Bank Mergers and

UNIT 16 BANK MERGERS AND Acquisitions

ACQUISITIONS
Objectives
After reading this unit you should be able to:
l understand the meaning and types of mergers in general;
l appreciate the need for bank mergers;
l describe the legal framework in which merger takes place; and
l analyse some bank merger case studies.

Structure
16.1 Introduction
16.2 Types of Mergers
16.3 Motives for Merger
16.4 Bank Mergers
16.5 Legal Framework
16.6 Procedure for Amalgamation of Banking Companies
16.7 Restructuring of Banks and Some Relevant Committees
16.8 Case Studies
16.9 Summary
16.10 Key Words
16.11 Self Assessment Questions
16.12 Further Readings
Appendix

16.1 INTRODUCTION
The Liberalisation, Privatisation and Globalisation process which was started in early
1990s has brought so many changes in the economic scene of the country. This
process of economic reforms has brought competition not only from India but also
from Overseas. In order to compete with these competitors, Indian corporate sector
has tried to reorganise and restructure the companies by adopting various strategies.
These strategies include Mergers, Acquisitions, Joint ventures, Spin off,
Divestitures, etc.
Restructuring can be broadly classified into three types. They are:
a) Portfolio Restructuring,
b) Financial Restructuring, and
c) Organisational Restructuring.
If a firm is reshuffling its assets by selling some of its existing production facilities or
acquiring some new facilities to produce the feeding raw–material for the main
product, it is called portfolio restructuring. In financial restructuring the composition
of debt and equity are shuffled. In the process of organisational restructuring,
Organisational Structure is revisited and changes are made. All these restructurings
are aimed to achieve better results for the company.
5
Special Issues Figure 16.1 presents a broad view of the different forms of Organisational
Restructuring which can be seen these days in the Corporate World:

Figure 16.1: Forms of Restructuring Business Firms

Forms of Restructuring Business Firms

Expansion Sell-offs Corporate Control Changes in Ownership

l Mergers and l Spin-offs l Premium Buy-backs Structure
acquisitions l Split – offs l Standstill Agreements l Exchange Offers

l Tender Offers l Split – ups l Anti-takeover Amendments l Share Repurchases

l Joint Ventures l Divestitures l Proxy contests l Going Private

l Equity Carve-outs l Leveraged Buy-outs

Source: Adapted from Weston, Chung and Hong, 1998, Mergers, Restructuring and Corporate Control

Some of the sectors which saw a lot of activity in the last decade in relation to
mergers are : fast moving consumer goods sector, financial services sector, cement,
paper, chemicals and tyre industries. Some of the corporates which are involved
actively in this activity are: Reliance group, Hindustan Levers, Aravind group,
Eicher group, Vijay Mallaya, Chhabria group, etc. In the Banking sector ICICI Bank,
HDFC Bank, and Punjab National Bank (PNB) are actively involved in the merger
activity . In this unit we shall discuss the bank mergers in detail.

16.2 TYPES OF MERGERS

When a company acquires another company, the acquiring company is called the
‘Acquirer Company ’and the company which is being acquired is called the ‘Acquired
Company’. The acquirer company has two alternatives for dealing the acquired
company. First the acquiring company can takeover the management of acquired
company and run it as a separate company with its own new Management. This is
called the ‘Takeover’ or the ‘Change of Management’. The second alternative for
Acquirer Company is to merge the acquired company into itself. This is called the
‘merger’. In this unit we shall be discussing mostly about the mergers. In case of
mergers there could be three situations. They are:
i) The acquirer company merges the acquired company into itself and the acquired
company looses its entity,
ii) The acquirer company may merge with the acquired company and may give up
its own identity. Normally this kind of merger takes place for getting some Tax
benefits.
iii) There could be a situation in which both the acquirer company and acquired
company loose their identity and form a altogether new company with a new
name.
Mergers can be broadly classified into three types. They are vertical mergers,
horizontal mergers, and conglomerate mergers. Let us understand each of these types
hereunder:
a) Vertical Mergers: If a company acquires another company, which buys the
products of Acquirer Company and uses them as raw material in its production
process or acquires a company from which the company buys its raw material,
then it is called vertical merger. If a bank acquires a marketing company which
provides the bank, marketing services for its products as an outsourcing solution,
6 then it can be stated as vertical merger.
b) Horizontal Mergers: If a bank acquires another bank and merges it into itself, Bank Mergers and
it is known as Horizontal merger. Similarly if a company acquires another Acquisitions
company which is operating in the same area of its operation and merges it into
itself, it is said to be horizontal merger. This could be to increase the market
share, or to get technological advantages, or to enter into the new geographical
areas, or to acquire any other strategic advantages.
c) Conglomerate Mergers: If a company acquires a company which is not at all
connected with the area of operations of acquiring company, it is said to be a
conglomerate merger. For example, if a bank acquires a cement company and
merges it into itself, then it can be treated as conglomerate merger.
Depending upon the situation and need of the acquiring company, it may adopt any
one of the above types of mergers.

16.3 MOTIVES FOR MERGER

Any acquisition takes place with a number of motivations culminating in a positive
synergy (2+2=5 relationship). This means that the performance of the combined
company is more than the sum of the performance of erstwhile two independent
companies. Let us, now, examine the motives behind the merger.
A study conducted in the U.S.A., identified 12 motives that promote merger and
acquisition activity. They are given below in the order of their priority:
1. Taking advantage of awareness that a company is undervalued.
2. Achieving growth more rapidly than by internal effort.
3. Satisfying market demand for additional products/services.
4. Avoiding risks of internal start-ups of expansion.
5. Increasing earnings per share.
6. Reducing dependence on a single product/service.
7. Acquiring market share or position.
8. Offsetting seasonal or cyclical fluctuations in the present business.
9. Enhancing the power and prestige of the Owner, CEO, or Management.
10. Increasing utilization of present resources, et., physical plant and individual
skills.
11. Acquiring outstanding Management or Technical Personnel.
12. Opening new markets for present products/services.
A survey, conducted in 1955, by the U.S. Federal Trade Commission, to find out why
companies choose the merger and acquisition route, listed seven major benefits of
acquisition for the acquiring company. They are:
1. Gaining additional capacity to supply to a market already being serviced by the
acquirer.
2. Gaining extended product lines.
3. Achieving diversification of product base.
4. Gaining facilities to produce goods purchased earlier.
5. Gaining facilities to process or distribute goods sold earlier.
6. Gaining access to additional markets.
7. Other advantages such as empty plants, control of patents, etc.
7
Special Issues In India, the merger and takeover phenomenon in the past was understood largely as
one of the sick units being taken over by healthy ones. This is because of the reason
that Sec. 72A of the Income Tax Act, 1961, provides for the carry forward of losses.
The advantage that the merging corporations get is that the book losses of the sick
corporation get written off against the future profits, thus saving the profitable
corporations some tax outflow.
As far as the Banking sector is concerned following reasons are more relevant:
1. Growth with External Efforts: With the economic liberalization the competition
in the banking sector has increased and hence there is a need for mega banks,
which will be intensely competing for market share. In order to increase their
market share and the market presence some of the powerful banks have started
looking for banks which could be merged into the acquiring bank. They realized
that they need to grow fast to capture the opportunities in the market. Since the
internal growth is a time taking process, they started looking for target banks.
2. Deregulation: With the liberalisation of entry barriers, many private banks came
into existence. As a result of this there has been intense competition and banks
have started looking for target banks which have market presence and branch
network.
3. Technology: The new banks which entered as a result of lifting of entry barriers
have started many value added services with the help of their technological
superiority. The older banks which can not compete in this area may decide to go
for mergers with these high-tech banks.
4. New Products/Services: New generation private sector banks which have
developed innovative products/services with the help of their technology may
attract some old generation banks for merger due to their incapacity to face these
challenges.
5. Over Capacity: The new generation private sector banks have began their
operation with huge capacities. With the presence of many players in the market,
these banks may not be able to capture the expected market share on its own.
Therefore, in order to fully utilise their capacities these banks may look for target
banks which may not have modern day facilities.
6. Customer Base: In order to utilise the capacity of the new generation private
sector banks, they need huge customer base. Creating huge customer base takes
time. Therefore, these banks have started looking for target banks with good
customer bases. Once there is a good customer base, the banks can sell other
banking products like car loans, Housing loans, consumer loans, etc., to these
customers as well.
7. Merger of Weak Banks: There has been a practice of merging weak banks with
a healthy bank in order to save the interest of customers of the weak Bank.
Narasimham Committee–II discouraged this practice. Khan Group suggested
that weak Developmental Financial Institutions (DFIs) may be allowed to merge
with the healthy banks.

16.4 BANK MERGERS

In the 1950s and 1960s there were instances of private sector banks, which had to be
rescued or closed down because they had very low capital and were mostly operating
with other people’s money. For instance, against total deposits of Rs.2750 crore at the
end of December 1968, the paid-up capital of private sector banks was only Rs.28.5
crore or just a little over 1%. In 1960, the failure of Palai Central Bank and Laxmi
Bank led to loss of confidence in the banking system as a whole. So mergers were
initiated to avoid losses to depositors and maintain confidence in the system. In 1961,
8 the Banking Companies (Amendment) Act empowered RBI to formulate and carry out
a scheme for the reconstitution and compulsory amalgamation of sub-standard banks Bank Mergers and
with well-managed ones. Consequently, out of 42 banks which were granted Acquisitions
moratoria, 22 were amalgamated with other banks, one was allowed to go into
voluntary liquidation, one to amalgamate voluntarily with another bank, three were
ordered to be wound up and the moratorium on three was allowed to lapse.
In India, mergers have been used to bail out weak banks till the Narasimham
Committee-II discouraged this practice. For instance, since the mid-1980s, several
private banks had to be rescued through mergers with public sector banks, as shown
in the Table 16.1 given below:
Table 16.1: Bank Mergers in India

Name of Bank Year of No. of Merged with

Merger Branches
Lakshmi Commercial Bank 1984 230 Canara Bank
Bank of Cochin 1984 108 State Bank of India
Miraj State Bank 1984 26 Union Bank of India
Hindustan Commercial 1985 140 Punjab National Bank
Traders Bank 1987 34 Bank of Baroda
United Industrial Bank 1988-89 145 Allahabad Bank
Bank of Tamilnadu 1988-89 99 Indian Overseas Bank
Bank of Thanjavur 1988-89 156 Indian Bank
Parur Central Bank 1988-89 51 Bank of India
Prubanchal Bank 1990 40 Central Bank of India
New Bank of India 1993 591 Punjab National Bank
BCCI (Mumbai) 1993 1 State Bank of India
Bank of Karad 1994 48 Bank of India
Kasinath Seth Bank 1995 11 State Bank of India
Bari Doab Bank & Punjab 1997 Oriental Bank of Commerce
Co-operative Bank

