CHAPTER 1
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1. Introduction 1.1 Mergers and Acquisitions (Global scenario) Business Combinations are a critical part of the fabric of doing business in a free market economy and are deeply ingrained in the business strategy the world over. Such combinations include mergers, acquisitions acquisitions and other forms of corporate restructuring undertaken both within a country and across international boundaries. The intensity of M&A activity, in US in 1990s was unlike any other year in US history. Following a drop in both the number of transactions and the total dollar volume during the 1990 recession, M&A activity rebounded sharply in 1992. Deals during the nineties were prompted more by strategic considerations and used less debt as compared to 1980s. The financial environment which was quite favorable in terms of vibrant stock markets and relatively low interest rates facilitated the resurgence of M&A activity in US.According to the data furnished by Thomson Thomson Financials, the global M&A activity jumped by 30% in the year 2006 to hit an all time record of $3.7 trillion surpassing the year 2000 high of $3.4 trillion. trillion . The USA which accounted for over 40% global M&A activity was the most targeted country for acquisitions. The UK was the most targeted European country for acquisitions, accounting for cross border and domestic transactions valued at $339 billion.
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In the meantime according to the data released by Dealogic, a deal tracking firm, Europe had overtaken the United States of America (USA) as the most targetd region, accounting for $1.34 trillion or about 40% of the total deal value compared with the USA share of 36%, or $1.22 trillion. This increase in M&A activity in Europe was caused by demographics and economic changes which were the major factors driving M&A activity as an integral part of the overall corporate restructuring activity in Europe according to experts. The cash surplus held by private equity firms (PEs) and public companies, the interest rates which touched their historic lows and the willingness of banks to provide financing were found to be the key factors for the global surge in M&A activity in 2006. The year 2007 was again a record year for global M&A volumes which were estimated at a record figure of around $4.4 billion according to Thomson Financials and $ 4.7 billion according to Dealogic. Volumes in Europe were higher than in the US for the first time in five years and only the second time ever: $1.78 trillion vs. $1.57 trillion according to Thomson Financials.
This has been partially
attributed to the lag in Europe being affected by the credit markets.
1.2 Global Financial Crisis and global M&A outlook for the future The global financial crisis has pushed many countries around the globe into deep recession and has dramatically affected their business plans and outlook the world over. The global economy plunged into
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recession in the latter half of the year 2008. This deepened in the early months of 2009, as global trade contracted sharply, investment was slashed and consumer demand faded. This nine month period coincided with the steepest decline in global economy in the post war era. This period witnessed a combination of severe banking crises in many mature economies like US, the credit squeeze, massive house price corrections and dramatic collapse in fixed investments. While the recession may be easing, as a sequel to the massive fiscal stimulus measures taken by the governments of the countries concerned and world bodies, the recovery is going to be slow and patchy. [The Great Thornton International Business Report (IBR) 2009]. Mike Hughes, global leader-mergers and acquisitions for Grant Thornton International while attributing the large scale reduction in transaction volumes to the tight lending policies exuded optimism that these turbulent times could also provide attractive opportunities to cash rich/well capitalized businesses to register substantial improvement in their growth
by acquiring ailing but fundamentally sound rivals. “The
next 12 months are likely to be a buyer’s market offering opportunities to make strategic acquisitions at attractive valuations” (Mergers and acquisitions release, 2009-Thornton). M&A activities gained traction globally in the fourth quarter of 2009,witnessing a rise in value by 46% to $739.6 billion which was $150 billion higher than any other quarter in 2009(Business Standard,20th March,2010). This has clearly thrown a
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hint at a resurgence of M&A activity in the Year 2010 according to Dealogic. Some key factors for the heightened M&A activity were:
the surplus of cash held by private equity(PE) firms and public companies
interest rates that touched their historic lows and
the keenness of banks to finance M&A deals.
