1.

1INTRODUCTION
INDUSTRY

OF

BANKING

A bank is a concern, which carries on the business of keeping the money of some people and leading money to other people. Banking signifies some form of dealing in money and securities. It is essentially the business of playing go-between the lenders and borrowers. It is the middling or intermediation function between the savings surplus and saving deficit economic units within a society.

Definition of Bank
It is very difficult to give a precise definition of a bank due to the fact that a modern bank performs a variety of functions. Different economists have given different definitions of a bank. Some of the definitions are as under:-

A bank collects money from those who have it to spare or who are saving it out of their incomes, and it lends this money to those who require it. G.Crowther

Under section 5(b) Banking means the accepting after the purpose of Indian companies lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawals by cheque, draft or otherwise. The banking companies (Regulation) Act, 1949 Under Section 5(c) A Banking Company is defined as any company which transacts the business of banking in India.

The banking companies (Regulation) Act, 1949

1.2 Evolution of Banking

Indian banking system, over the years has gone through various phases after establishment of reserve Bank of India in 1935 during the British Rule, to function as Central Bank of country. Indian banking system has become a powerful instrument for economic development today. As we all know about the economic development programs, which started from 1950 in India, at that time government was really conscious was about rural development. During the 1950s in India, banks were very conservative and inward looking, concerned with their profits. As a matter of fact, competition was not in existence. On the one side of the fence was State Bank of India alone, enjoying Govt. patronage and on the other side were private commercial banks, local by orientation, primarily serving the interests of the controlling business houses. Therefore, neither State Bank of India nor others cared much for the public they had limited range of services which included, current accounts, Terms Deposit Accounts and Savings Bank Accounts in deposits area. In the area of advances, limit were sanctioned on the basis of security by way of lock and key accounts and bills purchased limits; their miscellaneous services included issuance of drafts, collection of outstation cheques, executing standing instructions and lockers facility at a few centers. It was the phase of select banking and even the communication through the media was looked down upon with contempt as something against the tenets of banking culture. Even the Advertisements released till 1966 were very few and far between. However, after nationalization of 14 major commercial banks in 1969, banks woke up from their splendid isolation and found themselves placed in a highly competitive and rapidly changing environment, with competition becoming fierce day by day. In the above back-drop, banks approach towards customers and market underwent a change and

focus was gradually shifted to marketing their products. Banks were product oriented organization, placing before the prospective customer, their range of services, expecting him to choose, presuming that the customer had the knowledge, time, interest and skills to pick out the service that would suit him. At the same time, banks also became conscious of their corporate image and its projection and this introduced the public relations philosophy in banks with the purpose of image projection. The first major step in the direction of marketing was initiated by State Bank of India when in 1972, it re-organized itself on the basis of major market segments, dividing the customers on the basis of activity and carved out four major market segments, commercial and institutional segment, small industries and small business segment, the new organizational framework embodied the principle that the existence of an organization is primarily dependent upon the satisfaction of customer needs. Again in 1973, the State Bank of India took yet another major leap forward in the marketing direction when it, out its own volition, took upon itself the responsibility of involving itself in the neighborhood affairs and winning the cooperation of the community in developmental efforts. By 1947, the environment became more demanding with the emphasis on mass banking and canalisation of credit into priority areas and lendings at differential rates of interest to the weaker sections of the society. It was in early 1980, banks realized that marketing is more than that. They started thinking in terms of product development market penetration and market development. More importantly, banks also accelerated the process of equipping their staff with the marketing capabilities, in terms of both skills and attitudes through internal and external training interventions. Bank is an institute which deals with the money and credit in such a manner that it accepts deposits from the public and makes the surplus funds available to those who need them, and helps in remitting money from one place to another safely.

The banking industry which started in the olden days with merchants lending money has today developed to a very great extent. The nationalization of banks in 1969 led to the identification of banking institutions as organizations that they are meant to take the country towards development. Today banks are not mere suppliers of money but they have become providers of services such as selling insurance, mutual funds, investment opportunities etc. Today is the age of specialization and they can find specialization in all fields including banking.

1.3 BANKING IN INDIA

Banking in India has its origin as early as the Vedic period. It is believed that the transition from money lending to banking must have occurred even before Manu, the great Hindu jurist, who has devoted a section of his work to deposits and advances & laid down rules regarding too rate of interest. During the days of east India Company, it was the turn of the agency houses to carry on the banking business. The general bank of India was the first joint stock bank to be established in the year 1786. From 1786 till today, the journey of Indian banking system can be segregated into three distinct phases. They are as mentioned below: Early phase from 1786 to 1969 of Indian banks. Nationalization of Indian banks and up to 1991 prior to Indian banking sector reforms. New phase of Indian banking system with the advent of Indian financial & banking sector reforms after 1991.
Today, the journey of Indian banking system can be segregated into three distinct phases.

