Bank Merger and Acquisition

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Bank Mergers andAcquisitionsUNIT 16 BANK MERGERS AND

ACQUISITIONS

Objectives

After reading this unit you should be able to:

l understand the meaning and types of mergers in general;

l appreciate the need for bank mergers;

l describe the legal framework in which merger takes place; and

l analyse some bank merger case studies.

Structure

16.1 Introduction

16.2 Types of Mergers

16.3 Motives for Merger

16.4 Bank Mergers

16.5 Legal Framework

16.6 Procedure for Amalgamation of Banking Companies

16.7 Restructuring of Banks and Some Relevant Committees

16.8 Case Studies

16.9 Summary

16.10 Key Words

16.11 Self Assessment Questions

16.12 Further Readings

Appendix

16.1 INTRODUCTION

The Liberalisation, Privatisation and Globalisation process which was started in early1990s has brought so many changes in the economic scene of the country. Thisprocess of economic reforms has brought competition not only from India but alsofrom Overseas. In order to compete with these competitors, Indian corporate sectorhas tried to reorganise and restructure the companies by adopting various strategies.These strategies include Mergers, Acquisitions, Joint ventures, Spin off,Divestitures, etc.

Restructuring can be broadly classified into three types. They are:

a) Portfolio Restructuring,

b) Financial Restructuring, and

c) Organisational Restructuring.

If a firm is reshuffling its assets by selling some of its existing production facilities oracquiring some new facilities to produce the feeding raw–material for the mainproduct, it is called portfolio restructuring. In financial restructuring the compositionof debt and equity are shuffled. In the process of organisational restructuring,Organisational Structure is revisited and changes are made. All these restructuringsare aimed to achieve better results for the company.

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Special Issues Figure 16.1 presents a broad view of the different forms of OrganisationalRestructuring which can be seen these days in the Corporate World:

Some of the sectors which saw a lot of activity in the last decade in relation tomergers are : fast moving consumer goods sector, financial services sector, cement,paper, chemicals and tyre industries. Some of the corporates which are involvedactively in this activity are: Reliance group, Hindustan Levers, Aravind group,Eicher group, Vijay Mallaya, Chhabria group, etc. In the Banking sector ICICI Bank,HDFC Bank, and Punjab National Bank (PNB) are actively involved in the mergeractivity . In this unit we shall discuss the bank mergers in detail.

16.2 TYPES OF MERGERS

When a company acquires another company, the acquiring company is called the‘Acquirer Company ’and the company which is being acquired is called the ‘AcquiredCompany’. The acquirer company has two alternatives for dealing the acquiredcompany. First the acquiring company can takeover the management of acquiredcompany and run it as a separate company with its own new Management. This iscalled the ‘Takeover’ or the ‘Change of Management’. The second alternative forAcquirer Company is to merge the acquired company into itself. This is called the‘merger’. In this unit we shall be discussing mostly about the mergers. In case ofmergers there could be three situations. They are:

i) The acquirer company merges the acquired company into itself and the acquiredcompany looses its entity,

ii) The acquirer company may merge with the acquired company and may give upits own identity. Normally this kind of merger takes place for getting some Taxbenefits.

iii) There could be a situation in which both the acquirer company and acquiredcompany loose their identity and form a altogether new company with a newname.

Mergers can be broadly classified into three types. They are vertical mergers,horizontal mergers, and conglomerate mergers. Let us understand each of these typeshereunder:

a) Vertical Mergers: If a company acquires another company, which buys theproducts of Acquirer Company and uses them as raw material in its productionprocess or acquires a company from which the company buys its raw material,then it is called vertical merger. If a bank acquires a marketing company whichprovides the bank, marketing services for its products as an outsourcing solution,then it can be stated as vertical merger.

Sell-offsl Spin-offsl Split – offsl Split – upsl Divestituresl Equity Carve-outs

Forms of Restructuring Business Firms

Corporate Controll Premium Buy-backsl Standstill Agreementsl Anti-takeover Amendmentsl Proxy contests

Changes in OwnershipStructurel Exchange Offersl Share Repurchasesl Going Privatel Leveraged Buy-outs

Source: Adapted from Weston, Chung and Hong, 1998, Mergers, Restructuring and Corporate Control

Expansionl Mergers andacquisitionsl Tender Offersl Joint Ventures

Figure 16.1: Forms of Restructuring Business Firms

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Bank Mergers andAcquisitions

b) Horizontal Mergers: If a bank acquires another bank and merges it into itself,it is known as Horizontal merger. Similarly if a company acquires anothercompany which is operating in the same area of its operation and merges it intoitself, it is said to be horizontal merger. This could be to increase the marketshare, or to get technological advantages, or to enter into the new geographicalareas, or to acquire any other strategic advantages.

c) Conglomerate Mergers: If a company acquires a company which is not at allconnected with the area of operations of acquiring company, it is said to be aconglomerate merger. For example, if a bank acquires a cement company andmerges it into itself, then it can be treated as conglomerate merger.

Depending upon the situation and need of the acquiring company, it may adopt anyone of the above types of mergers.

16.3 MOTIVES FOR MERGER

Any acquisition takes place with a number of motivations culminating in a positivesynergy (2+2=5 relationship). This means that the performance of the combinedcompany is more than the sum of the performance of erstwhile two independentcompanies. Let us, now, examine the motives behind the merger.