The merger of the loss making New Bank of India with the profitable Punjab National
Bank was the first instance of merger of two public sector commercial banks. Now
public sector commercial banks are themselves in need of restructuring so it may be
more efficient to close down unviable bank. However, the recent merger of banks in
private sector , i.e., HDFC Bank and Times Bank (1999) as well as ICICI Bank and
Bank of Madura (2000) , could herald a welcome trend as it is driven by commercial
considerations. It is only such mergers among banks that will impart strength and
stability to the banking system in the new millennium.
With economic reforms and opening up of the economy, like other sectors, banking
sector also saw a lot of changes. Two major changes are worth mentioning. They are:
increased competition, and falling interest rates. There has been a decline in the
interest rates in the last decade world wide. As a result of this profitability of the
banks has been under tremendous pressure. The interest rates both on the deposits and
on the loans have come down drastically. The ‘spread’ which was available to the
banks thinned down and banks have started searching for cost reduction and market
enhancing strategies. Use of technology in their operations has come up as an
immediate strategy and banks have started using technology in a big way. This has
resulted in saving of salary expenses, which used to be a major part of the banks’
expenditure. In addition to this, banks have started looking for strategies which allow
the banks to grow faster. One of the options before the banks was to merge their
counterparts in it and become not only big but also gain entry into the new markets.
As a result of these mergers, banks are able to use their full capacities and avoid
unnecessary duplication of efforts. Some of the banks which merged in recent times 9
Special Issues are: Times Bank merged with HDFC Bank, Bank of Madura Merged with ICICI
Bank, Nedungadi Bank Merged with Punjab National Bank. Subsequently the RBI
allowed Development Financial Institutions also to merge with banks on the
recommendation of Khan Group. As a result of this ICICI Limited merged itself with
ICICI Bank and IFCI Limited is being merged with the Punjab National Bank.
As far as the merger activity in banking sector is concerned, there used to be mostly
merger of sick and weak banks with a healthy bank. The only purpose of this type of
mergers was to save the sick bank and its customers from the problems. With the
process of liberalization the thinking of the government also changed. We do not see
much of mergers of this type now-a-days. The merger of New Bank of India with
Punjab National Bank was a bad experience. This has not served any purpose. As a
result of the merger, PNB had to face lot of court litigations and also incurred a loss in
the year 1996 which was unusual in the history of the Bank.
With the liberalization policies of the government, many private banks came into
existence. In 1995 the government also removed entry barriers in the banking sector.
As a result of this good number of technology savvy, customer friendly banks have
started operating in India. In order to survive in the competition and get a market
share these new banks started offering innovative and attractive products with the help
of their technology. Some of the services like mobile banking, internet banking,
tele-banking, online share trading services, depository services , anywhere banking,
anytime banking which are offered by these new generation banks were never thought
of about a decade ago in India. These services have given an edge to these banks over
the public sector banks. The public sector banks also realised the need of the hour
and started using technology in a big way. These banks are also collaborating with
the new generation banks in offering certain services and getting mutually benefited.
Some of the new generation banks like HDFC Bank and ICICI Bank have started
looking for external growth by way of merger route. These banks have started looking
for healthy banks rather than sick and weak banks for acquisition. The main criteria
while selecting target bank was synergy benefits like market growth, market presence,
effect on profit and so on. It can be said merger of Times Bank with HDFC Bank in
1999 is a beginning of this new trend. HDFC Bank emerged as the largest private
sector bank in India after the merger. By this merger HDFC Bank got the customer
base of Times Bank, its infrastructure, and branch network. This merger also had
product harmonization effect, as HDFC Bank had Visa network and Times Bank had
Master card network. Following HDFC, ICICI also merged Bank of Madura into it.
ICICI Bank was looking for a bank which could be merged into it and which could
provide some synergic benefits after the merger. ICICI Bank had considered two
possible banks, Federal Bank and the Bank of Madura and finally went for Bank of
Madura, considering its better technological edge, attractive business per employee,
and its vast branch network in Southern India. At the time of merger the Bank of
Madura had 263 branches.
Another trend which is taking place in Bank Mergers is merging of Developmental
Financial Institutions (DFIs) with the Banks. Some of the examples are; merger of
ICICI Ltd. with ICICI Bank, and the proposed merger of IFCI Ltd. with Punjab
National Bank. This trend is a fall out of the recommendations of Khan Group and
Narasimham Committee-II.

16.5 LEGAL FRAMEWORK

Mergers and Takeovers are generally seen in Public Policy as activities, which, if left
uncontrolled, can lead to negation of Public interests. As a result, these activities are
controlled through various Statutes and Codes of Conduct. Some of the contentious
1 0 issues that emphasise the need for evolving a Takeover Code are discussed below.
Sec.s 111 and 390 to 396a of the Companies Act, 1956, govern mergers and Bank Mergers and
acquisitions. Similarly Sections 19, 26 and 29 of the erstwhile FERA relate to transfer Acquisitions
of shares. Where one of the transacting parties is a Non-Resident Indian, the Act
prohibits the transaction except with the sanction of the Reserve Bank of India
(R.B.I.). Sec.s 30(A) to 30 (F) of the MRTP Act pertain to transfer of shares relating
to dominant undertakings as defined in the Act. Further, Sec. 22 (A) of the Securities
Contract (Regulation) Act, 1956, deals with the transfer of shares. Clauses 40 (A) and
40 (B) of the Stock Exchange Listing Agreement Form also lay down the rules in case
of takeover bids.
Before 1960, section 44A of the Banking Regulation Act only provided for the
voluntary amalgamation of banks. But after widespread weakness in the banking
sector, the Act was amended by adding Section 45 to allow for compulsory
amalgamation wherever necessary and on a voluntary basis wherever possible, in
order to strengthen the banking system by eliminating small and weak banks. The
main difference between an amalgamation and a transfer is that, under amalgamation
the company, which is taken over, ceases to exist, while under transfer the company
can opt to either go into liquidation or convert itself into a non-banking company.
Under Section 45 of the Act, RBI has the power to compulsorily reconstruct or
amalgamate a weak bank with any other bank.
Section 44A of the Banking Regulation Act lays down the procedure for
amalgamation of banking companies. Section 44B of the Act further empowers RBI
in the matter of compromise arrangements between a bank and its creditors. These
have to be approved by RBI and such compromise cannot be sanctioned even by a
High Court. Under Section 36 AE of the Act, the Central Government can under
advice from RBI take over a weak bank. When a bank is placed under liquidation, the
High Court can appoint RBI, SBI or any other bank as the official liquidator and
monitor the speedy disposal of winding up proceedings.
Part-II C of the Banking Regulation Act deals with the acquisition of the undertaking
of banking companies. Section 36-AE of the Banking Regulation Act deals with the
power of Central Government to acquire undertakings of banking companies in
certain cases. Sec.36-AF deals with the powers of Central Government to make
scheme and Section 36AG deals with compensation to be given to shareholders of the
acquired bank.
The Central Government on receipt of a report from the RBI may acquire a banking
company if it fails to comply with the directions given to it under Sec.21 or Sec. 35-A
of the Banking Regulation Act. Similar action may also be taken if the Banking
Company is being managed in a manner which is detrimental to the interest of its
depositors, or against the banking policy. Reasonable opportunity should be given to
the bank before taking such action.
Let us now see how the Takeover Code evolved over a period of time in India:

The Evolution of the Takeover Code

1990
The Government amends clause 40 of the listing agreement according to which,
threshold acquisition level reduced from 25% to 10% ; change in management control
to trigger public offer’; minimum mandatory public offer of 20% disclosure
requirement through mandatory public announcement.
November 1994
SEBI notifies Substantial Acquisition of Shares and Takeover, 1994. New provisions
introduced to enable both negotiated and open market acquisitions and competitive
bids allowed. 1 1
Special Issues November 1995
SEBI sets up committee under former Chief Justice of India P.N. Bhagwati to review
the 1994 takeover Regulations in order to frame comprehensive regulations.

January 1997
The Bhagwati Committee submits its report on the takeover code to SEBI.

February 1997
SEBI accepts Bhagwati committee report and the Substantial Acquisition of Shares
and Takeovers Regulations, 1997, notified.

February 1998
SEBI proposes to revise the takeover code make it mandatory for acquirers to make a
minimum open offer for 20% (and not 10% as earlier) of the target company’s equity,
even if the holding goes beyond 51% as a result of the offer.

June 1998
SEBI asks justice Bhagwati to conduct a complete review of the takeover code. Issues
likely to be taken up are, the extent of disclosure in an open offer and if any change in
the objective of the offer needs to be spelt out in the revised offer.

June 1998
SEBI proposes to raise the creeping acquisition limit under its Takeover Code from
2% to 5%. It also proposes to increase the share acquisition limit for triggering the
takeover code from 10% to 15%.’

November 1998
Takeover panel amends the takeover code to incorporate buyback offers by
companies. The committee decides to allow takeover offers to be made when a
buyback offer is open and vice versa.

December 1998
Justice P.N. Bhagwati criticizes SEBI for unilaterally increasing the trigger limit for
making a public offer from 10% to 15%. The Bhagwati Committee also recommends
that once an acquirer acquires 75% of shares or voting rights in a company, he should
be outside the purview of the Takeover Regulations.
January 2000
SEBI again proposes that all open offers made by promoters for consolidating their
holding in a company will have to be for a minimum of 20% of equity. Exemption to
the minimum 20% requirement should be given only in the case of such companies in
which promoters hold over 75%.
The SEBI’s Takeover Committee also recommends that a special resolution approved
by 75% of the shareholders should be made mandatory for effecting a change in the
management of professionally managed companies. The step aims to avoid misuse of
the earlier provision, under which certain groups with 51% stake could effect the
changes through a simple resolution.
Another recommendation that follows was that venture capital funds should be treated
on par with State Financial Institutions. And like financial institution, they should be
exempted from making a public offer, in the event of acquiring a 15% stake in a
company.
1 2
February 2000 Bank Mergers and
Acquisitions
SEBI finalizes the recommendations of takeover panel and review the takeover norms.
However, the crucial decision on issue relating to ‘change in management control of
professionally managed companies’ left unresolved.

June 2000
SEBI plans to bring public financial institutions under the ambit of its takeover code,
both as acquirers and as pledgees.

