Tamal Bandyopadhyay: Banking on M&As

Banks are readying for the sector opening up to foreigners by consolidating operations.

The boards of Lord Krishna Bank and Centurion Bank of Punjab will meet on September 4 to consider the modalities of the proposed merger of the two banks. Lord Krishna Bank, an unlisted entity, has been on the lookout for a suitor for quite sometime now. GE Capital had held discussions with its promoter Mohan Puri, who holds about 65 per cent stake in the bank, for a possible takeover but it did not proceed since the Reserve Bank of India (RBI) was not comfortable with the idea of a non-banking entity taking over a bank. The next suitor was Federal Bank. There were even formal announcements by both the banks on their engagement but the marriage did not take place with serious differences on valuation cropping up in the final stages of negotiations.

If the deal goes through this time, it will be Centurion Bank of Punjab's second acquisition in two years and the fourth deal of this kind in the banking space, ever since the RBI announced its road map for opening up the sector.

Centurion Bank is involved in two of the four deals "" the first being the merger of Bank of Punjab with itself and now Lord Krishna Bank. The other two are the Indian Overseas Bank's buyout of a 70 per cent stake in Chennai-based old private sector Bharat Overseas Bank and merging with itself, and

Federal Bank's takeover of Ganesh Bank of Kurundwad which got its net worth wiped out by accumulated losses.

The Federal-Ganesh Bank deal has not yet been completed as some of the promoters of Ganesh Bank have challenged the deal and the regulator is defending its act in allowing the merger to go through at the Bombay High Court.

If the momentum is kept, we may see quite a few mergers and acquisitions before April 2009 when the sector will open up for foreign players to play a bigger role. Right now, foreign banks operating in India account for about seven per cent of the total banking assets and they have been waiting patiently to ramp up their market share in Asia's fourth largest and the world's second-fastest growing economy.

Traditionally, the driver for a majority of M&A deals in the banking space is the regulator's sensitivity to protect the depositors' money. The government has pumped in over Rs 22,000 crore since mid-1990s in the form of recapitalisation bonds to maintain the solvency of the public sector banking industry while the RBI has forced mergers of weak private banks with public sector banks. In 1969 the first such merger took place with State Bank of India taking over the ailing Bank of Behar. The trend continued till 2004 when Global Trust Bank was merged with Oriental Bank of Commerce. In between, 34 banks and non-banking finance companies had been merged and barring a few cases (SCICI, ITC Classic and Anagram merging with ICICI and finally ICICI merging itself with ICICI Bank as well as ICICI Bank taking over Bank of Madura), the banking regulator played the role of a merchant banker ensuring safety for depositors' money and protecting the resilience of the banking system.

The RBI continues to play a crucial role even now but in a different way. First, it announced the road map for opening up the system in April 2009. While the timeframe ring fences weaker financial intermediaries from predatory attacks, the banking regulator has laid down certain norms for the domestic players. All private banking entities must have at least Rs 300 crore net worth and a wider investor base with no single entity being allowed to hold more than 10 per cent stake. In case of one banking entity holding a stake in another bank, the upper limit for such a stake is capped at 5 per cent. Even though there is no fixed timeframe for implementing these two key conditions, it is presumed the outer limit will coincide with the opening up of the sector.

At least nine old private sector banks now have less than Rs 300 crore net worth. While two of them "" Lakshmi Vilas and Citi Union Bank "" are in sniffing distance of the threshold limit, quite a few of them are wide off the mark. For instance, Sangli Bank and Ratnakar Bank do not have even one-sixth of the required net worth and they cannot infuse such huge capital. So, some of them will be gobbled up by others who have stronger balance sheets and who see opportunity in inorganic growth.

The promoters stake in at least eight banks are higher than 10 per cent. These eight banks are IndusInd Bank, Development Credit Bank, United Western Bank, Dhanalakshmi Bank, Tamilnadu Mercantile Bank, Catholic Syrian Bank, Nainital Bank and Bank of Rajasthan. The Tayal family holds over 44 per cent stake in Bank of Rajasthan while IndusInd Bank's promoters' stake is over 30 per cent. Similarly, the Aga Khan Trust has over 68 per cent stake in Development Credit Bank and Rajmohan Rao holds around 37 per cent stake in Dhanalakshmi Bank.

The RBI wants the banking system of be in sound health when it opens the doors to foreign players in April 2009. If the regulator's wish to be fulfilled, over the next three years, on an average there should be at least four mergers every year. Time is fast running out for these banks. They must start looking around for suitors as any delay will only bring down their valuation. Of course, it will be a different story if the RBI changes its mind and decides against showing the green light to foreign players in April 2009.