A study conducted in the U.S.A., identified 12 motives that promote merger andacquisition activity. They are given below in the order of their priority:

1. Taking advantage of awareness that a company is undervalued.

2. Achieving growth more rapidly than by internal effort.

3. Satisfying market demand for additional products/services.

4. Avoiding risks of internal start-ups of expansion.

5. Increasing earnings per share.

6. Reducing dependence on a single product/service.

7. Acquiring market share or position.

8. Offsetting seasonal or cyclical fluctuations in the present business.

9. Enhancing the power and prestige of the Owner, CEO, or Management.

10. Increasing utilization of present resources, et., physical plant and individualskills.

11. Acquiring outstanding Management or Technical Personnel.

12. Opening new markets for present products/services.

A survey, conducted in 1955, by the U.S. Federal Trade Commission, to find out whycompanies choose the merger and acquisition route, listed seven major benefits ofacquisition for the acquiring company. They are:

1. Gaining additional capacity to supply to a market already being serviced by theacquirer.

2. Gaining extended product lines.

3. Achieving diversification of product base.

4. Gaining facilities to produce goods purchased earlier.

5. Gaining facilities to process or distribute goods sold earlier.

6. Gaining access to additional markets.

7. Other advantages such as empty plants, control of patents, etc.

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Special Issues In India, the merger and takeover phenomenon in the past was understood largely asone of the sick units being taken over by healthy ones. This is because of the reasonthat Sec. 72A of the Income Tax Act, 1961, provides for the carry forward of losses.The advantage that the merging corporations get is that the book losses of the sickcorporation get written off against the future profits, thus saving the profitablecorporations some tax outflow.

As far as the Banking sector is concerned following reasons are more relevant:

1. Growth with External Efforts: With the economic liberalization the competitionin the banking sector has increased and hence there is a need for mega banks,which will be intensely competing for market share. In order to increase theirmarket share and the market presence some of the powerful banks have startedlooking for banks which could be merged into the acquiring bank. They realizedthat they need to grow fast to capture the opportunities in the market. Since theinternal growth is a time taking process, they started looking for target banks.

2. Deregulation: With the liberalisation of entry barriers, many private banks cameinto existence. As a result of this there has been intense competition and bankshave started looking for target banks which have market presence and branchnetwork.

3. Technology: The new banks which entered as a result of lifting of entry barriershave started many value added services with the help of their technologicalsuperiority. The older banks which can not compete in this area may decide to gofor mergers with these high-tech banks.

4. New Products/Services: New generation private sector banks which havedeveloped innovative products/services with the help of their technology mayattract some old generation banks for merger due to their incapacity to face thesechallenges.

5. Over Capacity: The new generation private sector banks have began theiroperation with huge capacities. With the presence of many players in the market,these banks may not be able to capture the expected market share on its own.Therefore, in order to fully utilise their capacities these banks may look for targetbanks which may not have modern day facilities.

6. Customer Base: In order to utilise the capacity of the new generation privatesector banks, they need huge customer base. Creating huge customer base takestime. Therefore, these banks have started looking for target banks with goodcustomer bases. Once there is a good customer base, the banks can sell otherbanking products like car loans, Housing loans, consumer loans, etc., to thesecustomers as well.

7. Merger of Weak Banks: There has been a practice of merging weak banks witha healthy bank in order to save the interest of customers of the weak Bank.Narasimham Committee–II discouraged this practice. Khan Group suggestedthat weak Developmental Financial Institutions (DFIs) may be allowed to mergewith the healthy banks.

16.4 BANK MERGERS

In the 1950s and 1960s there were instances of private sector banks, which had to berescued or closed down because they had very low capital and were mostly operatingwith other people’s money. For instance, against total deposits of Rs.2750 crore at theend of December 1968, the paid-up capital of private sector banks was only Rs.28.5crore or just a little over 1%. In 1960, the failure of Palai Central Bank and LaxmiBank led to loss of confidence in the banking system as a whole. So mergers wereinitiated to avoid losses to depositors and maintain confidence in the system. In 1961,the Banking Companies (Amendment) Act empowered RBI to formulate and carry out

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a scheme for the reconstitution and compulsory amalgamation of sub-standard bankswith well-managed ones. Consequently, out of 42 banks which were grantedmoratoria, 22 were amalgamated with other banks, one was allowed to go intovoluntary liquidation, one to amalgamate voluntarily with another bank, three wereordered to be wound up and the moratorium on three was allowed to lapse.

In India, mergers have been used to bail out weak banks till the NarasimhamCommittee-II discouraged this practice. For instance, since the mid-1980s, severalprivate banks had to be rescued through mergers with public sector banks, as shownin the Table 16.1 given below:

Table 16.1: Bank Mergers in India

Name of Bank Year of No. of Merged withMerger Branches

Lakshmi Commercial Bank 1984 230 Canara BankBank of Cochin 1984 108 State Bank of IndiaMiraj State Bank 1984 26 Union Bank of IndiaHindustan Commercial 1985 140 Punjab National BankTraders Bank 1987 34 Bank of BarodaUnited Industrial Bank 1988-89 145 Allahabad BankBank of Tamilnadu 1988-89 99 Indian Overseas BankBank of Thanjavur 1988-89 156 Indian BankParur Central Bank 1988-89 51 Bank of IndiaPrubanchal Bank 1990 40 Central Bank of IndiaNew Bank of India 1993 591 Punjab National BankBCCI (Mumbai) 1993 1 State Bank of IndiaBank of Karad 1994 48 Bank of IndiaKasinath Seth Bank 1995 11 State Bank of IndiaBari Doab Bank & Punjab 1997 Oriental Bank of CommerceCo-operative Bank