October 2000
Confederation of Indian Industry, FICCI and ASSOCHAM seek amendments in the
takeover code, especially in the case of creeping acquisitions, to provide the promoters
a level-playing field against corporate raiders who may disrupt existing managements.
Under the current takeover code, corporate raiders can pick up 15% of the paid-up
equity of the target company over a 12 month period without triggering off the
takeover code.

November 2000
SEBI takeover panel decides to make it mandatory for an ‘acquirer’ to disclose his
holdings in the target company to the company as well to the exchanges, at three
levels; 5 %, 10% and 14%, instead of the existing stipulation of only 5%.

December 2000
SEBI promises a new draft on the takeover code in place by the end of March 2001
with ‘investor protection’ as its pivot. The main objective of the new code would be to
ensure that acquiring companies are prompt in informing the stock exchanges when
they cross the prescribed limits of holding a company’s stake, make public
announcements and allow companies to make counter offers.
Source: www.capitalmarket.com

16.6 PROCEDURE FOR AMALGAMATION OF

BANKING COMPANIES
Sec. 44A of the Banking Regulation Act,1949, deals with the procedure for
amalgamation of banking companies. This procedure is discussed hereunder:
1. No banking company shall be amalgamated with another banking company,
unless the shareholders of both the banking companies approve merger scheme in
a meeting called for the purpose by a majority in number representing two-thirds
in value of the shareholders of each of the said company.
2. The approved scheme of amalgamation shall be sent to RBI for its approval.
3. Any shareholder who has voted against the scheme of merger or has given notice
in writing at or prior to the meeting shall be entitled to claim from banking
company the value of the shares held by him as determined by the RBI while
approving the scheme.
4. Once the scheme of amalgamation is sanctioned by the RBI, the property and
the liabilities of the amalgamated company shall become the property and the
liabilities of the acquiring company.
5. After sanctioning the scheme of amalgamation by the RBI, the RBI may further
order the closure of acquired bank and the acquired bank stands dissolved from
such a data as may be specified.
1 3
Special Issues
16.7 RESTRUCTURING OF BANKS AND SOME
RELEVANT COMMITTEES
The reports of three committees appointed by the RBI are relevant in relation to the
restructuring of Banks. These are: Report of the Narasimham Committee on Banking
Sector Reforms, Report of the Working Group for Harmonizing the Role and
Operations of DFIs and Banks, and the Report of the Working Group on
Restructuring of Weak Public Sector Banks. If we study these three reports we can get
a good idea of the trends and future of Bank restructuring in India.

1. Narasimham Committee
The Narasimham Committee on Banking Sector Reform was set up in December,
1997. This Committee’s terms of reference include; review of progress in reforms in
the banking sector over the past six years, charting of a programme of banking sector
reforms required making the Indian banking system more robust and internationally
competitive and framing of detailed recommendations in regard to banking policy
covering institutional, supervisory, legislative and technological dimensions. The
Committee submitted its report on 23 April, 1998 with the following suggestions:
l Merger with strong banks, but not with the weak.
l Two or three banks with international orientation, eight to 10 national banks and
a large number of local banks.
l Rehabilitate weak banks with the introduction of narrow banking
l Confine small, local banks to States or a cluster of Districts.
l Review the RBI Act, the Banking Regulation Act, the Nationalisation Act and
the State Bank of India Act.
l Speed up computerisation of public sector banks.
l Review the recruitment procedures, and the training and remuneration policies of
PSU banks.
l Depoliticisation of appointments of the bank CEOs and professionalisation of the
bank Boards.
l Strengthen the legal framework to accelerate credit recovery.
l Increase capital adequacy to match the enhanced banking risk.
l Budgetary support non-viable for recapitalisation.
l No alternative to the asset reconstruction fund.
2. Khan Group
The Group was set up by the RBI in December, 1997, under the Chairmanship of
Shri S.H. Khan, the then Chairman of IDBI. The Group was to review the role and
structure of the Developmental Financial Institutions and the Commercial Banks in the
emerging environment, and to recommend measures to achieve coordination and
harmonization of Lending policies of financial institutions before they move towards
Universal Banking. Some of the recommendations of this Group are given below:
i) A progressive move towards universal banking and the development of an
enabling regulatory framework for the purpose.
ii) A full banking licence may be eventually granted to DFIs. In the interim, DFIs
may be permitted to have a banking subsidiary (with holdings up to 100 per
cent), while the DFIs themselves may continue to play their existing role.
iii) The appropriate corporate structure of universal banking should be an internal
1 4 management/shareholder decision and should not be imposed by the regulator.
iv) Management and shareholders of banks and DFIs should be permitted to explore Bank Mergers and
and enter into gainful mergers. Acquisitions

v) The RBI/Government should provide an appropriate level of financial support in

case DFIs are required to assume any developmental obligations.

3. Verma Group
The Reserve Bank of India set up a Working Group on Restructuring Weak Public
Sector Banks, under the Chairmanship of Shri M.S. Verma, former Chairman, State
Bank of India, to suggest the measures for revival of weak Public Sector Banks. The
group has gone deep into the issue and analyzed the problem fully and made specific
suggestions. The summary report of this is given in the appendix to this unit. This
group has identified some core principles for incorporation into the future
restructuring strategies for weak banks. They are reproduced below from the report.
Future restructuring strategies for weak banks must incorporate the following core
principles:
a) Manageable Cost: The restructuring effort that is embarked upon has to be at
the least cost possible. However, the fact that injudiciously chosen lower cost
alternatives may lead to much higher costs in the long term must not be lost
sight of.
b) Least Possible Burden on the Public Exchequer: As far as practicable the cost
of restructuring must come out of the unit being restructured. Even if its
contribution to the cost of restructuring is not available upfront, it should be
possible to recover this later, out of the value that can be created by the
restructuring. The need to minimise the burden of such cost, preferably initially,
but certainly finally is obvious and cannot be overstated. Any plan for
restructuring which does not clearly result in value addition at the end of the
exercise, is not worth attempting.
c) All Concerned must Share Losses: The restructuring strategy as also the
instruments employed in the implementation of this strategy have to make a clear
statement about the manner in which the losses already incurred and to be
incurred have to be shared. The principle of sharing of losses will have to remain
fully operative in both operational and financial restructuring envisaged for a
bank. Such a plan for sharing losses will include reduction in staff as well as all
other administrative cost of operations.
d) Changes for Strong Internal Governance: The internal governance of the banks
and their operations at all levels has to be strengthened and fully sensitised to the
needs of protecting against all foreseeable future problems. Restructuring always
involves some amount of destabilisation in the organisation and during this
period as also immediately after it, management and all its operatives have to
make sure that the intended benefits of the restructuring plans are not allowed in
any way to be frittered away or lost due to delays and lack of diligence in its
implementation.
e) Effective Monitoring and Timely Course Corrections: Individual restructuring
plans are to be implemented by the banks concerned internally and their success
will depend upon the quality of governance and organisational commitment to the
proposed restructuring. However, for a successful restructuring it is important
that there is an independent agency which will own it and in the process of
driving it forth, constantly monitor its progress. This role can be played by the
owner but such an arrangement has limitations because of the conflict of
interests that are likely to arise in such cases and the lack of time and skill for the
job, which the owner may suffer from. It will be more so when the ownership of
the banks is with the government. For obvious reasons, this responsibility cannot 1 5
Special Issues be given to the regulator either. The regulator will no doubt have interest in the
success of the restructuring programme but direct efforts on its part to ensure its
implementation could result in conflict of interests. The objective can, therefore,
be best achieved by an independent agency, which with the express consent of the
owner shall have full authority over the restructuring process and be in a position
to effectively monitor its progress. In this process, while this independent agency
will monitor to ensure that the restructuring process remains on course, wherever
necessary it shall also take steps to facilitate due implementation of the plan.
Such steps by this agency may include devising corrective measures and ensuring
that the banks concerned adopt these measures.
f) Ease of Implementation: Above all there must be an all-round consensus on the
process of restructuring, its modalities and timing. The process itself and all the
attendant instruments and instrumentalities will have to be simple and easy to
employ.
While setting the core principles, which should govern any programme of bank
restructuring is not so difficult, deciding upon precise modalities of restructuring, is
indeed, quite a vexatious and difficult issue to settle. As can be learnt from
international experiences various modalities and quite a few variations of each of these
modalities have been tried with varying degrees of success. In their time and given
socio-economic environment each of these options chosen had good logic behind them.
While, therefore, they have their applicability and merit these are certainly not
transplantable where the prevailing conditions are different.

16.8 CASE STUDIES

In this section we shall be discussing three case studies of bank mergers. They are:
1. Punjab National Bank (PNB) and New Bank of India (NBI),
2. ICICI Bank and Bank of Madura, and
3. ICICI Bank and ICICI Ltd.
The case of Punjab National Bank and New Bank of India is a case of two Public
Sector Banks merging together as a solution to protect a weak bank (New Bank of
India) by merging with a healthy bank (PNB).The case study of ICICI Bank and Bank
of Madura is a representative case of modern thinking in the banking industry, i.e.,
growth through the merger route. The merger of ICICI Bank and ICICI Ltd is a case
of a Developmental Financing Institution merging with a Commercial Bank and
emerging into an Universal Bank. The first case (PNB-NBI) reflects the old thinking
and the remaining two cases reflect new trends in the banking and financial services
sector. Let us now know more details about these cases.

Punjab National Bank and New Bank of India Merger

In year 1970 fourteen banks including PNB were nationalized. In 1980 six more
banks including New Bank of India were nationalized. Both these banks were merged
in 1993 by the Central Government. The New Bank of India was incurring losses and
by the year 1991-92, its financial position had become so bad that its capital and
deposits completely stood eroded.
Punjab National Bank commenced its operations on April 12,1895 from Lahore with
an authorized capital of Rs. 2 lakhs and working capital limit of Rs. 20,000/- .
The Bank has more than 100 years of history and has faced many financial and other
crises in the Indian financial system over these years.
New Bank of India was a comparatively small bank among the nationalized banks.
It had around 600 branches all over the country with 12,400 employees and was
1 6 having 2,500 crores of deposits and advances Rs. 970 crores.
Whereas PNB was working with 3734 branches all over the country with total Bank Mergers and
employees numbered 71,650. it was having total deposits of Rs. 25,280 crore and Acquisitions
advances of Rs. 12,078 crore.
This was the first case in the Indian History that one nationalized bank was merged
with another nationalized bank. The basic reasons for this merger were as follows:
– The New Bank of India was in loss consecutively for last three years when
merger took place on 4th September, 1993.
– Productivity per employee of New Bank of India was low.
– Work ethics of the union(s) workers was low.
– Only option left out was either liquidation or merger with another bank.
Since it was a small bank having its head office in Delhi and also with the similarities
of work culture of Punjab National Bank whose head office also happened to be in
Delhi, Govt. of India under recommendations of Narasimham Committee report
decided to merge New Bank of India with Punjab National Bank.
Table 16.2: Financials of the PNB and NBI at the time of Merger (1992-93)

PNB NBI PNB+NBI

Capital (Rs. in Crore) 187.84 68.69 256.53
No. of Shares 187842200 186000000 373842200
Reserves (Rs. in Crore) 360.94 8.43 369.37
Profits (Rs. in Crore) 38.01 (-)75.79 (–)37.382
Earnings per Share (Rs.) 2.02 (-) 4.07 (–) 1.01
Deposits (Rs. in Crore) 18241.31 2362.32 20603.63
Advances (Rs. in Crore) 9915.21 974.81 10890.02

The PNB and NBI merger has not been a marriage of convenience. It had the seeds of
long-term detrimental effect to the health of PNB. The most ticklish problem which
the amalgamated entity faced was the complete absorption of the sizeable NBI
workforce into its own work-culture. The NBI was notorious for rampant indiscipline
and intermittent dislocation of work due to fierce inter-union rivalries.