PHASE 1: The general bank of India was set up in the year 1786. Next came back of Hindustan and Bengal bank. The east India Company established bank of Bengal (1809), bank of Bombay (1840), bank of Madras (1843) as independent units & called it Presidency Banks. These three were amalgamated in 1920 & Imperial bank of India was established. In 1865 Allahabad bank was established. Punjab national bank was set up in 1894. Between 1906 & 1913, Bank of India, central bank of India, bank of Baroda, Canara bank, Indian bank were set up. Reserve Bank of India came in 1935. PHASE 2: Govt. took major steps in this Indian banking sector reform after independence. In 1955, it nationalized imperial bank of India. It formed state bank of India to act as the principal agent of RBI and to handle banking transactions. Seven banks forming subsidiary of state bank of India was nationalized in 1960 on 19th July, 1969, major process of nationalization was carried out. It was the effort of Mrs. Indira Gandhi. The following are the steps taken by govt of India to regulate banking institutions in the country: 1949: enactment of banking regulation act. 1955: nationalization of SBI. 1959: Nationalization of SBI subsidiaries. 1961: insurance cover extended to deposits 1969: Nationalization of 14 major banks. 1971: creation of credit guarantee corporation. 1975: creation of regional rural banks. 1980: Nationalization of 7 banks with deposits over 200 crore.

PHASE 3: This phase has introduced many more products & facilities in the banking sector. In 1991, under the chairmanship of M. Narasimham, a committee was set up his name which worked for the liberalization of banking practices. The country is flooded with foreign banks & their ATM stations. Efforts are being put to give satisfactory services to customers. The financial system of India has shown a great deal of resilience. It is sheltered from any crisis triggered by any external macro economics shock as other East Asian Countries. For the past three decades Indias banking system has several outstanding achievements to its credit. The most striking is its extensive reach. It is no longer confined to only metropolitans or cosmopolitans in India. In fact, Indian banking system has reached even to the remote corners of the country. This is one of the main reasons of Indias growth process. The government regular policy for Indian bank since 1969 has paid rich dividends with the nationalization of 14 major banks in India. Long ago most efficient banks were taking two days to transfer money from one branch to another but now it is as simple as ordering a pizza. The first bank in India, though conservative, was established in 1786. From 1786 till today, the journey of Indian banking system can be segregated into three distinct phases. In India the banks are being segregated in different groups. Each group has its own benefits, limitations, target market. Few of the working only in rural sector while others in both rural and urban sector.

We have been learning about the companies coming together to from another company and companies taking over the existing companies to expand their business. With recession taking toll of many Indian businesses and the feeling of insecurity surging over our businessmen, it is not surprising when we hear about the immense numbers of corporate restructurings taking place, especially in the last couple of years. Several companies have been taken over and several have undergone internal restructuring, whereas certain companies in the same field of business have found it beneficial to merge together into one company. In this context, it would be essential for us to understand what corporate restructuring and mergers and acquisitions are all about. All our daily newspapers are filled with cases of mergers, acquisitions, spin- offs, tender offers, & other forms of corporate restructuring. Thus important issues both for business decision and public policy formulation have been raised. No firm is regarded safe from a takeover possibility. On the more positive side Mergers & Acquisitions may be critical for the healthy expansion and growth of the firm. Successful entry into new product and geographical markets may require Mergers & Acquisitions at some stage in the firm's development. Successful competition in international markets may depend on capabilities obtained in a timely and efficient fashion through Mergers & Acquisition's. Many have argued that mergers increase value and efficiency and move resources to their highest and best uses, thereby increasing shareholder value. To opt for a merger or not is a complex affair, especially in terms of the technicalities involved. We have discussed almost all factors that the management may have to look into. Before going for merger, Considerable amount of brainstorming would be required by the managements to reach a conclusion. E.g. A due diligence report would clearly identify the status of the company in respect of the financial position along with the net worth and pending legal matters and details about various contingent liabilities. Decision has to be taken after having discussed the pros & cons of the proposed merger & the impact of the same on the business, administrative costs benefits, addition to

shareholders' value, tax implications including stamp duty and last but not the least also on the employees of the Transferor or Transferee Company.