The merger of the loss making New Bank of India with the profitable Punjab NationalBank was the first instance of merger of two public sector commercial banks. Nowpublic sector commercial banks are themselves in need of restructuring so it may bemore efficient to close down unviable bank. However, the recent merger of banks inprivate sector , i.e., HDFC Bank and Times Bank (1999) as well as ICICI Bank andBank of Madura (2000) , could herald a welcome trend as it is driven by commercialconsiderations. It is only such mergers among banks that will impart strength andstability to the banking system in the new millennium.

With economic reforms and opening up of the economy, like other sectors, bankingsector also saw a lot of changes. Two major changes are worth mentioning. They are:increased competition, and falling interest rates. There has been a decline in theinterest rates in the last decade world wide. As a result of this profitability of thebanks has been under tremendous pressure. The interest rates both on the deposits andon the loans have come down drastically. The ‘spread’ which was available to thebanks thinned down and banks have started searching for cost reduction and marketenhancing strategies. Use of technology in their operations has come up as animmediate strategy and banks have started using technology in a big way. This hasresulted in saving of salary expenses, which used to be a major part of the banks’expenditure. In addition to this, banks have started looking for strategies which allowthe banks to grow faster. One of the options before the banks was to merge theircounterparts in it and become not only big but also gain entry into the new markets.As a result of these mergers, banks are able to use their full capacities and avoidunnecessary duplication of efforts. Some of the banks which merged in recent times

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Special Issues are: Times Bank merged with HDFC Bank, Bank of Madura Merged with ICICIBank, Nedungadi Bank Merged with Punjab National Bank. Subsequently the RBIallowed Development Financial Institutions also to merge with banks on therecommendation of Khan Group. As a result of this ICICI Limited merged itself withICICI Bank and IFCI Limited is being merged with the Punjab National Bank.

As far as the merger activity in banking sector is concerned, there used to be mostlymerger of sick and weak banks with a healthy bank. The only purpose of this type ofmergers was to save the sick bank and its customers from the problems. With theprocess of liberalization the thinking of the government also changed. We do not seemuch of mergers of this type now-a-days. The merger of New Bank of India withPunjab National Bank was a bad experience. This has not served any purpose. As aresult of the merger, PNB had to face lot of court litigations and also incurred a loss inthe year 1996 which was unusual in the history of the Bank.

With the liberalization policies of the government, many private banks came intoexistence. In 1995 the government also removed entry barriers in the banking sector.As a result of this good number of technology savvy, customer friendly banks havestarted operating in India. In order to survive in the competition and get a marketshare these new banks started offering innovative and attractive products with the helpof their technology. Some of the services like mobile banking, internet banking,tele-banking, online share trading services, depository services , anywhere banking,anytime banking which are offered by these new generation banks were never thoughtof about a decade ago in India. These services have given an edge to these banks overthe public sector banks. The public sector banks also realised the need of the hourand started using technology in a big way. These banks are also collaborating withthe new generation banks in offering certain services and getting mutually benefited.

Some of the new generation banks like HDFC Bank and ICICI Bank have startedlooking for external growth by way of merger route. These banks have started lookingfor healthy banks rather than sick and weak banks for acquisition. The main criteriawhile selecting target bank was synergy benefits like market growth, market presence,effect on profit and so on. It can be said merger of Times Bank with HDFC Bank in1999 is a beginning of this new trend. HDFC Bank emerged as the largest privatesector bank in India after the merger. By this merger HDFC Bank got the customerbase of Times Bank, its infrastructure, and branch network. This merger also hadproduct harmonization effect, as HDFC Bank had Visa network and Times Bank hadMaster card network. Following HDFC, ICICI also merged Bank of Madura into it.

ICICI Bank was looking for a bank which could be merged into it and which couldprovide some synergic benefits after the merger. ICICI Bank had considered twopossible banks, Federal Bank and the Bank of Madura and finally went for Bank ofMadura, considering its better technological edge, attractive business per employee,and its vast branch network in Southern India. At the time of merger the Bank ofMadura had 263 branches.

Another trend which is taking place in Bank Mergers is merging of DevelopmentalFinancial Institutions (DFIs) with the Banks. Some of the examples are; merger ofICICI Ltd. with ICICI Bank, and the proposed merger of IFCI Ltd. with PunjabNational Bank. This trend is a fall out of the recommendations of Khan Group andNarasimham Committee-II.

16.5 LEGAL FRAMEWORK

Mergers and Takeovers are generally seen in Public Policy as activities, which, if leftuncontrolled, can lead to negation of Public interests. As a result, these activities arecontrolled through various Statutes and Codes of Conduct. Some of the contentiousissues that emphasise the need for evolving a Takeover Code are discussed below.