ICICI Bank and Bank of Madura Merger

Bank of Madura (BOM) was a profitable, well-capitalized, Indian private sector
commercial bank operating for over 57 years. The bank had an extensive network of
263 branches, with a significant presence in the southern states of India. The bank had
total assets of Rs. 39.88 billion and deposits of Rs.33.95 billion as on September
30,2000. The bank had a capital adequacy ratio of 15.8% as on March 31,2000.
The Bank’s equity shares were listed on the Stock Exchanges at Mumbai and Chennai
and National Stock Exchange of India before its merger.
ICICI Bank then was one of the leading private sector banks in the country. ICICI
Bank had total assets of Rs. 120.63 billion and deposits of Rs. 97.28 billion as on
September 30, 2000. The bank’s capital adequacy ratio stood at 17.59% as on
September 30, 2000. ICICI Bank was India’s largest ATM provider with 546 ATMs
as on June 30, 2001. The equity shares of the bank were listed on the Stock
Exchanges at Mumbai, Calcutta, Delhi, Chennai, Vadodara and National Stock
Exchange of India. ICICI Bank’s American Depository Shares were listed on the New
York Stock Exchange.

1 7
Special Issues In February 2000, ICICI Bank was one of the first few Indian banks to raise its
capital through American Depository Shares in the international market, and received
an overwhelming response for its issue of $ 175 million, with a total order of USD
2.2 billion. At the time of filling the prospectus, with the US Securities and
Exchange Commission, the Bank had mentioned that the proceeds of the issue would
be used to acquire a bank.
As on March 31, 2000, bank had a network of 81 branches, 16 extension counters
and 175 ATMs. The capital adequacy ratio was at 19.64% of risk-weighted assets, a
significant excess of 9 % over RBI Benchmark.
ICICI Bank was scouting for private banks for merger, with a view to expand its
assets and client base and geographical coverage. Though it had 21% of stake, the
choice of Federal bank, was not lucrative due to employee size (6600), per employee
business was as low as Rs. 161 lakh and a snail pace of technical upgradation. While,
BOM had an attractive business per employee figure of Rs. 202 lakh, a better
technological edge and a vast base in southern India as compared to Federal Bank.
While all these factors sound good, a cultural integration was a tough task ahead for
ICICI Bank.
ICICI Bank had then announced a merger with the 57 year old BOM, with 263
branches, out of which 82 of them were in rural areas, with most of them in southern
India. As on the day of announcement of merger (09-12-2000), Kotak Mahindra
group was holding about 12% stake in BOM, the Chairman BOM, Mr. K.M.
Thaigarajan, along with his associates was holding about 26% stake, Spic group had
about 4.7%, while LIC and UTI were having marginal holding. The merger was
supposed to enhance ICICI Bank’s hold on the south Indian market.
The swap ratio was approved in the ratio of 1:2- two shares of ICICI Bank for
normal every one share of BOM. The deal with BOM was likely to dilute the current
equity capital by around 2%. And the merger was expected to bring 20% gains in
EPS of ICICI Bank and a decline in the bank’s comfortable Capital Adequacy Ratio
from 19.64% 17.6%.
Table 16.3: Financials of ICICI Bank and Bank of Madura
(Rs. In Crores)

Parameters ICICI Bank ICICI Bank Bank of Madura Bank of Madura

1999-2000 1998-1999 1999-2000 1998-1999
Net worth 1129.90 308.33 247.83 211.32
Total deposits 9866.02 6072.94 3631.00 3013.00
Advances 5030.96 3377.60 1665.42 1393.92
Net Profit 105.43 63.75 45.58 30.13
Shre capital 196.81 165.07 11.08 11.08
Capital adequacy ratio 19.64% 11.06% 14.25% 15.83%
Gros less NPAs/gross 2.54% 4.72% 11.09% 8.13%
advances
Net NPAs/net advances 1.53% 2.88% 6.23%5 4.66%

The scheme of amalgamation was expected to increase the equity base of ICICI Bank
to Rs. 220.36 crore. ICICI Bank was to issue 235.4 lakh shares of Rs. 10 each to the
shareholders of BOM. The merged entity will have an increase of asset base over
Rs. 160 billion and a deposit base of Rs. 131 billion. The merged entity will have 360
branches across the country and also enable ICICI Bank to serve a large customer
base of 1.2 million customers of BOM through a wider network, adding to the
customer base to 2.7 million.
1 8
Some Issues of the Merger Bank Mergers and
Acquisitions
The Board of Directors at ICICI Bank had contemplated the following synergies
emerging from the merger:
Financial Capability: The amalgamation will enable them to have a stronger financial
and operational structure, which is supposed to be capable of grater resource/deposit
mobilization. In addition to this, ICICI will emerge as one of the largest private sector
banks in the country.
Branch Network: The ICICI’s branch network would not only increase by 263. but
also increase its geographic coverage as well as convenience to its customers.
Customer Base: The emerged largest customer base will enable the ICICI Bank to
offer other banking and financial services and products to the erstwhile customers of
BOM and also facilitate cross selling of products and services of the ICICI group to
their customers.
Tech Edge: The merger will enable ICICI Bank to provide ATM, phone and the
Internet banking and such other technology based financial services and products to a
large customer base, with expected savings in costs and operating expenses.
Focus on Priority Sector: The enhanced branch network will enable the bank to
focus on micro finance activities through self-help groups, in its priority sector
initiatives through its acquired 87 rural and 88 semi-urban branches.
Managing Rural Branches: Most of the branches of ICICI were in metros and major
cities, whereas BOM had its branches mostly in semi urban and city segments of
south India. The task ahead lying for the merged entity was to increase dramatically
the business mix of rural branches of BOM. On the other hand, due to geographic
location of its branches and level of competition, ICICI Bank will have a tough time to
cope with.
Managing Software: Another task, which stands on the way, is technology. While
ICICI Bank, which is a fully automated entity was using the package, banks 2000,
BOM has computerized 90% of its businesses and was conversant with ISBS
software. The BOM branches were supposed to switch over to banks 2000. Thought
it is not a difficult task, 80% computer literate staff would need effective retraining
which involves a cost. The ICICI Bank needs to invest Rs.50 crores, for upgrading
BOM’s 263 branches.
Managing Human Resources: One of the greatest challenges before ICICI Bank was
managing the human resources. When the head count of ICICI Bank is taken, it was
less than 1500 employees; on the other hand, BOM had over 2,500. The merged entity
will have about 4000 employees which will make it one of the largest banks among the
new generation private sector banks. The staff of ICICI Bank was drawn from 75
various banks, mostly young qualified professionals with computer background and
prefer to work in metros or big cities with good remuneration packages.
Managing Client Base: The client base of ICICI Bank, after merger, will be as big as
2.7 million from its past 0.5 million, an accumulation of 2.2 million from BOM. The
nature and quality of clients is not uniform. The BOM has built up its client base over
a long time, in a hard way, on the basis of personalized services. In order to deal with
the BOM’s clientele, the ICICI Bank needs to redefine its strategies to suit to the new
clientele. If the sentiments or a relationship of small and medium borrowers is hurt; it
may be difficult for them to reestablish the relationship, which could also hamper the
image of the bank.

1 9
Special Issues ICICI Ltd. and ICICI Bank Merger
The merger between ICICI Bank and ICICI Ltd. pioneered the concept of Universal
Banking in India. Taking the reverse merger route ICICI Ltd. Merged with its
erstwhile subsidiary, ICICI Bank. The swap ratio has been decided at 2:1 that is 1
share of ICICI Bank for every 2 shares held in ICICI Ltd. It was also supposed to
include merger of two ICICI subsidiaries, namely, ICICI Personal Finance Services
Limited and ICICI Capital Services Limited with ICICI Bank.
At the time of merger, ICICI Ltd was holding (held) 46 per cent stake in ICICI Bank.
In the case of merger, instead of extinguishing the shares, the company has decided to
transfer the stake to a Special Purpose Vehicle (SPV) to be created in the form of a
trust. Post merger, this was to form about more than 16 per cent of the total capital.
This is an intelligent move by the company, as it would serve many purposes. First of
all it is not prudent to extinguish capital in a scenario where the cost of raising capital
itself is very high. Secondly, by doing so the bank would be able to safeguard its
capital adequacy ratio. Thirdly, the plan is to divest the stake to a strategic partner
few years down the line, which would fetch the bank considerable amount of cash.
The shares would be transferred to the SPV at the price at which ICICI bought the
shares i.e. Rs 12 per share.