MERGER STORY SO FAR YEAR 1969 1970 1971 1974 1976 1984-85 1984-85 1985 1986 1988 1989-90 1989-90 1989-90 1989-90 1990-91 1993-94 1993-94 1995-96 1996 1997 1997 1998 1998 1999 1999 2000 2001 2002 2003 2004 BANK Bank Of Bihar National Bank Of Lahore Eastern Bank Ltd. Krishnaram Baldeo Bank Ltd. Belgaum Bank Ltd. Lakshmi Commercial Bank Bank Of Cochin Miraj State Bank Hindustan Commercial Bank Traders Bank Ltd. United Industrial Bank Bank Of Tamilnad Bank Of Thanjavur Parur Central Bank Purbanchal Bank New Bank Of India Bank Of Karad Kasinath Seth Bank SCICI ITC Classic BARI Doab Bank Punjab Co-operative Bank Anagram Fianance Bareilly Corporation Bank Sikkim Bank ltd. Times bank Bank of Madura Benaras state bank Nedungadi Bank South Gujarat Local Area Bank MERGED WITH State Bank Of India State Bank Of India Chartered Bank State Bank Of India Union Bank Of India Canara Bank State Bank Of India Union Bank Of India Punjab National Bank Bank Of Baroda Allahabad Bank Indian Overseas Bank Indian Bank Bank Of India Central Bank Of India Punjab National Bank Bank Of India State Bank Of India ICICI ICICI Oriental Bank of Commerce Oriental Bank of Commerce ICICI Bank of Baroda Union Bank HDFC Bank ICICI Bank of Baroda Punjab national Bank Bank of Baroda

2004 2005 2005 2008

Global Trust Bank Bank of Punjab IDBI bank HDFC bank

Oriental Bank of Commerce Centurion bank IDBI Centurion bank of punjab

CHAPTER -2
LITERATURE REVIEW

The two important issues examined by several academic studies relating to bank mergers are: first, the impact of mergers on operating performance and efficiency of banks and second, analysis of the impact of mergers on market value of equity of both bidder and target banks. Berger et.al (1999) provides an excellent literature review on both these issues. Hence in what follows we restrict the discussion to reviewing some of the important studies. The first issue identified above is the study of post merger accounting profits, operating expenses, and efficiency ratios relative to the pre-merger performance of the banks. Here the merger is assumed to improve performance in terms of profitability by reducing costs or by increasing revenues. Cornett and Tehranian (1992) and Spindit and Tarhan (1992) 5 provided evidence for increase in post-merger operating performance. But the studies of Berger and Humphrey (1992), Piloff (1996) and Berger (1997) do not find any evidence in post-merger operating performance. Berger and Humphrey (1994) reported that most studies that examined pre-merger and post-merger financial ratios found no impact on operating cost and profit ratios. The reasons for the mixed evidence are: the lag between completion of merger process and realization of benefits of mergers, selection of sample and the methods adopted in financing the mergers. Further, financial ratios may be misleading indicators of performance because they do not control for product mix or input prices. On the other hand they may also confuse scale and scope efficiency gains with what is known as Xefficiency gains. Recent studies have explicitly employed frontier X-efficiency methods to determine the X-efficiency benefits of bank mergers. Most of the US based studies concluded that there is considerable potential for cost efficiency benefits from bank mergers (since there exists substantial X-inefficiency in the industry), but the data show that on an average, such benefits were not realized by the US mergers of the 1980s (Berger and Humphrey, 1994). Some studies have also examined the potential benefits and scale economies of mergers. Landerman (2000) explores potential diversification benefits to be had from banks merging with non banking financial service firms. Simulated mergers between US banks and non-bank financial service firms show that diversification of banks into insurance business and securities brokerage are optimal for reducing the probability of bankruptcy for bank holding companies. Wheelock and Wilson (2004) find that expected merger activity in US banking is positively related to management rating, bank size, competitive position and geographical location of banks and negatively related to market concentration. Substantial gains from mergers are expected to come from cost savings owing to economies of scale and scope. In a survey of US studies, Berger and Humphrey (1994) concluded that the consensus view of the recent scale economy literature is that the average cost curve has a relatively flat U-shape with only small banks having the potential for scale efficiency gains and usually the measured economies are relatively small. Studies on scope economies found no evidence of these economies. Based on the 6 literature, Berger and Humphrey (1994) conclude that synergies in joint products in banking are rather small. The second issue identified above is the analysis of merger gains in terms of stock price performance of the bidder and target