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Sec.s 111 and 390 to 396a of the Companies Act, 1956, govern mergers andacquisitions. Similarly Sections 19, 26 and 29 of the erstwhile FERA relate to transferof shares. Where one of the transacting parties is a Non-Resident Indian, the Actprohibits the transaction except with the sanction of the Reserve Bank of India(R.B.I.). Sec.s 30(A) to 30 (F) of the MRTP Act pertain to transfer of shares relatingto dominant undertakings as defined in the Act. Further, Sec. 22 (A) of the SecuritiesContract (Regulation) Act, 1956, deals with the transfer of shares. Clauses 40 (A) and40 (B) of the Stock Exchange Listing Agreement Form also lay down the rules in caseof takeover bids.

Before 1960, section 44A of the Banking Regulation Act only provided for thevoluntary amalgamation of banks. But after widespread weakness in the bankingsector, the Act was amended by adding Section 45 to allow for compulsoryamalgamation wherever necessary and on a voluntary basis wherever possible, inorder to strengthen the banking system by eliminating small and weak banks. Themain difference between an amalgamation and a transfer is that, under amalgamationthe company, which is taken over, ceases to exist, while under transfer the companycan opt to either go into liquidation or convert itself into a non-banking company.Under Section 45 of the Act, RBI has the power to compulsorily reconstruct oramalgamate a weak bank with any other bank.

Section 44A of the Banking Regulation Act lays down the procedure foramalgamation of banking companies. Section 44B of the Act further empowers RBIin the matter of compromise arrangements between a bank and its creditors. Thesehave to be approved by RBI and such compromise cannot be sanctioned even by aHigh Court. Under Section 36 AE of the Act, the Central Government can underadvice from RBI take over a weak bank. When a bank is placed under liquidation, theHigh Court can appoint RBI, SBI or any other bank as the official liquidator andmonitor the speedy disposal of winding up proceedings.

Part-II C of the Banking Regulation Act deals with the acquisition of the undertakingof banking companies. Section 36-AE of the Banking Regulation Act deals with thepower of Central Government to acquire undertakings of banking companies in

certain cases. Sec.36-AF deals with the powers of Central Government to makescheme and Section 36AG deals with compensation to be given to shareholders of theacquired bank.

The Central Government on receipt of a report from the RBI may acquire a bankingcompany if it fails to comply with the directions given to it under Sec.21 or Sec. 35-Aof the Banking Regulation Act. Similar action may also be taken if the BankingCompany is being managed in a manner which is detrimental to the interest of itsdepositors, or against the banking policy. Reasonable opportunity should be given tothe bank before taking such action.

Let us now see how the Takeover Code evolved over a period of time in India:

The Evolution of the Takeover Code

1990

The Government amends clause 40 of the listing agreement according to which,threshold acquisition level reduced from 25% to 10% ; change in management controlto trigger public offer’; minimum mandatory public offer of 20% disclosurerequirement through mandatory public announcement.

November 1994

SEBI notifies Substantial Acquisition of Shares and Takeover, 1994. New provisionsintroduced to enable both negotiated and open market acquisitions and competitivebids allowed.

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Special Issues November 1995

SEBI sets up committee under former Chief Justice of India P.N. Bhagwati to reviewthe 1994 takeover Regulations in order to frame comprehensive regulations.

January 1997

The Bhagwati Committee submits its report on the takeover code to SEBI.

February 1997

SEBI accepts Bhagwati committee report and the Substantial Acquisition of Sharesand Takeovers Regulations, 1997, notified.

February 1998

SEBI proposes to revise the takeover code make it mandatory for acquirers to make aminimum open offer for 20% (and not 10% as earlier) of the target company’s equity,even if the holding goes beyond 51% as a result of the offer.

June 1998

SEBI asks justice Bhagwati to conduct a complete review of the takeover code. Issueslikely to be taken up are, the extent of disclosure in an open offer and if any change inthe objective of the offer needs to be spelt out in the revised offer.

June 1998

SEBI proposes to raise the creeping acquisition limit under its Takeover Code from2% to 5%. It also proposes to increase the share acquisition limit for triggering thetakeover code from 10% to 15%.’

November 1998

Takeover panel amends the takeover code to incorporate buyback offers bycompanies. The committee decides to allow takeover offers to be made when abuyback offer is open and vice versa.

December 1998

Justice P.N. Bhagwati criticizes SEBI for unilaterally increasing the trigger limit formaking a public offer from 10% to 15%. The Bhagwati Committee also recommendsthat once an acquirer acquires 75% of shares or voting rights in a company, he shouldbe outside the purview of the Takeover Regulations.

January 2000

SEBI again proposes that all open offers made by promoters for consolidating theirholding in a company will have to be for a minimum of 20% of equity. Exemption tothe minimum 20% requirement should be given only in the case of such companies inwhich promoters hold over 75%.

The SEBI’s Takeover Committee also recommends that a special resolution approvedby 75% of the shareholders should be made mandatory for effecting a change in themanagement of professionally managed companies. The step aims to avoid misuse ofthe earlier provision, under which certain groups with 51% stake could effect thechanges through a simple resolution.

Another recommendation that follows was that venture capital funds should be treatedon par with State Financial Institutions. And like financial institution, they should beexempted from making a public offer, in the event of acquiring a 15% stake in acompany.

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February 2000

SEBI finalizes the recommendations of takeover panel and review the takeover norms.However, the crucial decision on issue relating to ‘change in management control ofprofessionally managed companies’ left unresolved.