1.3 M&As in the Indian context The
Indian
economy
has
experienced
a
major
structural
transformation following the introduction of economic reforms by the Government of India in 1991. The forces of Liberalization, Privatization and Globalization unleashed by these reforms have brought about a sea change in the traditional Indian business mindset. Indian business leaders started thinking in terms of inorganic growth both within and beyond the borders of the country. In this backdrop, M&A presented a viable alternative for the businesses aspiring to grow quickly and gain the benefits of sustainable competitive advantage by realizing the benefits of scale and scope economies, fast changing technologies for effectively
facing
competition.
rapidly
Many
intensifying
corporates
domestic
embarked
upon
and
international
several
corporate
restructuring activities like M&As, Joint Ventures, Spin-offs and Divestitures. The major industry sectors influenced by the forces of
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consolidation in India, though varied from time to time, were mostly in the realm of infrastructure sectors like cement, power and steel, drugs, telecommunications, media & entertainment and banking. A major change evident after 2002 in the corporate restructuring activity in India is that of Indian companies making forays into developed foreign markets through acquisitions and joint ventures (JVs). During this period India also became an attractive destination for foreign direct investment (FDI) as the inbound acquisitions also gained considerable momentum. Merger and Acquisition activity in India comes under the purview of the various provisions of the Companies Act, Securities Exchange Board of India (SEBI) and Competition Commission Act of India, 2002. In the year 2009,M&A and PE investments in India almost halved both in volume and value terms due to the economic slowdown precipitated by the global financial crisis. According to Grant Thornton’s Deal Tracker report, the total value of M&A and PE deals announced in 2009 stood at $21.20 billion as against $41.54 billion in 2008. PE and qualified institutional placement in the same year was at $11.17 billion ($10.59 billion). The M&A and PE investments in 2007 were of the order of $70.14 billion. There were 488 deals in the year 2009 against over 766 in 2008.Domestic M&A volumes dipped to 142 from 172 in 2008. Outbound M&A was down at 64(196) while inbound M&A to 61(86). Coming to the value of deals, the value of inbound deals dipped by about 75% to $ 3.11 billion from $12.55 billion in 2008, the Russian
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Government’s acquisition of a strategic stake in Sistema Shyam Telecom for $676 million was the largest inbound deal in 2009 while Daichi’s acquisition of Ranbaxy Technologies for $4.5 billion was the largest inbound deal in 2008. The value of outbound deals declined to $1.12 billion ($13.19 billion) in 2009. However, the top two outbound deals in 2008-Tata-Jaguar Land Rover and ONGC-Imperial accounted for almost 40% of the outbound deals. Top deals occurred in the oil and gas sector followed by telecom, pharmaceuticals, healthcare and biotech while in the year 2008 the top deals were spread across various sectors. It may also be noted that in 2008, cash-rich Indian companies like Infosys Technologies made new acquisitions both in India and abroad following a steep drop in the valuations of target companies. According to global M&A(Mergers and Acquisitions) intelligence service, Mergermarket , the overall improvement in economic and business
environment of India has resulted in an impressive (166.5%) jump in the M&A deals (both inbound and outbound being nearly equal in volume terms at around $25 billion) in the year 2010 as against 2009.Telecom sector got the lion’s share with 16 transactions amounting to $19.6 billion while Bharti's acquisition of Zain Africa for $10.7 billion contributed signifcantly to the M&A pie in the year 2010.
1.4 Motives for Mergers and Acquisitions Infrastructure-related
industries
dominated
M&As
in
2008
(accounting for over 45% of the deals in value terms). According to
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Bundeep Singh Rangar, Chairman, Indus View Advisors Ltd, Europe’s fastest-growing Indian M&A firm advising multinational companies on business opportunities emanating from India’s rapidly growing economy, the dominance of this sector in M&As symbolizes the growing need for world class facilities, adoption of globally acceptable best practices, experienced global management expertise & technology applications to accelerate growth in the Indian economy. Grant Thornton (2006) conducted a survey of Indian corporate managers across various sectors. Their findings revealed that M&As continued to be a significant form of business strategy for Indian corporate. The results of the survey are furnished below:
Table 1.1 Objectives of Indian Corporate For M&As
( In percentage) Objective behind the M&A Transaction
To improve revenues and profitability
Responses
33
Faster growth in scale and quicker time to market
28
Acquisition of new technology or competence
22
To eliminate competition and increase market share Tax shields and investment savings
11 3
Any other reason 3 Source: Grant Thornton (India), The M&A and Private Equity Scenario, 2006.
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1.5 Scope of the research study In recent times, the world economy has developed serious difficulties in terms of failure of major banks & financial institutions and declining demand. Future growth prospects became very uncertain exposing major economies to deep recession. However, in the midst of all this gloom and chaos engulfing the world economy, India’s banking sector has been amongst the few to maintain resilience.