banks on announcement of merger. A merger is expected to create value if the combined value of the bidder and target banks increases on the announcement of the merger. Pilloff and Santomero (1997) conducted a survey of the empirical evidence and reported that most studies fail to find a positive relationship between merger activity and gains in either performance or stockholder wealth. But studies by Baradwaj, Fraser and Furtado (1990), Cornett and Tehranian (1992), Hannan and Wolkan (1989), Hawawini and Swary (1990), Neely (1987), and Trifts and Scanlon (1987) report a positive reaction in the stock prices of target banks and a negative reaction in the stock prices of bidding banks to merger announcements. A recent study on mergers of Malaysian banks shows that, forced mergers have destroyed wealth of acquired banks (Chong et. al., 2006). Again the reasons for mixed evidence are many. A merger announcement also combines information on financing of the merger. If the merger is financed by equity offerings it may be interpreted as overvaluation of issuer. Hence, the negative announcement returns to bidding firm could be partly attributable to negative signaling unrelated to the value created by the merger (Houston et. al., 2001). Returns to bidder firms shareholders are significantly greater in bank mergers financed with cash than in mergers financed with stock (Houston and Ryngaert, 1997). The other short coming of event study analysis of abnormal returns is that if a consolidation wave is going on, mergers are largely anticipated by shareholders and stock market analysts. Potential candidates for mergers are highlighted by the financial press and analysts. In such cases event study analysis of abnormal returns may not capture positive gains associated with mergers. In sum, the international evidence does not provide strong evidence on merger benefits in the banking industry. However it may be useful to note that these findings from the academic literature usually conflict with consultant studies which typically forecast 7 considerable cost savings from mergers. Berger and Humphrey (1994) suggest why most academic studies do not find cost gains from mergers whereas consultants tend to advocate mergers. This is because of the following reasons: Consultants focus on potential cost savings which do not always materialize, whereas economists study actual cost savings, Consultants tend to highlight specific operations of the banks where there may be merger benefits but ignore those where there are scale diseconomies, whereas economists study overall costs, Consultants prescribe potential cost saving practices which are not necessarily implemented, whereas economists study data on banks that implement as well as those who do not implement the cost saving practices, Consultants often refer to the successful cases, but ignore the unsuccessful ones, whereas economist study all banks, Consultants portray merger benefits as large whereas they may be small in relative terms to the total costs of the consolidated entity. On the other hand,

economists employ standard measures from academic literature that do suffer from this limitation. The academic studies motivate the examination of two important issues relating to mergers in Indian banking. First, do mergers in Indian banking improve operational performance and efficiency of banks? But in India, guided by the central bank, most of the weak banks are being merged with healthy banks in order to avoid financial distress and to protect the interests of depositors. Hence the motivation behind the mergers may not be increase in operating efficiency of banks but to prevent financial distress of weak banks. Hence we do not examine the long term performance and efficiency gains from bank mergers. The other issue emerging from the academic literature is the analysis of abnormal returns of bidder and target banks upon merger announcement by examining the stock price data. We develop testable form of hypotheses for bank mergers in the Indian context as follows: In the case of forced mergers since target firms are given an inducement to accept an acquisition they are expected to earn abnormal returns during the announcement, regardless of the motivation of the acquisition. Hence the expected 8 impact of forced mergers is target banks abnormal returns should be positive. This also supports the safety net motive. Forced mergers are expected to create value for target banks. In the case of voluntary mergers, merger motives are market power, scale economies and cost efficiency. Thus merger announcements are expected to yield abnormal returns to both target and bidder banks as shareholders of both the banks are perceiving benefits out of the merger. Next we conduct a questionnaire survey to ascertain the views of bank managers. Finally we present arguments for why big banks are needed for Indian and other emerging economies. Before that, in the next section we present some consolidation trends in banking. The merger of retail focused-Centurion Bank of Punjab (CBOP) with HDFC Bank effective May 23, 2008, will shore up revenues in the medium-term. However, the synergies from the merger with start reflecting over 12-24 months, and boost profitability. Put together, the gains from organic and inorganic initiatives will help the bank sustain growth rates in excess of its historical average of 29-30 per cent, and in a profitable manner. The inherent synergies of HDFC Bank and CBOP in their retail focus was the driver for the merger, which added around 400 branches to HDFC Banks' branch strength of 760 (as on March 2008) along with a 15-20 per cent increase in the asset base to more than Rs 1.7 lakh crore. While the merger has helped increase the size of HDFC Bank, it has also led to some pressure on key ratios (see Merger Effects) for the combined entity; CBoP ratios were lower than that of HDFC Bank. The next pertinent question is the pace of integration, and how fast HDFC Bank can ramp up efficiency levels of CBOP to its own benchmarks. The integration plan is on schedule. The re-branding of CBOP was completed in May itself; training processes to assign all the employees of CBOP in their new roles is marching ahead with almost 90 per cent of the people retrained. With regards the systems, treasury, wholesale banking and retail loan segments, they have already been