June 2000

SEBI plans to bring public financial institutions under the ambit of its takeover code,both as acquirers and as pledgees.

October 2000

Confederation of Indian Industry, FICCI and ASSOCHAM seek amendments in thetakeover code, especially in the case of creeping acquisitions, to provide the promotersa level-playing field against corporate raiders who may disrupt existing managements.Under the current takeover code, corporate raiders can pick up 15% of the paid-upequity of the target company over a 12 month period without triggering off thetakeover code.

November 2000

SEBI takeover panel decides to make it mandatory for an ‘acquirer’ to disclose hisholdings in the target company to the company as well to the exchanges, at threelevels; 5 %, 10% and 14%, instead of the existing stipulation of only 5%.

December 2000

SEBI promises a new draft on the takeover code in place by the end of March 2001with ‘investor protection’ as its pivot. The main objective of the new code would be toensure that acquiring companies are prompt in informing the stock exchanges whenthey cross the prescribed limits of holding a company’s stake, make publicannouncements and allow companies to make counter offers.

Source: www.capitalmarket.com

16.6 PROCEDURE FOR AMALGAMATION OF BANKING COMPANIES

Sec. 44A of the Banking Regulation Act,1949, deals with the procedure foramalgamation of banking companies. This procedure is discussed hereunder:

1. No banking company shall be amalgamated with another banking company,unless the shareholders of both the banking companies approve merger scheme ina meeting called for the purpose by a majority in number representing two-thirdsin value of the shareholders of each of the said company.

2. The approved scheme of amalgamation shall be sent to RBI for its approval.

3. Any shareholder who has voted against the scheme of merger or has given noticein writing at or prior to the meeting shall be entitled to claim from bankingcompany the value of the shares held by him as determined by the RBI whileapproving the scheme.

4. Once the scheme of amalgamation is sanctioned by the RBI, the property andthe liabilities of the amalgamated company shall become the property and theliabilities of the acquiring company.

5. After sanctioning the scheme of amalgamation by the RBI, the RBI may furtherorder the closure of acquired bank and the acquired bank stands dissolved fromsuch a data as may be specified.

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Special Issues16.7 RESTRUCTURING OF BANKS AND SOME

RELEVANT COMMITTEES

The reports of three committees appointed by the RBI are relevant in relation to therestructuring of Banks. These are: Report of the Narasimham Committee on BankingSector Reforms, Report of the Working Group for Harmonizing the Role andOperations of DFIs and Banks, and the Report of the Working Group onRestructuring of Weak Public Sector Banks. If we study these three reports we can geta good idea of the trends and future of Bank restructuring in India.

1. Narasimham Committee

The Narasimham Committee on Banking Sector Reform was set up in December,1997. This Committee’s terms of reference include; review of progress in reforms inthe banking sector over the past six years, charting of a programme of banking sectorreforms required making the Indian banking system more robust and internationallycompetitive and framing of detailed recommendations in regard to banking policycovering institutional, supervisory, legislative and technological dimensions. TheCommittee submitted its report on 23 April, 1998 with the following suggestions:

l Merger with strong banks, but not with the weak.

l Two or three banks with international orientation, eight to 10 national banks anda large number of local banks.

l Rehabilitate weak banks with the introduction of narrow banking

l Confine small, local banks to States or a cluster of Districts.

l Review the RBI Act, the Banking Regulation Act, the Nationalisation Act andthe State Bank of India Act.

l Speed up computerisation of public sector banks.

l Review the recruitment procedures, and the training and remuneration policies ofPSU banks.

l Depoliticisation of appointments of the bank CEOs and professionalisation of thebank Boards.

l Strengthen the legal framework to accelerate credit recovery.

l Increase capital adequacy to match the enhanced banking risk.

l Budgetary support non-viable for recapitalisation.

l No alternative to the asset reconstruction fund.

2. Khan Group

The Group was set up by the RBI in December, 1997, under the Chairmanship ofShri S.H. Khan, the then Chairman of IDBI. The Group was to review the role andstructure of the Developmental Financial Institutions and the Commercial Banks in theemerging environment, and to recommend measures to achieve coordination andharmonization of Lending policies of financial institutions before they move towardsUniversal Banking. Some of the recommendations of this Group are given below:

i) A progressive move towards universal banking and the development of anenabling regulatory framework for the purpose.

ii) A full banking licence may be eventually granted to DFIs. In the interim, DFIsmay be permitted to have a banking subsidiary (with holdings up to 100 percent), while the DFIs themselves may continue to play their existing role.

iii) The appropriate corporate structure of universal banking should be an internalmanagement/shareholder decision and should not be imposed by the regulator.

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iv) Management and shareholders of banks and DFIs should be permitted to exploreand enter into gainful mergers.

v) The RBI/Government should provide an appropriate level of financial support incase DFIs are required to assume any developmental obligations.

3. Verma Group

The Reserve Bank of India set up a Working Group on Restructuring Weak PublicSector Banks, under the Chairmanship of Shri M.S. Verma, former Chairman, StateBank of India, to suggest the measures for revival of weak Public Sector Banks. Thegroup has gone deep into the issue and analyzed the problem fully and made specificsuggestions. The summary report of this is given in the appendix to this unit. Thisgroup has identified some core principles for incorporation into the futurerestructuring strategies for weak banks. They are reproduced below from the report.