Reason for Merger

l Analysts say ICICI wanted to merge with its banking subsidiary to obtain
cheaper funds for lending, and to increase its appeal to investors so that it can
raise capital needed to write off bad loans.
l This merger was basically a survival, more for ICICI, as its core business didn’t
look too good and they needed some kind of a bank because only a bank has
access to low-cost funds.
l Cheap Cash was another reason for merger.
Main Concerns
l A major concern in the road ahead to the merger was the reserve requirement that
a bank was supposed to maintain. At that time these requirements were not
applicable to ICICI Ltd. A bank has to maintain a Cash Reserve Ratio of 5.5
per cent with RBI and Statutory Liquidity Ratio of 25 per cent. ICICI required a
total of Rs.18,000 crore to fulfill this requirement. This was a huge amount and
given the scenario of that time and it was difficult for the institutions to raise
such an amount. The group planned to raise the required funds partly through
ICICI and partly through ICICI Bank.
l Another issue was of fulfilling the priority sector lending requirement. This
requirement at the time of merger was at 40 per cent i.e. 40 per cent of the
lending was to be made to priority sectors.
Benefit to the Players
l The main objective of adopting the path of Universal Banking is that
financial institutions are finding it increasingly hard to survive in a scenario of
high cost of borrowing and decreasing spread with interest rates going down.
Cost of borrowing for a financial institution through bonds is much higher than
a bank, which can raise current and saving deposits. As per regulations,
financial institutions cannot raise these deposits. Post merger it would be
possible to do so.
l Also increasing disintermediation had made things increasingly difficult for
ICICI Ltd. Some of the customers of ICICI Ltd. were in a position to access
funds at much lower cost than from ICICI Ltd. and ICICI Ltd. could not afford
2 0
 to lend at that rate as its own cost of funds was high. Once converted into a Bank Mergers and
bank, its access to cheap funds would enable it to lend at competitive rates. Acquisitions

l ICICI Ltd. as a combined entity would be better equipped to handle issues

arising from potential asset liability mismatches due to more stable deposit base.
l Post merger ICICI Bank would be able to significantly enhance its fee based
income based on the strength of its balance sheet. Before the merger, ICICI Ltd.
could not carry out certain activities as it was not a bank and therefore loses out
on the fee based income. ICICI Bank on the other hand was constrained because
of the limited size of its balance sheet. The sheer size of the balance sheet post
merger would boost the fee based income.
l The high margin retail loan portfolio before the merger was with the various
subsidiaries. Post merger this was to be transferred to ICICI Bank.

The Negative Side of the Merger

l The assets quality of ICICI Bank, which has been its major strength, would be
affected post merger. ICICI Ltd. had NPAs of 5.2 per cent for FY01 as against
ICICI Bank’s NPAs of 1.4 per cent.
l Before the merger, ICICI Ltd. could claim a deduction upto 40 per cent of its
profits from its long term lending by transferring the amount to special reserve.
Post merger, this benefit was to stand withdrawn in the case of incremental loans.
l Average cost of borrowing for ICICI Ltd. for financial year 2001 was 11.71 per
cent. Its Gross yield was 13.54 per cent for the same period. Either way ICICI
Ltd. would have to take a hit in the bottom-line in the initial years.
l By bringing down its loan portfolio and diverting these funds for the reserve
requirement it would have to forego some of the interest spread.
l CRR would get a return of 6.5 per cent and amount in SLR would generate a
return of about 9.5 per cent. Even in the case of fresh funds the cost of
borrowing would be higher and the return on those funds would be less.
Table 16.4: Some Financial Parameters at the time of Merger

Particular ICICI Ltd. ICICI Bank

MP at the time of merger (Rs.) 51 101

EPS (Rs.) 15.4 11.9
Book Value (Rs.) 102.8 65.5
MP/ Book Value 0.50 1.54
PE ratio 3.3 8.5

ICICI group has pioneered the concept of universal banking in India. IFCI Ltd is also
in the process of merging with PNB. The concept of universal banking has found
favour with many global players. Some of the international players, which have
realized the benefits of universal banking are ABN-AMRO, Citigroup, HSBC, UBS
etc. No doubt in the times to come the benefits of this will start flowing in.

16.9 SUMMARY
As a result of economic changes and liberalization, the corporate sector has been
undergoing major changes and restructuring themselves to face these challenges.
Corporate restructuring can take place in three different ways; restructuring of
business portfolios, financial restructuring, and organisational restructuring. Mergers
could be of three types; vertical mergers, horizontal mergers, and conglomerate 2 1
Special Issues mergers. Before the liberalization process started in India, there used to be bank
mergers as and when a bank lands itself into problems. However, the merger of Times
Bank into HDFC Bank started a new wave of merger of healthy banks in order to get
synergic benefits. After the Khan Group recommendations the DFIs have also started
thinking of merging with banks in order to have easy and cheap access to funds.

16.10 KEY WORDS

Narrow Banks mean banks which place their funds only in short-term, risk-free
assets or demand deposits of banks are matched by safe and liquid assets. They have
access to deposit insurance as well as to the payment system.
Universal Banks: Banking that includes investment services in addition to services
related to savings and loans.
Merger: Merger is a combination of two or more companies into one company. In
India, we call mergers as amalgamations, in legal parlance. The acquiring company
acquires the assets and the liabilities of the target company. Typically, shareholders of
the amalgamating company get shares of the amalgamated company in exchange for
their existing shares in the target company.
Takeover: Takeover can be defined as the acquisition of controlling interest in a
company by another company. It does not lead to the dissolution of the company
whose shares are being acquired. It simply means a change in the controlling interest
of a company through the acquisition of its shares by another group.

16.11 SELF ASSESSMENT QUESTIONS

1. Why do banks go for mergers? Explain the reasons with suitable examples.
2. Explain the trends in bank restructuring in India?
3. Distinguish between mergers and Takeovers.
4. Describe the procedure for Bank Amalgamations as laid down by theBanking
Regulation Act, 1949.
5. Discuss the major recommendations of Khan Group.
6. Discuss the different types of Bank mergers that are taking place in India in
recent time.

16.12 FURTHER READINGS

Ravi Sankar, K.,2003, Financial Analysis of Takeovers, Anmol Publishers (pvt.)
Ltd., New Delhi.
Mattoo, P.K, 1998, Corporate Restructuring: An Indian Perspective, Macmillan
India, New Delhi.
Shiva Ramu, 1998, Corporate Growth through Mergers and Acquisitions,
Response Book, New Delhi.
Weston J. Fred, Chung Kwang S, and Hong Susan E., 1998, Mergers,
Restructuring, and Corporate Control ,Prentice-Hall of India, New Delhi.
Alexandra M. post, 1994 Anatomy of a merger: the causes and effects of Mergers
and Aacquisitions, Prentice Hall, Englewood cliffs, New Jersey.
Report of the Narasimham Committee on Banking Sector Reforms.
Report of the Working Group for Harmonizing the Role and Operations of DFIs and Banks.
Report of the Working Group on Restructuring of Weak Public Sector Banks.
Banking Regulation Act, 1949.
2 2
 Appendix 16.1 Bank Mergers and
Acquisitions
Summary Report of the Working Group on
Restructuring Weak Public Sector Banks

Introduction
1. The Reserve Bank of India, in consultation with the Government of India, set up
the present Working Group under the chairmanship of Shri M.S. Verma, former
Chairman, State Bank of India, and presently Honorary Adviser to the Reserve Bank
of India, to suggest measures for revival of weak public sector banks. The terms of
reference were (a) criteria for identification of weak public sector banks, (b) to study
and examine the problems of weak banks, (c) to undertake a case by case examination
of the weak banks and to identify those which are potentially revivable, and (d) to
suggest a strategic plan of financial, organisational and operational restructuring for
weak public sector banks.

International Experience
2. During the last twenty years, over 130 countries, developed and developing, have
experienced banking crises in one form or the other. The Working Group has tried to
understand the strategies adopted by some of these countries in the handling of the
crises. Restructuring of a banking system needs to address macro systemic issues
pertaining to factors responsible for ensuring banking soundness and also the micro
level, individual bank problems. While there is no unique solution to banking crises
that could be prescribed and applied across the board to all countries, there are some
common threads that seem to run through all cases of successful restructuring.
Initially, each bank needs to be restored to a minimum level of solvency through
financial restructuring. Thereafter, only longer term operational and systemic
restructuring can help them maintain their competitiveness and enable them to ensure
sustained profitability. Only a comprehensive approach to restructuring can have a
lasting effect on the cost, earnings and profits of the banks to be restructured.

Public Sector Banks: An Overview

3. Till the adoption of prudential norms relating to income recognition, asset
classification, provisioning and capital adequacy, twenty-six out of twenty-seven
public sector banks were reporting profits (UCO Bank was incurring losses from
1989-90). In the first post-reform year, i.e., 1992-93, the profitability of the PSBs as a
group turned negative with as many as twelve nationalised banks reporting net losses.
By March 1996, the outer time limit prescribed for attaining capital adequacy of 8 per
cent, eight public sector banks were still short of the prescribed level.
4. The emphasis on maintenance of capital adequacy and compliance with the
requirement of asset classification and provisioning norms put severe pressure on the
profitability of PSBs. Deregulation of interest rates on deposits and advances has
intensified competition and PSBs now have to contend with competition not only from
other public sector banks but also from old/new private sector banks, foreign banks
and financial institutions. While some public sector banks have succeeded in adjusting
to the changing business environment and managed competition some others have not
been able to do so, and have displayed serious weaknesses.
5. The malady has been deep in the case of three banks, viz., Indian Bank, UCO
Bank and United Bank of India. Continuous decline in profitability and efficiency of
these banks and their dependence on capital support from government are causes for
concern. They are trapped in a vicious circle of declining capability to attract good
business and increasing need for capital support.
2 3
Special Issues 6. It is likely that the seeds of weakness are latent in some other public sector banks
as well. The problem of weak banks, which could have spill over effect on the system
itself, therefore, assumes serious proportions.
7. The Committee on Banking Sector Reforms (CBSR) had recommended that a
weak bank would be one (a) where accumulated losses and net NPAs exceed the net
worth of the bank or (b) one whose operating profits less the income on
recapitalisation bonds has been negative for three consecutive years. To identify a
bank’s weakness or strength with a fair degree of certainty, the Group has
recommended the use of the following seven parameters in conjunction with the two
suggested by the CBSR: (i) capital adequacy ratio, (ii) coverage ratio, (iii) return on
assets, (iv) net interest margin, (v) ratio of operating profit to average working funds,
(vi) ratio of cost to income, and (vii) ratio of staff cost to net interest income (NII) +
all other income.

Identification of Weak Banks

8. All the public sector banks were evaluated on the above seven parameters keeping
the median as the threshold in five of the parameters. For capital adequacy ratio, the
threshold was 8 per cent and in respect of the coverage ratio it was kept at 0.50 per cent.
9. Indian Bank did not meet any of the parameters in both the years. UCO Bank and
United Bank of India could comply with the capital adequacy prescription but failed in
all the other six parameters. These banks, along with Indian Bank, were the only
banks to have received capital infusion during the last two years and would not have
attained minimum capital adequacy otherwise.
10. The above approach serves the immediate objective of setting the criteria for
identifying weakness in banks in general and for locating potentially weak banks. The
Working Group, therefore, recommends building a database in respect of banks on an
ongoing basis for the purpose of benchmarking and on that basis identifying signals of
weakness.