integrated with HDFC's platform, while the overall retail banking is expected to be completed in the next two months. The actual benefits will start to filter in the next 12-24 months, with improved productivity in terms of net revenue (net interest income and other income) and CASA (the ratio of low cost deposits to total deposits) growth of CBoP branches on par with HDFC outlets. But before that to happen, HDFC bank will have to shoulder the pressure in the medium-term. For instance, on the efficiency front, the cost to income ratio has also increased from 50 per cent in March, 2008 to around 55 per cent in Q2 FY09 on the back of higher employee costs and integration costs, post the merger. The integration of the two banks' technology-based platforms is expected to be completed by the end of this fiscal, and will improve the cost efficiencies going forward.

HDFC Banks' net revenues have grown at a CAGR of 44.5 per cent in the last five years on the back of net interest income (NII) and other income growing by 43 per cent and 47.7 per cent, respectively. Net profits grew by 33 per cent; the lower pace is due to the bank's prudent policy of higher provisioning (last three years). Of late, HDFC Bank has been going slow on the retail loans and even CBoP's nonissuance of fresh loans (since December 2007) to the two-wheeler and personal loan segments, has ensured comfortable NPA (non-performing assets) levels for the combined entity. Gross NPA and net NPA are up 40 basis points and 20 basis points y-o-y in Q2 FY09 to 1.6 per cent and 0.6 per cent, but are comfortable in comparison to peers. Analysts say that HDFC Bank, after the merger, would provide higher provisions to the combined entity in line with its own superior provision coverage of around 67 per cent (CBOP's at 55 per cent). Although, it will add pressure on the profitability in the near term, it will help avoid slippages in asset quality in the future. The advances haven't slowed and this is indicated from the credit-deposit ratio rising from 63 per cent (FY08) to around 75 per cent in Q2 FY09. The recent CRR cut has released additional funds of around Rs 4,500 crore that could be used for further loan disbursements and provide support to NIMs (CRR balances with RBI do not yield any returns). The higher yield on advances and investments in conjunction with high interest rates has meant that NIM is still comfortable at 4.2 per cent.

1. Mr. DEEPAK PAREKH, CHAIRMAN, HDFC BANK. (1999): We were amongst the first to get a banking license, the first to do a merger in the private sector with Times Bank in 1999, and now if this deal happens, it would be the largest merger in the private sector banking space in India. HDFC Bank was

looking for an appropriate merger opportunity that would add scale, geography and experienced staff to its franchise. This opportunity arose and we thought it is an attractive route to supplement HDFC Banks organic growth. We believe that Centurion Bank of Punjab would be the right fit in terms of culture, strategic intent and approach to business.

2. Mr. ADITYA PURI, MANAGING DIRECTOR, HDFC BANK:These are exciting times for the Indian banking industry. The proposed merger will position the combined entity to significantly exploit opportunities in a market globally recognized as one of the fastest growing. Im particularly bullish about the potential of business synergies and cultural fit between the two organizations. The combined entity will be an even greater force in the market.

3. Mr.

RANA

TALWAR,

CHAIRMAN

CENTURIAN

BANK

OF

PUNJAB :Stated, Over the last few years, Centurion Bank of Punjab has set benchmarks for growth. The bank today has a large nationwide network, an extremely valuable franchise, 7,500 talented employees, and strong leadership positions in the market place. I believe that the merger with HDFC Bank will create a world class bank in quality and scale and will set the stage to compete with banks both locally as well on a global level.

4. Mr. SHAILENDER BHANDARI, MANAGING DIRECTOR & CEO, CENTURIAN BANK OF PUNJAB: Said, We are extremely pleased to receive the go ahead from our board to pursue this opportunity. A merger between the banks provides significant synergies to the combined entity. The proposed merger would further improve the franchise and customer proposition offered by the individual banks.

5. PARMATMA SINGH: I was so happy when I heard that Centurion bank is going to merge with hdfc bank. Still i am working with centurion bank on Punjab but I am thinking of leaving this bank. B coz I want desperately to work with HDFC bank .I can not stand to centurion bank of Punjab any more.

6. As far as my opinion is concerned HDFC bank shouldnt merge with centurion bank ltd. Most of people have got unemployment due to merger. Every body knows very well that HDFC is larger than CBOP bank. After merger HDFC definitely will get loss.