Future restructuring strategies for weak banks must incorporate the following coreprinciples:

a) Manageable Cost: The restructuring effort that is embarked upon has to be atthe least cost possible. However, the fact that injudiciously chosen lower costalternatives may lead to much higher costs in the long term must not be lostsight of.

b) Least Possible Burden on the Public Exchequer: As far as practicable the costof restructuring must come out of the unit being restructured. Even if itscontribution to the cost of restructuring is not available upfront, it should bepossible to recover this later, out of the value that can be created by therestructuring. The need to minimise the burden of such cost, preferably initially,but certainly finally is obvious and cannot be overstated. Any plan forrestructuring which does not clearly result in value addition at the end of theexercise, is not worth attempting.

c) All Concerned must Share Losses: The restructuring strategy as also theinstruments employed in the implementation of this strategy have to make a clearstatement about the manner in which the losses already incurred and to beincurred have to be shared. The principle of sharing of losses will have to remainfully operative in both operational and financial restructuring envisaged for abank. Such a plan for sharing losses will include reduction in staff as well as allother administrative cost of operations.

d) Changes for Strong Internal Governance: The internal governance of the banksand their operations at all levels has to be strengthened and fully sensitised to theneeds of protecting against all foreseeable future problems. Restructuring alwaysinvolves some amount of destabilisation in the organisation and during thisperiod as also immediately after it, management and all its operatives have tomake sure that the intended benefits of the restructuring plans are not allowed inany way to be frittered away or lost due to delays and lack of diligence in itsimplementation.

e) Effective Monitoring and Timely Course Corrections: Individual restructuringplans are to be implemented by the banks concerned internally and their successwill depend upon the quality of governance and organisational commitment to theproposed restructuring. However, for a successful restructuring it is importantthat there is an independent agency which will own it and in the process ofdriving it forth, constantly monitor its progress. This role can be played by theowner but such an arrangement has limitations because of the conflict ofinterests that are likely to arise in such cases and the lack of time and skill for thejob, which the owner may suffer from. It will be more so when the ownership ofthe banks is with the government. For obvious reasons, this responsibility cannot

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Special Issues be given to the regulator either. The regulator will no doubt have interest in thesuccess of the restructuring programme but direct efforts on its part to ensure itsimplementation could result in conflict of interests. The objective can, therefore,be best achieved by an independent agency, which with the express consent of theowner shall have full authority over the restructuring process and be in a positionto effectively monitor its progress. In this process, while this independent agencywill monitor to ensure that the restructuring process remains on course, wherevernecessary it shall also take steps to facilitate due implementation of the plan.Such steps by this agency may include devising corrective measures and ensuringthat the banks concerned adopt these measures.

f) Ease of Implementation: Above all there must be an all-round consensus on theprocess of restructuring, its modalities and timing. The process itself and all theattendant instruments and instrumentalities will have to be simple and easy toemploy.

While setting the core principles, which should govern any programme of bankrestructuring is not so difficult, deciding upon precise modalities of restructuring, isindeed, quite a vexatious and difficult issue to settle. As can be learnt frominternational experiences various modalities and quite a few variations of each of thesemodalities have been tried with varying degrees of success. In their time and givensocio-economic environment each of these options chosen had good logic behind them.While, therefore, they have their applicability and merit these are certainly nottransplantable where the prevailing conditions are different.

16.8 CASE STUDIES

In this section we shall be discussing three case studies of bank mergers. They are:

1. Punjab National Bank (PNB) and New Bank of India (NBI),

2. ICICI Bank and Bank of Madura, and

3. ICICI Bank and ICICI Ltd.

The case of Punjab National Bank and New Bank of India is a case of two PublicSector Banks merging together as a solution to protect a weak bank (New Bank ofIndia) by merging with a healthy bank (PNB).The case study of ICICI Bank and Bankof Madura is a representative case of modern thinking in the banking industry, i.e.,growth through the merger route. The merger of ICICI Bank and ICICI Ltd is a caseof a Developmental Financing Institution merging with a Commercial Bank andemerging into an Universal Bank. The first case (PNB-NBI) reflects the old thinkingand the remaining two cases reflect new trends in the banking and financial servicessector. Let us now know more details about these cases.

Punjab National Bank and New Bank of India Merger

In year 1970 fourteen banks including PNB were nationalized. In 1980 six morebanks including New Bank of India were nationalized. Both these banks were mergedin 1993 by the Central Government. The New Bank of India was incurring losses andby the year 1991-92, its financial position had become so bad that its capital anddeposits completely stood eroded.

Punjab National Bank commenced its operations on April 12,1895 from Lahore withan authorized capital of Rs. 2 lakhs and working capital limit of Rs. 20,000/- .The Bank has more than 100 years of history and has faced many financial and othercrises in the Indian financial system over these years.

New Bank of India was a comparatively small bank among the nationalized banks.It had around 600 branches all over the country with 12,400 employees and washaving 2,500 crores of deposits and advances Rs. 970 crores.

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Whereas PNB was working with 3734 branches all over the country with totalemployees numbered 71,650. it was having total deposits of Rs. 25,280 crore andadvances of Rs. 12,078 crore.

This was the first case in the Indian History that one nationalized bank was mergedwith another nationalized bank. The basic reasons for this merger were as follows:

– The New Bank of India was in loss consecutively for last three years whenmerger took place on 4th September, 1993.