Causes of Weakness
11. The causes of weakness need to be addressed properly so that the remedial
measures adopted prove effective and actually succeed in improving the functioning of
the weak banks. The weaknesses relate to three areas: operations, human resources
and management.
12. Operational failures mainly relate to high level and fresh generation of NPAs,
slow decision making with regard to fresh sanction of advances and compromise
proposals and loss of fund-based advances and fee income. Declining market share in
key areas of operations, limited product line and revenue stream, absence of cost
control and effective MIS and costing exercise, weak internal control and
housekeeping, poor risk management and insufficient customer acquisition due to
mediocre service, low level of technology and non-competitive rates are the other causes.
13. The operations of subsidiaries and foreign branches, which are a drain on two of
the banks, lead bank and RRB responsibilities and locational disadvantages are also
related issues.
14. Overstaffing, low productivity and a high age profile are the main HR related
issues. Restrictive practices in deployment of staff have further aggravated the cost of
overstaffing. In the three identified banks, staff cost as a proportion of total operating
income has been above the industry median. Another area of concern is the level of
skill and low levels of motivation. Skills in foreign exchange, treasury management
and other specialised areas are not significant enough to generate business in these
areas on a sustained basis.
2 4
15. Training facilities are not adequate to meet the training requirements of the staff Bank Mergers and
of the banks and motivation and morale of employees at all levels is low. Acquisitions

16. Under management related issues, lack of succession planning, short tenures and
frequent changes in top management, inadequate support from the Board of Directors
and the lackadaisical implementation of earlier SRPs and MOUs are causes of
weakness. Even after infusion of Rs. 6,740 crore in the three banks over the last seven
years, their basic weaknesses persist. Unconditional recapitalisation from the
Government of India has proved to be a moral hazard as no worthwhile attempt has
been made by the banks to gain adequate good business or to reduce costs.

Past Efforts at Restructuring

17. The restructuring efforts initiated so far have not had the desired impact. Hard
options have been avoided and the steps taken so far have only had the objective of
maintaining the capital adequacy ratio of the banks with the assistance of Government
of India. The banks have failed to develop the required resilience or strength to
become competitive in the true sense.

Present Position of the Weak Banks

Indian Bank
18. Indian Bank continued to incur operating losses in 1998-99 also. The capital
adequacy which had turned positive and reached 1.41 per cent in March 1998 with
capital infusion of Rs. 1,750 crore from the Government of India turned negative
again in March 1999. The decline in other income continued during 1998-99 as well.
The bank did not make any provision for liabilities arising on account of the
proposed wage revision. The deterioration on the NPA front is unabated. Gross NPA
went up from Rs. 3,428 crore as on 31 March 1998 to Rs. 3,709 crore as on
31 March 1999, i.e., 37 per cent of gross advances. This was the highest among
public sector banks.

UCO Bank
19. UCO Bank’s operating profit improved marginally in 1998-99. However, if the
interest income on recapitalisation bonds is excluded, the bank would have incurred
operating loss of Rs. 91 crore in 1997-98 and Rs. 157 crore in 1998-99.
Recapitalisation by the government to the tune of Rs. 200 crore helped the bank
achieve capital adequacy of 9.63 per cent in 1998-99. The bank has not made
provision for liability on account of wage revision. Gross NPAs as on 31 March 1999
aggregated Rs. 1,716 crore (23 per cent). Net NPAs at Rs. 715.63 crore were higher
as compared to Rs. 705 crore as on 31 March 1998. The inability of the bank to
register any improvement in the net NPA position is a matter for concern.

United Bank of India

20. United Bank of India’s operating profit decreased substantially in 1998-99.
Operating income increased mainly on account of extraordinary income by way of
interest received on income tax refund. Further, if the interest income on
recapitalisation bonds is excluded, the bank would have incurred operating loss of
Rs. 89 crore in 1997-98 and Rs. 117 crore in 1998-99. Recapitalisation by the
Government of India to the tune of Rs. 100 crore helped the bank achieve capital
adequacy of 9.60 per cent in 1998-99. The bank has not made provision during
1998-99 for future pension liability and wage revision. The gross NPAs of the bank as
on 31 March 1999 increased in absolute terms to Rs. 1,549 crore (32 per cent) from
Rs. 1,451 crore as on 31 March 1998 (34 per cent). Net NPAs also went up to
Rs. 573 crore (15 per cent) as on 31 March 1999 from Rs. 472 crore (14 per cent) as
on 31 March 1998. 2 5
Special Issues Assessment of Revival Plans Prepared by the Banks
21. The plans prepared by the banks at the Working Group’s instance were no better
than the earlier ones that had failed in that they continue to be based on ambitious
projections of growth in business and income for which the banks are not equipped in
terms of skill or technology. The plans do not reflect the growing compulsions of
having to achieve steady growth in income and sustained control of expenditure within
as short a time as possible. Therefore, the restructuring plans drawn up by the banks
do not meet the objectives. It is felt that, as long as government assurance as to
continued capital infusion is there, the banks would only look at soft options
regardless of the time and cost involved.

Future Course of Action

22. The restructuring exercise has to be comprehensive and must address operational
and financial restructuring simultaneously. There is no room for half way measures or
gradualism. It is tempting to confine restructuring to financial aspects since solvency
is immediately restored and there is a visible impact on the balance sheet. But, if
operational aspects are not attended to, long term sustainability cannot be ensured.
This will only lead to additional problems necessitating further and costlier
restructuring down the road.
23. Future restructuring strategies must incorporate the core principles of manageable
cost, least burden on the exchequer, sharing of losses equitably and strong internal
governance. There should be an independent agency that will constantly monitor the
progress of restructuring.
24. Bank restructuring has been attempted mainly by using one or more of the
following modalities: merger or closure, change in ownership, narrow banking and a
comprehensive operational and financial restructuring. The Working Group has
examined the applicability of each of the above options in the present Indian context.

Merger or Closure
25. Merger would be advantageous only if it takes into account the synergies and
complementing strengths of the merging units. The Working Group does not
recommend merger as a possible solution in reviving the weak banks without first
preparing them for it.
26. Closure has a number of negative externalities affecting depositors, borrowers,
other clients, employees and, in general, the areas served by the banks being closed.
This is an extreme option and would need to be exercised after all other options of
successful restructuring are ruled out.

Change in Ownership
27. Privatisation is an acceptable course as this process alone can reduce the
government’s responsibility of capitalising the three banks further and, in the long run,
enable it to recoup, fully or partially, the investment made in their capital. This will
remove the moral hazard implicit in the present situation that government support will
always be available and make the three banks responsive to the rules of market
economy. The three banks will then also have a sense of accountability to all the
stakeholders and appreciate the need for good performance.
28. However, in their present state, it is just not possible to consider their
privatisation because the cost of restructuring is prohibitively high and no private
group can normally be expected to bring in the kind of resources that the three banks
require at present. These banks are also not likely to succeed in accessing the capital
market given their present position. Their present staffing pattern and level of skills
2 6 and technology will be deterrents to any investor.
Narrow Banking Bank Mergers and
Acquisitions
29. All the three weak banks have pursued some form of narrow banking, without
success, for reasons such as inability to lend to quality customers, as a matter of
deliberate policy, high levels of NPAs and “fear psychosis”. Preferring government
securities to fresh lending creates dissatisfied borrowers who tend to change their
bank. Banks’ ability to generate non-interest income is linked to the size and quality of
their advances portfolio. A restriction on this results in a fall in fee income. Such a
two-pronged loss in income adds to the weakness of the bank making its recovery even
more difficult. Further, resorting to narrow banking does not protect a bank against all
risks as even investments in gilts are open to market risks. In any case, narrow
banking can at best be only a temporary phase and cannot by itself be adopted as a
restructuring strategy.

Comprehensive Operational and Financial Restructuring

30. With the three other options not being found suitable to the present environment,
the only other option left for consideration is that of a comprehensive operational and
financial restructuring. The Group has tried to answer the question whether this option
of restructuring is available in the case of the three identified weak banks.
31. The three banks are obviously beset with serious weaknesses and have not been
able to turn around despite repeated recapitalisations almost all through the 1990s
adding up to a massive sum of Rs. 6,740 crore. They continue to depend upon the
government for further recapitalisation and Indian Bank alone will need another Rs.
1,000 crore urgently to gain the prescribed minimum capital adequacy of 9 per cent
with no guarantee that at the end of the current year, they will once again not need
further infusion of capital to maintain this ratio. The position of the other two banks is
only marginally better as they do not need capital infusion immediately. However,
their future operations too are unlikely to continue without further infusion of capital.
It does not, therefore, make economic sense to let them continue in the present manner
for, after all, the government cannot undertake to capitalise them endlessly.
32. It is, therefore, time to take a long term view and ensure that the present state of
affairs does not get prolonged. The choice is, therefore, limited to either closing them
or subjecting them to such extensive operational, organisational and financial
restructuring as can effectively restore their competitive efficiencies.
33. In view of the very extensive network and large client base of each of these banks,
as also the other attendant negative externalities, closure is to be considered only as
the last option. The choice of comprehensive restructuring, therefore, requires careful
consideration. Any such restructuring, however, will mean exercising hard options and
involve firm, decisive and timely actions. There must be a firm political will backed
by firm commitments from the bank management and the employee unions that the
restructuring exercise will be completed without any let up or hindrance.
The management and employee unions of the banks will have to come to an
agreement before the restructuring exercise begins as regards every important
ingredient of the proposed exercise. The crux of the issue is that it is going to be an
expensive one-time exercise and, unless its success is reasonably assured, it will not
be worth undertaking.
34. Subject to what has been stated above, the Group has developed a four-
dimensional comprehensive restructuring programme covering operational,
organisational, financial and systemic restructuring. These are as under:
1. Operational restructuring involving
i) basic changes in the mode of operations,
ii) induction of modern technology, 2 7
Special Issues iii) resolution of the problem of high non-performing assets and
iv) drastic reduction in cost of operations.
2. Organisational restructuring aimed at improved governance of the banks and
enhancement in management involvement and efficiency.
3. Financial restructuring with conditional recapitalisation.
4. Systemic restructuring providing for, inter alia, legal changes and institution
building for supporting the restructuring process.