A progressively growing balance sheet, faster credit expansion, increasing profitability and productivity similar to banks in developed markets, lower incidence of nonperforming assets(NPAs)(around 2% on an average) and increased emphasis on financial inclusion by the Government of India and RBI have contributed to making Indian banking sector viable, vibrant, and strong. In this backdrop, Indian banks have started to revise their growth strategies and re-evaluate the prospects to keep the economy rolling. The way forward for the Indian banks is to innovate to take advantage of the emerging business opportunities besides ensuring continuous assessment and effective management of risks in the light of Basel norms on Banking Supervision. Against this backdrop, Indian banking sector has been selected as the theme of the research study on Mergers and Acquisitions (M&As) in the Indian context.
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1.6 M&As in the Indian Banking Sector During the last two decades, the Indian banking sector has undergone a metamorphic change following the economic reform process initiated by the Government of India. The forces of globalization, deregulation and liberalization unleashed by the
economic
reforms, set in motion in
1991, have transformed the face of the Indian financial services sector landscape , including that of the Indian banking sector in a big way. There has been a paradigm shift from a regulated to a deregulated environment. Earlier, the banking industry was largely a nationalized industry (since 1969). The larger developments in the economies across the globe, the economic crisis in 1991 &
more recently the sub-prime
crisis and the changing outlook of the policy makers in India have forced the pace of change of the Indian banking industry. The economic liberalization and deregulation measures intiated in the 1990s have opened up the doors to foreign competition and made the markets more efficient and competitive. Continuous innovation and keeping pace with technological change have become a must
for survival of the firms in
the financial services industry including the banking sector. The developments in the Indian banking sector have witnessed
quite a few
mergers and acquisitions (M&As). The banking sector in India has made remarkable progress since the economic reforms in 1991.The entire financial sector - the banking
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sector in particular is of fundamental importance to a developing economy. The Narasimham Committee report in August 1991 highlighted the need for financial sector reforms and fostering competitive spirit in the Indian banking sector. The report also suggested a roadmap to achieve this objective. The central theme of the reforms was straight forward: providing the much needed platform to the Indian banks to operate from a vantage point on the basis of operational flexibility and functional autonomy, thereby improving efficiency, productivity and profitability. The Government did not accept all the recommendations due
to
political
compulsions
and
the
practical
difficulties
in
implementation. In 1997, a second committee was set up (under M. Narasimham) to specifically suggest further measures for banking sector reforms. The second Narasimham committee, in its report submitted in April, 1998 had suggested, inter alia mergers among strong banks, both in the public and private sectors. Since the onset of reforms in 1990, according to the RBI report, 22 bank amalgamations, have taken place in India (up to 2007). While, the amalgamations of Indian banks were mostly driven by weak financials as reflected in the continuously deteriorating balance sheets of the merging entities prior to the year 1999, in the post-1999 period there have been mergers between healthy banks prompted by business and commercial considerations. The mergers of the largest commercial bank of India, SBI with State Bank of Saurashtra and State
11
Bank of Indore (in progress) are the latest among such mergers. A table depicting the size and net profits of major public sector banks of India as at the end of March, 2009 is furnished below.
Table1.2 Size of Public sector Banks in India: March 2009 Name of the Bank
Total Business Net Profit (Rs. (Rs. in crores) in crores)
State Bank of India 642288 9121 Punjab National Bank 364463 3091 Canara Bank 336383 2072 Bank of India 334440 3007 Bank of Baroda 325112 2227 Union Bank 236968 1727 Central Bank 218012 571 Syndicate Bank 198380 913 Indian Overseas Bank 175925 1326 UCO Bank 169880 558 Oriental Bank of Commerce 167434 905 Allahabad bank 144415 769 Indian Bank 124413 1245 Corporation Bank 122496 893 Andhra Bank 103818 656 United Bank of India 90563 185 Vijaya Bank 90410 262 Bank Of Maharashtra 87072 375 Dena Bank 72235 422 Punjab and Sind Bank 59590 437 Source: Statistical Tables Relating to Banks in India: March, 2009, RBI
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1.7 Need for the study The main motivation for the study is the sustained effort made by the Government
of
India
and
the
Reserve
Bank
of
India
towards
consolidating the Indian Baking sector, especially in the postliberalization period of the Indian economy. In this context, while the Government of India and the RBI argue that (in the words of
Mr.