– Productivity per employee of New Bank of India was low.

– Work ethics of the union(s) workers was low.

– Only option left out was either liquidation or merger with another bank.

Since it was a small bank having its head office in Delhi and also with the similaritiesof work culture of Punjab National Bank whose head office also happened to be inDelhi, Govt. of India under recommendations of Narasimham Committee reportdecided to merge New Bank of India with Punjab National Bank.

Table 16.2: Financials of the PNB and NBI at the time of Merger (1992-93)

PNB NBI PNB+NBI

Capital (Rs. in Crore) 187.84 68.69 256.53

No. of Shares 187842200 186000000 373842200

Reserves (Rs. in Crore) 360.94 8.43 369.37

Profits (Rs. in Crore) 38.01 (-)75.79 (–)37.382

Earnings per Share (Rs.) 2.02 (-) 4.07 (–) 1.01

Deposits (Rs. in Crore) 18241.31 2362.32 20603.63

Advances (Rs. in Crore) 9915.21 974.81 10890.02

The PNB and NBI merger has not been a marriage of convenience. It had the seeds oflong-term detrimental effect to the health of PNB. The most ticklish problem whichthe amalgamated entity faced was the complete absorption of the sizeable NBIworkforce into its own work-culture. The NBI was notorious for rampant indisciplineand intermittent dislocation of work due to fierce inter-union rivalries.

ICICI Bank and Bank of Madura Merger

Bank of Madura (BOM) was a profitable, well-capitalized, Indian private sectorcommercial bank operating for over 57 years. The bank had an extensive network of263 branches, with a significant presence in the southern states of India. The bank hadtotal assets of Rs. 39.88 billion and deposits of Rs.33.95 billion as on September30,2000. The bank had a capital adequacy ratio of 15.8% as on March 31,2000.The Bank’s equity shares were listed on the Stock Exchanges at Mumbai and Chennaiand National Stock Exchange of India before its merger.

ICICI Bank then was one of the leading private sector banks in the country. ICICIBank had total assets of Rs. 120.63 billion and deposits of Rs. 97.28 billion as onSeptember 30, 2000. The bank’s capital adequacy ratio stood at 17.59% as onSeptember 30, 2000. ICICI Bank was India’s largest ATM provider with 546 ATMsas on June 30, 2001. The equity shares of the bank were listed on the StockExchanges at Mumbai, Calcutta, Delhi, Chennai, Vadodara and National StockExchange of India. ICICI Bank’s American Depository Shares were listed on the NewYork Stock Exchange.

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Special Issues In February 2000, ICICI Bank was one of the first few Indian banks to raise itscapital through American Depository Shares in the international market, and receivedan overwhelming response for its issue of $ 175 million, with a total order of USD2.2 billion. At the time of filling the prospectus, with the US Securities andExchange Commission, the Bank had mentioned that the proceeds of the issue wouldbe used to acquire a bank.

As on March 31, 2000, bank had a network of 81 branches, 16 extension countersand 175 ATMs. The capital adequacy ratio was at 19.64% of risk-weighted assets, asignificant excess of 9 % over RBI Benchmark.

ICICI Bank was scouting for private banks for merger, with a view to expand itsassets and client base and geographical coverage. Though it had 21% of stake, thechoice of Federal bank, was not lucrative due to employee size (6600), per employeebusiness was as low as Rs. 161 lakh and a snail pace of technical upgradation. While,BOM had an attractive business per employee figure of Rs. 202 lakh, a bettertechnological edge and a vast base in southern India as compared to Federal Bank.While all these factors sound good, a cultural integration was a tough task ahead forICICI Bank.

ICICI Bank had then announced a merger with the 57 year old BOM, with 263branches, out of which 82 of them were in rural areas, with most of them in southernIndia. As on the day of announcement of merger (09-12-2000), Kotak Mahindragroup was holding about 12% stake in BOM, the Chairman BOM, Mr. K.M.Thaigarajan, along with his associates was holding about 26% stake, Spic group hadabout 4.7%, while LIC and UTI were having marginal holding. The merger wassupposed to enhance ICICI Bank’s hold on the south Indian market.

The swap ratio was approved in the ratio of 1:2- two shares of ICICI Bank fornormal every one share of BOM. The deal with BOM was likely to dilute the currentequity capital by around 2%. And the merger was expected to bring 20% gains inEPS of ICICI Bank and a decline in the bank’s comfortable Capital Adequacy Ratiofrom 19.64% 17.6%.

Table 16.3: Financials of ICICI Bank and Bank of Madura

(Rs. In Crores)

Parameters ICICI Bank ICICI Bank Bank of Madura Bank of Madura1999-2000 1998-1999 1999-2000 1998-1999

Net worth 1129.90 308.33 247.83 211.32

Total deposits 9866.02 6072.94 3631.00 3013.00

Advances 5030.96 3377.60 1665.42 1393.92

Net Profit 105.43 63.75 45.58 30.13

Shre capital 196.81 165.07 11.08 11.08

Capital adequacy ratio 19.64% 11.06% 14.25% 15.83%

Gros less NPAs/gross 2.54% 4.72% 11.09% 8.13%advances

Net NPAs/net advances 1.53% 2.88% 6.23%5 4.66%

The scheme of amalgamation was expected to increase the equity base of ICICI Bankto Rs. 220.36 crore. ICICI Bank was to issue 235.4 lakh shares of Rs. 10 each to theshareholders of BOM. The merged entity will have an increase of asset base overRs. 160 billion and a deposit base of Rs. 131 billion. The merged entity will have 360branches across the country and also enable ICICI Bank to serve a large customerbase of 1.2 million customers of BOM through a wider network, adding to thecustomer base to 2.7 million.