Operational Restructuring
35. In a well-researched document published by the IMF in 1997, one of its
contributors, Gillian Garcia, has identified the following as key elements of
operational restructuring:
a) Formulating a business plan that focuses on core products and competencies.
b) Reducing operating costs by cutting staff and eliminating branches where
appropriate, ceasing unprofitable activities, and disposing of unproductive
assets.
c) Implementing new technology and improving systems of accounting,
asset valuation, and internal controls and audit.
d) Establishing and enforcing internal procedures for risk pricing, credit
assessment and approval, monitoring the condition of borrowers, ensuring
payment of interest and principal, and active loan recovery.
e) Creating internal incentive structures to align the interests of directors,
managers, and staff with those of the owners.
The Working Group considers the above to be a very good and concise statement of
operational restructuring requirements. The plan evolved by the Working Group for
restructuring of the three banks is also on similar lines.
36. Operational restructuring for the weak banks is two pronged: one of increasing
income and the other of reducing costs. Income has to be increased by revamping the
banks’ mode of doing business and by reducing the effect of current and future NPAs
on their earnings. Cost reduction will have to be achieved by dropping the lines of
business and products that are proving to be a drag on their profitability and effecting
reduction in staff costs which account for most of the operating costs incurred by the
weak banks.

Change in mode of Operations

37. None of the weak banks is identified with any special business or customer niche.
Each of them, therefore, needs to develop strengths in chosen areas and build its skills
and business strategy around those strengths. By trying 12 to be all-India banks, they
are neither any more dominant in the area of their concentration nor are they able to
make a mark countrywide.
38. The growth of these banks’ credit portfolios has been extremely limited and their
fee-based earnings minimal. They need to take urgent steps to reintroduce credit
culture and ensure a rapid growth in non-fund based earnings by laying stress on a
few selected services, particularly, movement and management of funds.
39. These banks had left the traditional areas of business in which they had
experience and moved into areas for which they neither had skills nor the experience
and this has been their undoing. They need to go into areas in which they have the
experience and can develop expertise in a short time. The appropriate markets for
them will be the middle and lower segments of the credit market.
2 8
40. Unions have pleaded for allocation of a share of the PSU and other government Bank Mergers and
departments’ related business. Such an approach is not practical nor is it desirable Acquisitions
especially in the present deregulated environment where the banks need to stand on
their own and where these bodies themselves are autonomous in their functioning.

Foreign Branches and Subsidiaries

41. Both UCO Bank and Indian Bank would find it extremely difficult to run their
foreign branches in the short and medium term. The position even now is tenuous and
would get exacerbated if any of these operations runs into the slightest of difficulty or
if the local regulators stipulate conditions regarding capital adequacy which the banks
may not be able to meet. This could pose a problem for not only the three banks but
also for the Indian banking system. These branches need to be taken off their hands by
selling them to13 prospective buyers including other Indian public sector banks. The
resources raised could fund some of the various demands of the restructuring
operations.
42. The subsidiaries of Indian Bank are likely to be a continued drag on its viability
and would add to the cost of restructuring. A decision to close them needs to be taken
at the earliest. An effort could also be made to find buyers for the bank’s holdings in
the subsidiaries.

Adoption of Modern Technology

43. Public sector banks, particularly the weaker ones, are losing ground and share of
business to the technologically well-equipped new private sector as well as foreign
banks. The weak banks do not have either the skills or the resources to implement and
maintain complex IT solutions of the kind that are required to meet the challenges. A
desirable solution would be to have common networking and processing facilities.
Such common facilities may be outsourced from an existing reputed company. The
service provider could also be invited to follow a ‘Build Own Operate Transfer’ model
for this purpose.
44. Implementation of an IT solution in the above manner will, among other things,
enable introduction of extended working hours and shifts and improve overall
customer service. In the first stage itself, which may be spread over twelve to eighteen
months, the IT solutions should target coverage of over 70 per cent of the
participating banks’ present business. This would require that around 250 to 300 of
the largest branches from each of the three banks be linked to the proposed
outsourcing. The Working Group has estimated the total cost for this at Rs. 300 crore
which may come by way of assistance from the government or from multilateral
lending institutions.

NPA Management
45. NPAs have been the most vexing problem faced by the weak banks with additions
to NPAs often outstripping recoveries. A significant portion of the NPAs are chronic
and/or tied up in BIFR cases. There are also loans given to state and central public
sector units which have failed to repay. The operations of Debt Recovery Tribunals
are such that they have not so far made a dent in the NPA position of banks. The route
of compromises has also not been very successful despite setting up of Settlement
Advisory Committees. It is necessary that measures are found to ensure an early
resolution of chronic NPAs. Where guarantees have been given by the central or state
governments and where these have been invoked by the banks, these demands need
to be met.
46. Separate institutional arrangements for taking over problem loans have played a
key part in bank restructuring in different countries with varying degrees of success.
2 9
Special Issues The Committee on Financial System (1991) and the CBSR (1998) had made similar
recommendations. Such separation of NPAs is an important element in a
comprehensive bank restructuring strategy.
47. It would be desirable to develop a structure which will combine the advantages of
government ownership and private enterprise. The broad structure would be that of a
government-owned Asset Reconstruction Fund (ARF) managed by an independent
private sector Asset Management Company (AMC). Assets belonging to public sector
banks can be transferred to the ARF. The ARF will be constituted with the objective
of buying impaired loans from the weak banks and to recover or sell them after some
reconstruction or in an ‘as is where is’ condition. The ARF may be set up by the
proposed Financial Restructuring Authority under a special Act of the Parliament
which while protecting it against obstructive litigation from the borrowers could also
provide for quick and effective enforcement of its rights. The ARF may be required to
acquire assets of the face value of about Rs. 3,000 crore. The capital needed by the
ARF would be in the region of Rs. 1,000 crore.
48. The payment in respect of the assets purchased from the weak banks may be
made by the ARF by issuing special bonds for the purpose bearing a suitable rate of
interest. It may also be guaranteed by the government in order to improve its liquidity.
The bonds may, however, be issued to the weak bank with an initial lock-in period of
at least two years. These bonds as also those which will be issued for raising funds
against the security of assets purchased by the ARF may have a maturity of five years.
49. The ARF should purchase from the banks loans, which are NPAs as on a certain
date, say, 31 March 2000. The responsibility of recovering loans, which become
NPAs after that date should remain totally with the banks concerned. It will, therefore,
be adequate for the ARF to have a life of not more than seven years. The ARF may
buy NPAs only from the banks which have been identified as weak, though the option
of buying loans from other banks should not be closed. It should be possible to set up
more such funds later if the need arises.
50. The transfer price has to be fair to both the buyer and the seller. It would be
difficult to prescribe rigid arrangements or a floor price for the transfer of NPAs and
each case may have to be decided on merits. So long as pricing is arrived at by mutual
agreement and in a transparent manner, the Group does not consider it necessary
either to prescribe a floor price or a formula therefor.
51. The management of the ARF would be entrusted to an independent Asset
Management Company, a private sector entity, which will employ and avail of the
services of top class professionals. The AMC can be compensated for the services it
provides in the form of service commission on the value of assets managed coupled
with incentives for recoveries if these are higher than an agreed benchmark.
52. In the ownership of the AMC, while the government would have a fair share of
up to 49 per cent, may be even dominant, majority shareholding will be non-
government. The other shareholders could be institutions like SBI, LIC, GIC, UTI
and IFCI whose participation does not add to government shareholding and also
parties from the private sector. The initial capital requirement of the AMC is not
likely to be more than Rs. 15 crore and it would, therefore, not be difficult to attract
non-government participants therein. It would also be possible to attract participation
of multilateral agencies like IFC or ADB. The possibility of an existing Fund
Manager, in public or private sector, offering to manage the ARF may also be
explored.
53. To the extent that NPAs are taken off the books of the three banks and are moved
on to the Asset Reconstruction Fund, the Fund would be paying them for the assets
taken over by way of bonds bearing interest. This interest earning will add to the
3 0 concerned bank’s income which to a considerable extent will help the bank in meeting
their staff expenses. Assuming that NPAs will be transferred at a rate so as to bring Bank Mergers and
them down to the average level of NPAs in PSBs which is around 15 per cent, the Acquisitions
annual income for Indian Bank, UCO Bank and United Bank of India can be expected
to be augmented by around Rs. 91 crore, Rs. 44 crore and Rs. 24 crore respectively.
Reduction in Cost of Operations
54. Cost income ratio of the Indian Bank, UCO Bank and the United Bank of India
for the year 1998-99 worked out to 141.22, 93.94 and 89.90 per cent respectively
showing clearly that the cost of their operations has reached unsustainable levels and
that, unless the situation is corrected immediately, survival of these banks could be in
jeopardy.
55. The cost of operations of the three banks is clearly unsustainable and is
threatening long term viability and survival of these banks. When it comes to cost
management and reduction, non-staff expenses are far less critical than staff expenses.
These comprise of expenses incurred on items governed by market conditions over
which banks have little or no control.
56. Management of costs necessarily boils down to management of staff expenses
which in the year 1998-99 accounted for 76.37 per cent and 80.60 per cent of the total
operating income (NII + all other income) in UCO Bank and United Bank of India
respectively. In the case of Indian Bank, the position was much worse at 107.79 per
cent. Other similarly placed public sector banks have this ratio generally below 45 per
cent. Banks which have to allocate a comparatively lower portion of their overall
income towards their staff costs obviously have a tremendous competitive advantage
over the others.
57. Since chances of increasing income in the short term are remote, the weak banks
have little choice but to take all possible measures to reduce their staff costs and bring
it in line with at least the average performing public sector banks in terms of its
percentage to total operating income (net interest income + non-interest income).
58. The three banks have not factored in the wage revision that is to become effective
from November 1997. No provision in respect of the increase (12.25 per cent) has
been made and should it become applicable to them not only will the yearly wage bill
for the future years go up but substantial amounts will also go towards arrears for the
period beginning from the date from which the revision becomes effective.
59. With the added income from transfer of NPAs in the form of interest on the
relative bonds, the requirement of staff reduction would get suitably modified and has
been estimated to be of the order of 30 to 35 per cent in the three banks. Considering
all factors involved, the Group is of the view that initially a reduction in the staff
strength of the order of 25 per cent may serve the purpose and should, therefore, be
aimed at. This reduction in staff strength would help the banks reduce staff costs
correspondingly which going by the expenses incurred in the year 1998-99, would
work out approximately to Rs. 107 crore, Rs. 121 crore and Rs. 85 crore in the case
of Indian Bank, UCO Bank and United Bank of India respectively.
60. This step is unavoidable since continuing with the present strength could
jeopardise the survival of the three banks. In order to control their staff costs, the three
banks will have to resort to a voluntary retirement scheme (VRS) covering at least 25
per cent of the staff strength. It is estimated that a reasonable VRS for the three banks
aimed at 25 per cent reduction would cost between Rs. 1,100 and Rs. 1,200 crore.
61. The rightsizing of staff will have to be achieved by the individual banks
structuring their schemes in such a way that they are able to maintain the required
balance between the different categories of staff and do not lose the desirable
experience and skills they possess. The scheme will have to be voluntary but the right
to accept or reject individual applications should rest with the management. 3 1
Special Issues The scheme should aim at separation of employees in the age group of 45 and above
especially those in the 50-55 age group. The scheme should be in operation for a
period not exceeding six months. The banks will need to undertake considerable
retraining and relocation of the post-VRS staff strength. Such reskilling and relocation
should be made a precondition for future recapitalisation.
62. In order that the VRS and the needed reduction in staff costs have a real impact
on the operating results of the banks concerned, it would also be necessary to place a
cap on the staff expenses of the three banks. Towards this, the Working Group
recommends that a freeze on all future wage increase including the one presently
under contemplation, i.e., with effect from November 1997, be put in place. This may
continue for a period of five years.
63. If VRS does not lead to the needed reduction in the banks’ operating costs, there
will be no alternative left but to resort to an across-the-board wage cut of an order
which will result in a similar reduction in costs. It is with this urgency in mind that the
Working Group has suggested keeping the VRS open for a limited period of six
months.
64. The only other source of sustenance in these cases is recapitalisation support
from the government but this too is not readily available because of the increasing
pressures and other compelling demands on the government’s resources. If, therefore,
the banks are to survive, most efforts and sacrifices will have to be their own. Outside
support can only be limited and short term and will be predicated upon what the banks
can do themselves.

