC0.12293412CBOP + LORD KRISHNA0.305223594CBOP + BANK OFPUNJAB0.961347473ICICI0.772110838ICICI0.270677601BOB0.277245138TABLE-4SUMMARY SHEET90 DayT-Test ScoreHDFC0.2734273FEDERAL BANK 0.736749455


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OBC0.607327665CBOP + LORD KRISHNA0.720474714CBOP + BANK OF

PUNJAB0.325859037ICICI + Sangli Bank 0.19773643ICICI + Madura Bank 0.728710799BOB0.373697396MERGERS IN INDIAN BANKING SECTOR MOTIVES AND BENEFITSAkhil Bhan

Page 27MERGERS IN INDIAN BANKING SECTOR MOTIVES AND BENEFITSAkhil BhanPage 28Conclusion

This paper has examined the merger deals which have happened in the Indian bankingsector over the period from 1999 to 2006 in the post reforms period .Through this paper we have looked at the various motives and benefits of the merger .Through the empiricalmethods by applying t-test and EVA value calculations the potential of the mergers has

been evaluated. This paper also validates if the mergers have created any value for itsshareholders by checking the value of EVA pre merger and post merger .

Overall with the given sample of mergers in the Indian banking sector , it is clearlyindicated that post reform mergers have been efficient for the merging banks .They havecreate a value for the acquiring banks.Some conclusions which have been arrived under the given sample are:

1. In the Indian banking context the effect of mergers in not seen over a short period of time .Around the time of the merger the market stock price returns pre merger and postmerger do not shown much of the difference so as to conclude a significant effect of themerger

2. Economic value added method is a good method to study the long term effect of theefficiencies of the merger. As the value of the merger lies in its synergies and thesesynergies are not released over a very short period of time but over a considerable periodof time .So EVA gives us a clearer picture of the value which has been added by themerger in the context of Indian banking sector


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Page 37References1. Why Do Banks Merge? By D. Focarelli, F. Panetta and C. Salleo

2. The Economic Impact of Merger Control Legislation by Elena Carletti (Wharton

Financial Institutions Center) , Philipp Hartmann (European Central Bank) and StevenOngena(CentER - Tilburg University)3. Consolidation in Financial Sector (Summary Report) throughhttp://www.imf.org/external/index.htm

4. Motives for Mergers and Acquisitions in the Indian Banking Sector A Note onOpportunities & Imperatives by Jay Mehta (XLRI School of Business, Jamshedpur) andRam Kumar Kakani (S P Jain Center of Management, Singapore Campus)5. India Banking 2010 -Towards a High-performing Sector- Mckinsey Report6. Competition, consolidation and systemic stability in the Indian banking

industry by - S P Talwar 7. Bank Mergers Possibilities and Preparation - Dr. Meera Sharma8. Non-Parametric Analysis of Efficiency Gains from Bank Mergers in Indiaa. Adrian Gourlay, Geetha Ravishankar, Tom Weyman-Jones WP- 2006 -179. Consolidation in Banking and Financial Stability in Europe by UlrichHeimeshoff 10. Ruhr-University of Bochum, Department of Economics11. Banking Sector Developments in India, Ramasastri A.S. and AchammaSamuel12. Reserve Bank of India

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