Chidambaram, former finance minister) consolidation of the banking sector would result in economies of scale and help the Indian banks acquire the much needed critical mass to compete effectively in the global arena, the present level of research does not clearly bring out the benefits of consolidation, particularly in the banking sector. The study makes an attempt to examine the effectiveness of this consolidation exercise of the RBI to enhance the competitiveness of the Indian Banking industry employing a ratio based approach in the f irst phase. It also makes a few suggestions which might enable the policy makers to sharpen their thinking in the area and help them in adopting a more rigorous and critical approach to bank consolidation, which is necessarily a timeconsuming and complex process. The vital importance of an efficient banking system in the long term growth strategy of a fast developing economy like India can hardly be overemphasized. Research studies of this nature are crucial for the policy makers, business and industry leaders and even the ever growing investing public who are keen to know the strengths and weaknesses of
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the banking system of the country. The analysis of bank efficiency is significant
from
both
the
microeconomic
and
macroeconomic
perspectives (Berger and Humphrey, 1997).The issue is crucial from microeconomic perspective because of the emerging competitive business scenario and the steps taken by the government and the Reserve Bank of India (RBI) to liberalize the banking system. From the macroeconomic perspective the issue gains crucial importance in the context of the overarching influence that efficiency exercises on the cost structure of the banking system and the overall growth, vibrancy and stability of the financial markets. The motivation for the study stems from the crucial role of M&As in shaping the restructuring process of the Indian banking sector in future. Quite a few studies conducted to evaluate the impact of bank mergers have adopted either accounting based or market based approaches, with each one having its own strengths and shortcomings. The results of event studies seem to depend substantially on technical details such as the length of the event window selected. Further meaningful price data exist only for those banks whose shares are actively,publicly traded (Amihud et al, 1998). The bottom line of accounting studies is that there is no clear relation, on average, between acquisitions and subsequent accounting
performance.
One
plausible
explanation
is
that
the
accounting data are too noisy to isolate the effects of acquisition. This is because of the transformation the accounts of the merging entities
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undergo during the merger (like restatements, special amortization and depreciation, merger related costs etc) (Kaplan, 2006). While the period of study in many research studies
conducted to evaluate
banking
efficiency, especially in the context of bank mergers is relatively short, the present study
covers a fairly long period over which a sizeable
number of bank mergers (in India )
have taken place. The present
study therefore addresses a critical gap in the literature by providing recent evidence on the bank merger efficiency in the Indian context. Secondly, in order to evaluate the effectiveness of the commercial bank mergers in India, it is necessary to undertake a formal analysis. This study thus makes an attempt to provide empirical evidence on the efficiency changes of select Indian commercial banks over a period from 1995 to 2009 using the non-parametric Data Envelopment Analysis (DEA) methodology, as the second phase of this research effort. Employing this methodology, the overall, pure technical and scale efficiencies & cost and profit efficiencies of the twenty seven sample banks (both public and private sector) have been measured. The impact of mergers on efficiency changes has been investigated by comparing average relative efficiency scores three years before and three years after the merger. Further, the study employs the Tobit regression technique, which is a generally accepted methodology in the literature, to identify the determinants of efficiency of the Indian commercial banks. This technique also captures the long term trends. Tobit regression technique
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to identify the determinants of efficiency of the commercial banking sector in India for a panel data covering a fairly long period has been scarcely employed in the Indian context. The Indian banking sector has undergone massive upheaval in terms of the sophistication and innovation in the product and service mix, technological up gradation, customer reach and sectoral coverage fully exploiting the opportunities which help increasing revenues while optimizing on costs. At the same time, the expectations of the consumers of banking services have increased many fold. The entry of private and foreign banks has changed the competitive landscape and ushered in an era of intense competition. As a result, the customer has become the focal point in the decision making process of a bank and factoring his views/expectations in designing or developing various banking products or services is a must for achieving sustainable competitive advantage.
