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The survival of small banks in a market
that is simultaneously shrinking and getting intensely competitive is close to
impossible. Consolidation is necessary to ensure that banks attain appropriate
size. As the financial services sector becomes increasingly international, the
more narrowly defined and historically protected national financial markets
become less significant. Proponents of financial sector consolidation
argue that institutions need size, in order to spread growing information
technology and processing costs over larger revenue bases. Another key factor
is the need for greater market capitalisation, with governments and financial
sector regulators accepting the argument, that greater size is crucial to cost
cutting and strong national institutions. The race appears to be for size,
efficiency-synergies and profitability. Competition policy in the financial
sector is tending towards an easing of regulations and the elimination of
obstacles, in this regard. The effort has been to eliminate existing controls,
which had distorted resource allocation and inhibited entrepreneurship. The
economy is being nudged towards higher productivity and efficiency. Strong banking systems are required to
intermediate substantial flows. Size generates economies of scale essential to
compete in global markets. Oligopolies are not created as technology has the
ability to lower entry barriers to new types of financial service providers and
this somewhat reduces the power of concentration. Economies of Scale (size) and product
mix (scope) will lead bankers to operate from a greater resource base. Banks
need size and resources to compete globally. Global corporations today expect
their bankers to have the expertise, products and presence to serve them
anywhere and across a broad range of markets. As Reserve Bank of India (RBI) deputy
governor Dr Rakesh Mohan said: ?The significant transformation of the banking
industry is clearly evident from the changes that have occurred in the
financial markets, institutions and products. While deregulation has opened up
new vistas, it has entailed greater competition?. These developments have intensified
competition, thereby reducing operating margins and profitability. Financial
institutions compensate for the erosion in margins through a scramble for
volumes and easing of credit standards, which leads to a deterioration of loan
portfolios. Thus weak banks may proverbially rush in, where the strongest fear
to tread and generate seismic ripples, which can lead to systemic
instabilities. As a financial institution is only as strong as its weakest
link, it is necessary to address issues relating to shoring up weak banks,
through mergers and amalgamations. Driven by the need to raise additional
capital and to counter growing competition from domestic and foreign banks,
mergers have emerged as an alternative option in the context of banking sector
reform. In addition, if weak banks are allowed to continue in business,
competing, squeezing margins, or rushing into areas to increase business
without measuring the attendant risks, the stability of the financial system
would be threatened. Initially, mergers were one way of salvaging inefficient
banks. There have been three waves of mergers in India. In the early decades of the 60s, the
failure of Palai Bank generated a situation of near panic and led to the
amendment of Section 44 of the Banking Regulation Act. Prior to 1961, the Act
only provided for the voluntary amalgamation of banks. It was amended to
include section 44A which explicitly sets out the procedure for amalgamation of
banking companies. Further, Section 45 was inserted. This gives the RBI the
power to apply to the Centre for suspension of business by a banking company
and to prepare a scheme of reconstitution or amalgamation. Thus, Section 45
imparts RBI the power to compulsorily reconstruct or amalgamate a weak bank
with a stronger bank. In 1961, after the failure of Palai
Bank, the Banking Companies Amendment Act empowered the RBI to formulate and
carry out a scheme for the reconstruction and compulsory amalgamation of
substandard banks with well managed ones. Of the 42 banks granted moratoria, 22
were amalgamated with other banks. The first wave of amalgamations came in
1960s. Then there was a lull. In the mid-80s, there was again a great deal of activity,
which arose principally with the need to bail out weak banks. The third wave of
mergers which we have witnessed in the recent past is qualitatively different.
The merger of Times Bank with HDFC Bank and that of Bank of Madura with ICICI
Bank illustrate that merger of sound institutions leads to synergies achieved
by a combination of complementary strengths. Mergers help to maximise shareholders?
returns. Creating shareholder value means that the market favours firms that
increase the productive use of their assets by increasing turnover ratios,
margin and profitability. Strong, efficient and profitable financial
institutions are vital to economic success, especially in the form of engines
of economic viability in creating and maintaining credit systems for other
sectors, both nationally and globally. The contrary view is that market power
and economies of scale associated with market dominance fall victim ultimately
to insulation from the market. Bureaucratic inefficiency, that grows with size,
creates greater complexity in terms of bureaucratic controls and slows the
ability of organisations to respond fast to changing market conditions, leading
to complacency. Problems in meshing personnel and
systems, stemming from divergence in corporate culture and management also
cannot be wished away. However, in playing for the long haul, banks have little
option but to further buttress themselves through mergers and amalgamations,
whether these will proceed in a gentlemanly and sedate fashion or give rise to
predatory activity, only time will tell. But as a mode of business
consolidation, clearly, mergers and acquisitions are here to stay. |