[STC-Salt Lake] The New Leviathan

  • From: "Anup Sen, STC, Salt Lake City, Kolkata" <anupsen@xxxxxxx>
  • To: E-Group STC Salt Lake City Kolkata <banknews@xxxxxxxxxxxxx>
  • Date: Mon, 07 Jun 2004 10:40:45 +0530

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Title: State Bank of India, Staff Training Centre, Salt Lake, Kolkata. : : stcsaltlake@xxxxxxxx : :

 

The New Leviathan

 

Dr Deepali Pant Joshi  

The author is RBI regional director based in Hyderabad

The Financial Express

Published on June 07, 2004

 

 

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.

 

 

 

 

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