Businesses feel the need to merge when they exhaust possibilities of organic growth, or when they want to achieve increased market share in good time. In the era of globalization, banks will have to be financially strong and competitive to face the challenges and leverage the opportunities. Many well publicized mergers have transformed regional banks into national banking power houses. (Urban et al,2000). The Indian banking sector has embarked upon consolidation & restructuring that is expected to continue. Shri Purwar, the then
16
Chairman of State Bank of India, in a round table conference arranged by Business Standard said : “Seven to ten years down the line, there could be six to seven public sector banks and a couple of private sector banks and certainly some foreign banks”. According
to Mr.
Chidambaram, former finance minister of the Government of India, the three Cs, i.e. Competition, Convergence and Consolidation will be the key drivers of banking sector in the future. Addressing the bankers conference, R. Gopalan, Secretary, Financial Services, GOI said merger should take place at bank’s own initiative based on pure business sense . In mergers and acquisitions, banks should look at synergistic gains, technology, scale economies and operational benefits (Business Line, 13th January, 2010). In this complex and gigantic effort of bank consolidation, where does the customer stand? What are his views and expectations? Does he stand to gain or lose? How does he perceive the whole exercise? Does he feel that his voice is being heard or he feels let down and helpless. These questions, though seemingly simple, are the most difficult ones to answer. Service Quality Level and Customer Perception Many consumers are concerned that the level of service quality has been declining over the last two decades. From the customer service perspective, a decline in service quality can be attributed to the rise in two-income households, and the busier lifestyles of the cosumers of such services. Having higher incomes, better education, and less time has
17
made consumers more demanding with regard to convenience and service quality. Just as in the United States, the service sector is a critical component of the economy of other countries, like India. (Clow et al, 2008).Over the last decade and a half, lot of research has been undertaken to evaluate the various dimensions of service quality, which is being increasingly viewed as one of the key strategic values of service sector organizations.(Lewis,1991). It is important to explain the word perception in some detail. Perception “is the act of discerning, realizing, and becoming aware of through the senses”. The customer’s perception is what matters, not what we think it is (Tom Albrecht – President aQsi, October 10, 2003).To customers who are evaluating the quality of a service, it is their perception that counts, not what the service provider thinks. Service firms must understand the concept of service quality from the viewpoint of the customer, not from the viewpoint of the service firm or service provider. (Clow et al, 2008). Importance of Customer Service Quality in Banks State Bank of India, the largest commercial bank of the country, has over 150 million customers. In the words of O. P.Bhat, the Chairman of the bank, “One can not serve without a cause, nor become better without one. And our cause has been the customer. We have been addressing customer service in a million different ways”. While responding to a query from the media why the SBI has, of late, become aggressive, the Chairman has replied: “We have not become more aggressive, but more
18
focused,
agile,
customer-centric.
We
have
come
closer
to
our
constituents. We anticipate their needs, we respond to them to the best of our abilities, using technology. We have centralized every thing that could be centralized and made the branches available for sales and service”. The above statements are a clear reflection of the thinking of top management of the banks about
the importance the customer has in
their scheme of things. Banknet India, a banking research company’ s Financial Sector Survey 2007 identified that Customer Service, Security, Know Your Customer(KYC) were regarded as the top priority issues to be addressed by the financial sector in 2007. The impact of bank mergers on various stake holders including the communities involved and on customers is significant and it is therefore important to study their effects.
A plethora of information is available about the financial and human resource implications of mergers in general and bank mergers in particular from various sources. Many studies talk about the scale and scope economies, diversification benefits, and growth in market share, impact on valuation and other financial performance parameter improvements. A good number of studies have also investigated into the HR and cultural conflict related issues in the context of bank mergers. However, there is very little quantitative information available about the
19
impact of these mergers on consumers of banking services and on their perceptions of banking services in India. The present study therefore examines, in its third and final phase, the impact of commercial bank mergers in India on the service quality perceptions of bank customers. It also attempts to identify the factors which the customers consider critical in this regard. 1.8 Objectives of the Study
The present study has the following objectives: 1.8.1 Ratio Analysis approach for evaluating the post-merger performance of select commercial bank mergers:
To evaluate the financial performance of the commercial banks before and after merger, during the period 1994-2009 (post-reform period)
To summarize the findings and offer appropriate recommendations for the future banking merger policy of the Government of India/Reserve Bank of India.
