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This article is written by Vaidehi Soni pursuing B.A., LL.B. (Hons.), 4th Year from National University of Advanced Legal Studies, Kochi.
Background
The Central Government’s proposal to create the country’s third largest bank is an illuminated news with the government announcing the proposed amalgamation of Bank of Baroda, Vijaya Bank and Dena Bank stating it to be a concrete step in terms of strengthening lending capacity, cost efficiency and ease of operation, but the central government forgets to consider that most public sector banks have exposure to the same set of stressed assets and this latest move would eventually increase the concentration risk as the new entity would end up holding a larger exposure to stressed assets.
“Merger” refers to a corporate restructuring activity of two or more companies into a single company where all the properties and liabilities of transferor company get merged with the properties and liabilities of transferee company leaving behind nothing with the transferor company except its name, which also gets removed through the process of law.
Amalgamation, on the other hand, is a wider concept. In “Amalgamation”, there is a pooling of not only the assets and liabilities of amalgamating companies but also of the shareholders interests and of businesses of company. In such scenario when a company acquires another company, it tends to affect the shareholding where the shareholders do not continue to have a proportionate share in the equity of the combined company or the business of the company which is acquired.
Swap Ratios and Valuations
A Swap Ratio is an integral part of the scheme of amalgamation. It is one of the deciding factors from a perspective of who stands to gain or lose from such amalgamation. Swap ratio refers to the ratio of number of shares the acquiring company offers in exchange for the target company during merger or amalgamation. Since the Combined entity would entail the shares of both the target and the acquiring company, the shareholders in the target company tend to have their current equity diluted by the new shares.
Swap ratios play an important role to protect investors from such scheme of proposed amalgamation. Additionally, it enables Shareholders to preserve the same relative value when their existing shares are converted into shares for the merged company. In the current proposed deal, the swap ratio is still unknown and hence must be decided on the basis of present balance sheet strength considering the NPA’S without any prejudice against stronger banks. Therefore, for the desired synergies to be achieved, a proper valuation should be done thoroughly with the exercise of due diligence. Share values cannot be ascertained with exactitude for arriving at exchange ratios either on “net worth” basis or by the usual methods for valuation such as, market value, yield value, break-up value. Qualitative factors like market fluctuation, competition, managerial skills are also relevant for the purpose. Thus, a sound and granular analysis of every consolidating Public sector Bank in respect of its assets & liabilities, security back up, sector wise loan exposure is a conclusive indicator to consider a substantial value addition in an upcoming combined entity.
Supervisory power of RBI
Section 44A of the Banking Regulation Act, 1949 provides for the procedure for amalgamation of banking companies. Under this section, The RBI has been given specific powers to grant approval to scheme of merger of banking companies and to determine Market value of shares of dissenting shareholders. But this law that regulates and supervises banking companies does not wholly apply to Public Sector Banks. RBI is well equipped to use its power in relation to merger or amalgamation of a non-state bank but such powers are not available in the case of state-owned banks under the Banking Regulation Act, thus it only has a supervisory power as government is the owner of the Public Sector Banks.
Where does the shareholder stand?
The shareholder’s stand or lose is based on the swap ratios. Shareholders of the poor performing bank will gain than the shareholders of the better performing bank. Such synergies benefit weaker banks tackle the issue of Non-Performing assets. Such proposals no doubt have indirectly encouraged speculative investments in Banks that are not performing well on the basis that there will eventually be a rescue option called “merger” or “amalgamation”. The present deal would be considered as a bailout of weak lender, such amalgamation would be like a bitter merger pill for Bank of Baroda and Vijaya Bank.
Key Challenges post amalgamation
- Firstly, the financial and process integration of consolidating entity would take considerable time to benefit from scale economies. Where Bank of Baroda had just enjoyed a highly visible point of customer recall and begun reaping benefits of its business strategy, it will again have to start from square one providing a common information technology platform, banking products, procedures and operational systems to implement a common system in the new entity thereby consuming much of the management attention and energy.
- Secondly, the issue of rationalising the branch network post-amalgamation will lead to a reduction in manpower, where over thousands of branch may need to be combined/ relocated, the biggest challenge meanwhile would be of providing valuable expertise to Human resource in enhancing skill levels of employees of erstwhile weak public sector banks, in the present deal-Dena Bank which so far had a regional focus with limited exposure. Since there is no uniformity in the technological front
- Thirdly, management bandwidth will be the key challenge for any restructuring entity as it lacks right people in sufficient numbers to effectively and efficiently manage operations. Additionally, the combined entity will require capital support from the government, to improve their capitalisation profile post-amalgamation to sustain and enhance fresh lending in future.
The Perception of the concept of “Too big to fail in Banking” creates an expectation of government to step in and support at times of distress. Merging or Amalgamating PSBs is one of the most preferred rescue operations by the government to protect banks against losses as witnessed in the recent SBI merger. An assessment of such instances of merger or amalgamation by the government signifies that such steps in no way helps sustain an individual banks identity as there is no progress in resolving current unconscionable level of Non-Performing Assets post PSB’s merger. Such steps pose not to be an orderly and well thought out decision as the new amalgamated entity would end up hold a larger exposure to stressed assets.
Conclusion
It is considered that amalgamation has become vehicle of growth. The rationale behind the proposal to merge state owned banks is the “capacity to subsume a weaker bank” making the banks sustainable with huge market accessibility and the ability to tackle higher NPA’S but the excessive bad loans creating negative growth in Public sector banks has not been a new phenomenon because of which exercise of such amalgamation or merger should be a last resort based on sound analysis and not on a size of a combined balance sheet. It would make practical sense to marry banks having common identities in terms of banking business, cultural and technological aspects so as to strengthen network streamlining post-amalgamation.
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