Organisational Restructuring
65. The complex administrative structure of the weak banks is a serious limitation
impairing their decision making process. Each of these layers is delay laden and
without any clarity of policies and purpose. Even though some delayering has been
attempted in some banks, especially, UCO Bank, the administrative structure
continues to be diffused. Delayering alone would not speed up decision making unless
accompanied by clearly laid out policies and procedures, skills and adequate
discretionary powers at the different levels of decision making.
66. The three banks have a larger network of branches than what their levels of
business call for. There is also the question of concentration of branches in specific
areas with which United Bank of India and UCO Bank are faced. There is an urgent
need to consider rationalisation of branches in all the three weak banks.
67. The weak banks must take a hard and careful look at the branches the levels of
business of which are below 50 per cent of the level of nationalised banks in similar
area and after convincing themselves about their unviability decide to discontinue their
operations. By continuing such operations, hoping that these will improve in future or
by showing them artificially as profitable using a transfer pricing mechanism which
favours them unduly, the problem will be compounded and elude solution even in
future. It, therefore, stands to reason that the banks merge two or more unviable
operations into one viable operation.
68. Absence of dynamic leadership for long periods has been a major contributor to
the consistent deterioration in the functioning of the three banks. There is a need for
appointing CMDs who are especially suited to their jobs and are more in the nature of
wartime generals possessing special skills and attitude required for restructuring. They
should have a sufficiently long tenure of, say, four to five years and should be in the
age group of 50-52 years. In order to ensure uninterrupted progress of the
restructuring plan and to commit the top management thereto fully, this tenure may
not be ordinarily curtailed. The right persons for these jobs should be provided with
3 2 incentives, both monetary and non-monetary, for achieving the restructuring mission
successfully even if giving such incentives means making a departure from existing Bank Mergers and
norms. If in the four or five year career of a person as CMD of a weak bank the bank Acquisitions
shows a definite improvement, he could be considered for heading one of the prime
banks/financial institutions in the country.
69. A line of succession should be developed well in time and a system put in place
whereby, save exceptions, an ED would succeed the outgoing CMD. Excepting in
very small banks, there should be two EDs. One of the two EDs could be responsible
for driving the restructuring process leaving the CMD free to pursue other strategic
growth issues.
70. The boards need to be reconstituted to include eminent professionals,
industrialists and financial experts with the necessary training, experience and
background. There should be a clear distinction between the roles of ownership, which
the government has, and that of management, which it does not. The government may,
therefore, consider withdrawing from the banks’ boards its own serving officers and
replace them with independent nominees having relevant knowledge and experience.
71. Leadership is lacking in the middle levels of these banks because of inadequacies
in skills both in the traditional areas of bank operations as well as in new and
specialised areas such as credit, treasury operations, foreign exchange and IT. While a
longer term training and reskilling programme will have to be undertaken, the banks
would also need to resort to some recruitment in the senior and middle levels of
management from the market.
72. The training facilities are inadequate to meet the needs that would arise following
the restructuring efforts. These will have to be considerably strengthened. Training
facilities created by more than one bank could be pooled for optimum utilisation of the
limited training skills available. A sub-allocation out of the capital support earmarked
for VRS may be made for re-skilling and training.
Financial Restructuring
73. Financial restructuring has to be undertaken to ensure solvency. Capital infusion
in the three identified weak banks has so far aggregated Rs. 6,740 crore. Further
capital infusion in the case of Indian Bank is imperative to ensure its continued
operations. Financial restructuring should aim at raising CAR to at least one per cent
above the minimum required so that the banks can continue with their normal credit
business.
74. To the extent immediate cash funds are not being made available, the present
mode of recapitalisation by way of recapitalisation bonds may be continued. A portion
of the additional capital requirement would need to be provided in cash in the form of
either preference capital or long term subordinated debt. On this, the banks should
have an obligation of giving a return. Without this, they will fail once again to
appreciate the necessity of developing minimum competitive efficiency and their
obligation to service capital. Recapitalisation must be accompanied by strict
conditions relating to operating as well as managerial aspects of the recipient bank’s
working. Conditions should also apply to the manner in which these funds can be
deployed.
75. Additional capital is required to meet the cost of (a) moving some portion of the
NPAs out of the books, (b) cost of modernisation of technology, (c) HRD related costs
including that of VRS, relocation and training and (d) capital adequacy. Funds
required under (b) and (c) will have to come by way of cash. Requirements for items
under (a) and (d), however, can be met through recapitalisation bonds as hitherto.
Funds should become available only when the banks undertake the specific activities
for which these have been earmarked.
3 3
Special Issues 76. Recapitalisation should be under an agreement, between the government on the
one side and the bank’s Board of Directors, its management and staff and employee
unions on the other, laying out the restructuring goals. The agreement, while stating
clearly the extent of government’s involvement and the responsibilities of the bank,
should also contain details of the bank’s obligations to perform and report, precise
milestones for performance and measures that will follow non-performance, treatment
of NPAs and near term improvements in operating results. It would also be desirable
to assign selected financial indices for the bank to follow within a timeframe. The
performance under this agreement will have to be monitored closely.
77. The overall cost of restructuring the three banks over the next three years is
estimated by the Working Group to be of the order of Rs. 5,500 crore. A purpose-wise
break-up of the required amount is given below:
a. Technology Upgradation Rs. 300-400 crore
b. VRS Rs. 1,100-1,200 crore
c. NPA Buyout Rs. 1,000 crore
d. For Capital Adequacy Rs. 3,000 crore
The estimate could turn out to be inadequate if some hidden surprises surface or some
delays or other roadblocks are encountered in the course of implementing the
programme.

Systemic Restructuring
78. In order to ensure success in restructuring of weak banks, Government of India
should also consider setting up of an independent agency, say, Financial Restructuring
Authority (FRA), to co-ordinate and monitor the progress of the programme. It will
represent the owner, in this case the Government of India and, vested with due
authority from the government, be able to give the banks undergoing restructuring,
guidance and instructions for proper implementation of the programme including
course corrections wherever necessary. It will approve bank specific restructuring
programmes, enter into agreements with individual banks covering the terms and
conditions of the programmes and follow up its progress with the bank and other
concerned agencies. Among other things, it will also act as an owner of the Asset
Reconstruction Fund on behalf of the government and ensure its proper governance.
It would be desirable to set up such an authority under an Act of the Parliament so
that with the force of law behind it the FRA enjoys a distinct individuality. The FRA
is not being conceived as a permanent body as it is expected that, with the completion
of the restructuring process of the weak banks, it would have outlived the utility of its
existence and would be wound up with the winding up of the ARF it will own.
79. It will facilitate the process substantially and help effective implementation of the
restructuring programme if within the Reserve Bank of India, a special wing is formed
for regulating and supervising weak banks. On a number of issues like deposit
insurance, regulation of subsidiaries, risk management, disclosures and regulatory
compliance, the treatment of weak banks would need to be different from those of
much stronger normal banks. This arrangement would also help early detection of and
attention towards weaknesses emerging in other banks pre-empting a systemwide
spread of their problems.
80. Prolonged litigation prompted by legal lacunae in different commercial
enactments is one of the main reasons for the increase in the size of the banks’ NPAs.
Some of these enactments are several decades old and, in quite a few cases, out of line
with the present day realities. These provisions need to be amended urgently and some
new enactments are called for in order to cater to the requirements of the changed and
far more complex current economic and business environment.
3 4
81. Countries like Thailand and Malaysia which have undertaken extensive bank Bank Mergers and
restructuring recently have within a short period enacted amendments to their Acquisitions
bankruptcy laws and improved provisions for foreclosures and court procedures to
ensure speedier enforcement of lenders’ claims. Malaysia is also setting up specialised
bankruptcy courts and steps have been taken there to plug loopholes that previously
allowed borrowers to contract additional debts or dispose of their assets while
restructuring was being worked out. Our problems are similar and it would be of great
help to banks’ efforts in managing their NPAs if comparable laws are suitably
enacted/amended urgently.
82. DRTs have helped the recovery process of the banks only in a limited manner.
Their functioning is under review. Till necessary amendments to the Recovery of
Debts Due to Banks and Financial Institutions Act, 1993, are made, steps should be
taken to remove the administrative and infrastructural problems relating to the DRTs
to improve and facilitate their effective functioning. Insofar as the recovery process of
weak banks and the ARF is concerned, an arrangement may be worked out for the
DRTs to attend to their cases on a priority basis.
83. The investigations into accountability both at the bank and at the level of non-
bank agencies if completed in a time bound manner would go a long way in ending
uncertainties and help in the overall improvement of morale of the staff. A time bound
approach is absolutely necessary for creating appropriate conditions in banks in
general and in weak banks in particular.

Concluding Remarks
84. The restructuring programme will have to encompass operational, organisational,
financial and systemic restructuring and must be implemented in a time bound manner.
Any delay will add to the cost of the restructuring. The different measures suggested
by the Group for financial, operational and systemic restructuring are a unified
package and for results to be really achieved have to be implemented as such. A stage
has reached when gradualism will not succeed and if resorted to may cause more harm
than good. By adopting a pick and choose approach, not only a total effect expected
from the package will be lost, but even the individual measures picked up for
implementation would lose much of their efficacy.

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