1.8.2 Data Envelopment Analysis (DEA) approach to evaluate the post-merger performance of select commercial banks in India
To understand the role of Data Envelopment Analysis (DEA) in evaluating the relative efficiencies (Technical, Scale, Cost and Profit) of Decision Making Units (DMUs) in a given sample.
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To investigate the empirical evidence on the efficiency/productivity gains of the Indian commercial banks during the post-reform (deregulated) period.
To examine the role of commercial bank mergers in efficiency gains, if any, in the post-reform period.
To identify the factors which critically influence the efficiency and productivity of commercial banks in India.
To suggest measures to the policy makers (Government of India and the RBI) for effective implementation of merger policy of commercial banks in India. 1.8.3
Marketing
implications
of
commercial
bank
mergers
/
Customer perceptions of service quality in the face of commercial bank mergers in India.
To understand the marketing implications of commercial bank mergers in general and in the Indian context.
To identify the key factors influencing the service quality perception of customers in the face of commercial bank mergers in India.
To explore whether different demographic/behavioral groups have unique service needs and deserve distinct promotional appeals in the marketing strategy formulation of commercial banks in the face of mergers.
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To suggest measures aimed at improving the service quality of the commercial banks in India in the face of mergers.
1.9
Hypotheses of the Study
1.9.1 The following hypotheses have been set up for testing for statistical
significance of each financial ratio separately (Ratio approach).
H0: There is no significant change in the financial ratio due to the M&A event.
H1: There is significant change in the financial ratio due to the M&A event.
1.9.2 Keeping the objectives in perspective, and having regard to the
results of past research in the area of measuring post-merger efficiencies (DEA approach) in the global and Indian banking sectors which were at best mixed, the following four hypotheses have been framed to seek empirical evidence on the impact of mergers on the efficiency of Indian banking sector in the post-reform period.
Hypothesis: 1 (Technical Efficiency)
H0: Technical efficiency of acquiring bank will not improve in the postmerger scenario.
H1: Technical efficiency of acquiring bank will improve in the post-merger scenario.
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Hypothesis: 2 (Scale Efficiency)
H0:
Scale efficiency of acquiring bank will not improve in the post-
merger scenario.
H1: Scale
efficiency of acquiring bank will improve in the post-merger
scenario. Hypothesis: 3 (Cost or X- Efficiency)
H0: Cost or X- Efficiency of acquiring bank will not improve in the postmerger scenario.
H1: Cost or X- Efficiency of acquiring bank will improve in the postmerger scenario.
Hypothesis: 4 (Profit Efficiency)
H0:
Profit Efficiency of acquiring bank will not improve in the post-
merger scenario.
H1: Profit Efficiency of acquiring bank will improve in the post-merger scenario. 1.9.3 To evaluate the marketing implications of commercial bank
mergers in India, having regard to the review of literature in this regard, the following hypotheses are proposed: Ho:
There
is
no
significant
association
between
respondent’s
demographic/behavioral characteristics and perception of the effect of commercial bank mergers and acquisitions on banking services.
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H1:
There
is
significant
association
between
respondent’s
demographic/behavioral characteristics and perception of the effect of commercial bank mergers and acquisitions on banking services. 1.10 Limitations:
Non-availability of data for certain parameters for the period under study.
Efficiency calculations (under DEA) cannot be performed in case of inputs or outputs with negative values.
The present study’s (marketing implications) sample of customers is drawn from Hyderabad city only. To get better insights, a broader sample comprising other regions/cities of the country may be taken.
1.11 Fruitful avenues for future research:
The future banking M&A will be
cross-border with substantial
potential synergies but can create large systemic risk and hence future research should explore these perspectives more fully before we can draw conclusions there from as to the effectiveness of mergers and acquisitions.
Future research may also look at the cross-industry M&As within the financial services sector in India and abroad as this an area which has not been investigated much.
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In future research should lay more emphasis on dynamic analysis methods rather than static ones, which do not use data on M&As directly
but
instead
relate
the
potential
consequences
of
consolidation, like the market power, service availability etc.
DEA analysis may be attempted using slacks based models.
Market efficiency measures may also be employed to evaluate the efficiency effects of mergers.
If the sample size is large, parametric techniques like the stochastic frontier analysis (SFA) can be employed. BASEL-III norms which require more stringent risk management standards to be put in place by commercial banks call for more rigorous research into the M&A implications in the banking sector in the light of these requirements.
