Merger messages

In 2004, the Reserve Bank of India laid out a five-year timeframe for eliminating the restrictions on foreign banks' operations in India. After 2009, these banks would be allowed to expand organically, by setting up more branches, as well as inorganically, by acquiring domestic banks. The five-year window was supposed to provide room for Indian banks, particularly in the public sector, to gear themselves up for the more competitive environment which is supposed to emerge after 2009. The main strategic option they had was to consolidate among themselves, so as to gain scale economies as well as exploit complementarities in terms of geographies and/or market segments. Well, with one year to go in that timeframe, virtually nothing has happened on the consolidation front. Some public sector banks have entered into so-called strategic alliances, but it is doubtful if these have translated into significant operational synergies. If bank consolidation is to have any impact on efficiency, it will inevitably involve both deep integration between operating and risk management systems and a significant rationalisation of the workforce, both of which face serious resistance within the banks. This lack of movement puts the public sector banks at a disadvantage when the sector is opened up, or throws doubt on the timeframe itself.

Meanwhile, the domestic private banks are taking no chances. The compulsion to consolidate has been a strong driver within the sector right from the early days of new entry in the early 1990s. The latest move comes in the form of the proposed merger, an all-stock transaction, between HDFC Bank and the Centurion Bank of Punjab, which is likely to be formally announced today. HDFC Bank itself acquired Times Bank several years ago, while the Centurion Bank of Punjab is the outcome of a bank having evolved out of a non-bank financial company and having subsequently acquired two relatively small private banks, the Bank of Punjab and Lord Krishna Bank. The merged entity will become the seventh largest domestic bank, behind the Bank of India, in terms of total assets and about one-third the size of ICICI Bank, the largest private sector bank. In fact, the combined entity will have more branches than ICICI Bank, which offers both an opportunity for improving cost efficiency and a platform for future expansion. Post-merger performance has always been difficult to predict but, on the face of it, since both parties are themselves the products of successful integration, this one has good chances of making the new entity more competitive. This is probably the first of many, with other private sector banks also looking for growth through acquisition.

Globally, the financial sector has moved along two dimensions "" larger scales and product diversification. As the Indian banking sector opens up, domestic banks cannot but move down the same strategic path. Unfortunately, entrenched interests and the burdens of legacy prevent potentially competitive public sector banks from taking the steps necessary to prepare themselves for the inevitable "" the past decade has seen a steady erosion of market share for the public sector banks, and some observers predict that the rate of decline will now get accelerated. That will almost certainly spell serious trouble for many of the state-owned banks, a possibility that the resistors to consolidation and change in general should recognise. As it happens, it is the timely moves by their less fettered private sector peers that will ensure a strong presence for home-grown banks in an open financial environment, perhaps even providing a launch pad for their own global aspirations.