R Jagannathan: Consolidation without M&A

MICROVIEW

Bankers, brokers and deal-makers are salivating at the prospects of consolidation in the banking sector. With Finance Minister P Chidambaram leaving no one in any doubt about his own blessings for the idea, bank stocks have been headed north, never mind worries about interest rates and loss of treasury profits.

As an investor with personally significant stakes in some bank stocks (see disclosure below), I have been thrilled by this unexpected bounty. However, commonsense tells me that mindless M&A is the last thing one needs. Consolidation need not mean only mergers, though mergers have a role to play in the process.

Two reasons why. One, mergers make sense only if two and two make five. If they only make four, there's no benefit; and if two and two end up in three, mergers actually destroy value.

Globally, three out of four mergers fail the value creation test, and this is a very good reason for caution. Two, it is always a good idea to date and court your future partner before jumping into bed.

Banks intending to tie the knot would do well to put expected synergies into practice""through marketing and cross-selling tieups, for example""before they succumb to the urge to merge. This way, they can check for themselves how the marriage might work in actual practice before they book a honeymoon ride.

The basic logic driving Indian bank mergers is the old 3S formula""size, scale, and synergy. All three can be achieved without an actual merger. Newspapers are full of stories about north- or west-based banks wanting to gobble up banks with a stronger presence in the south and east, the obvious attraction being geographical complementarity.

But does one always need a merger to achieve this? Isn't it enough for you to take a controlling stake, or even a cross-holding? If the inherent strength of a south-based bank is its southern character and customer relationships, it is important to ensure that these are not lost in the process of merger with a northern bank (or vice versa).

Size and scale can also be achieved through devices other than merger. For example, if HSBC wants the branches, assets, and liabilities of Karnataka Bank, the simplest way to do this is by valuing all these assets and taking them onto HSBC's books.

Of course, you cannot do this without taking a significant part of Karnataka Bank's employees (for, they are the ones who service these customers), but this can be done through a formal re-recruitment process for the latter's employees who want to join HSBC.

The main benefit of this approach: HSBC will not be importing Karnataka Bank's work culture through this kind of takeover; for its part, Karnataka Bank will be free to get into any other business""including perhaps an ancillary business that HSBC itself may want to outsource from it""with its remaining employees.

This kind of consolidation can be a win-win situation, bringing the benefits of size and scale without delivering a huge culture shock to employees from two fundamentally different organisations.

Mergers may be a good idea when cultural issues are not that significant. Bank of India and Union Bank do not really have a geographical complementarity of branches in India, but the fact that both are headquartered in Mumbai should make culture clashes less likely.

The branch overlaps can always be fixed over time, by surrendering some licences and relocating others. Since public sector banks are not going to claim merger benefits by aggressively trimming labour, having a common culture will help.

In general, though, I am not too hot on mergers that cut across regional work cultures, especially in the public sector, since by definition the merged entity will not have a strong enough management that can cut through the internal fault-lines.

Sometimes, heads have to be bashed together to make mergers work. In India, though, we will have umpteen unions and politicians meddling with the process, each seeking to protect and project its favourites.

The finance minister should hasten slowly in pushing banks towards mergers as there are several other options that can be explored instead of, or as a prelude to, merger.

The roadmap he plans to unveil should encourage cross-holdings between public sector banks, commercial tieups to tap geographical and other complementarities, and asset purchases. This way consolidation can proceed without traumatic, value-reducing mergers.

In most cases, mergers may be a good goal to work for, but the operative words are "goal" and "work". Just as any marriage involves give and take between two partners, mergers too need to be worked on by both merging entities.

If the efforts are lacking, the merger will fail. M&A is the last stop on the journey to banking industry consolidation, not the first option.

(Disclosure: The author owns shares in Andhra Bank, UTI Bank, Karur Vysya Bank and SBI, and to that extent can be seen as an interested party in espousing the above views.)

rjagann@business-standard.com