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Some Issues of the Merger

The Board of Directors at ICICI Bank had contemplated the following synergiesemerging from the merger:

Financial Capability: The amalgamation will enable them to have a stronger financialand operational structure, which is supposed to be capable of grater resource/depositmobilization. In addition to this, ICICI will emerge as one of the largest private sectorbanks in the country.

Branch Network: The ICICI’s branch network would not only increase by 263. butalso increase its geographic coverage as well as convenience to its customers.

Customer Base: The emerged largest customer base will enable the ICICI Bank tooffer other banking and financial services and products to the erstwhile customers ofBOM and also facilitate cross selling of products and services of the ICICI group totheir customers.

Tech Edge: The merger will enable ICICI Bank to provide ATM, phone and theInternet banking and such other technology based financial services and products to alarge customer base, with expected savings in costs and operating expenses.

Focus on Priority Sector: The enhanced branch network will enable the bank tofocus on micro finance activities through self-help groups, in its priority sectorinitiatives through its acquired 87 rural and 88 semi-urban branches.

Managing Rural Branches: Most of the branches of ICICI were in metros and majorcities, whereas BOM had its branches mostly in semi urban and city segments ofsouth India. The task ahead lying for the merged entity was to increase dramaticallythe business mix of rural branches of BOM. On the other hand, due to geographiclocation of its branches and level of competition, ICICI Bank will have a tough time tocope with.

Managing Software: Another task, which stands on the way, is technology. WhileICICI Bank, which is a fully automated entity was using the package, banks 2000,BOM has computerized 90% of its businesses and was conversant with ISBSsoftware. The BOM branches were supposed to switch over to banks 2000. Thoughtit is not a difficult task, 80% computer literate staff would need effective retrainingwhich involves a cost. The ICICI Bank needs to invest Rs.50 crores, for upgradingBOM’s 263 branches.

Managing Human Resources: One of the greatest challenges before ICICI Bank wasmanaging the human resources. When the head count of ICICI Bank is taken, it wasless than 1500 employees; on the other hand, BOM had over 2,500. The merged entitywill have about 4000 employees which will make it one of the largest banks among thenew generation private sector banks. The staff of ICICI Bank was drawn from 75various banks, mostly young qualified professionals with computer background andprefer to work in metros or big cities with good remuneration packages.

Managing Client Base: The client base of ICICI Bank, after merger, will be as big as2.7 million from its past 0.5 million, an accumulation of 2.2 million from BOM. Thenature and quality of clients is not uniform. The BOM has built up its client base overa long time, in a hard way, on the basis of personalized services. In order to deal withthe BOM’s clientele, the ICICI Bank needs to redefine its strategies to suit to the newclientele. If the sentiments or a relationship of small and medium borrowers is hurt; itmay be difficult for them to reestablish the relationship, which could also hamper theimage of the bank.

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Special Issues ICICI Ltd. and ICICI Bank Merger

The merger between ICICI Bank and ICICI Ltd. pioneered the concept of UniversalBanking in India. Taking the reverse merger route ICICI Ltd. Merged with itserstwhile subsidiary, ICICI Bank. The swap ratio has been decided at 2:1 that is 1share of ICICI Bank for every 2 shares held in ICICI Ltd. It was also supposed toinclude merger of two ICICI subsidiaries, namely, ICICI Personal Finance ServicesLimited and ICICI Capital Services Limited with ICICI Bank.

At the time of merger, ICICI Ltd was holding (held) 46 per cent stake in ICICI Bank.In the case of merger, instead of extinguishing the shares, the company has decided totransfer the stake to a Special Purpose Vehicle (SPV) to be created in the form of atrust. Post merger, this was to form about more than 16 per cent of the total capital.This is an intelligent move by the company, as it would serve many purposes. First ofall it is not prudent to extinguish capital in a scenario where the cost of raising capitalitself is very high. Secondly, by doing so the bank would be able to safeguard itscapital adequacy ratio. Thirdly, the plan is to divest the stake to a strategic partnerfew years down the line, which would fetch the bank considerable amount of cash.The shares would be transferred to the SPV at the price at which ICICI bought theshares i.e. Rs 12 per share.

Reason for Merger

l Analysts say ICICI wanted to merge with its banking subsidiary to obtaincheaper funds for lending, and to increase its appeal to investors so that it canraise capital needed to write off bad loans.

l This merger was basically a survival, more for ICICI, as its core business didn’tlook too good and they needed some kind of a bank because only a bank hasaccess to low-cost funds.

l Cheap Cash was another reason for merger.

Main Concerns

l A major concern in the road ahead to the merger was the reserve requirement thata bank was supposed to maintain. At that time these requirements were notapplicable to ICICI Ltd. A bank has to maintain a Cash Reserve Ratio of 5.5per cent with RBI and Statutory Liquidity Ratio of 25 per cent. ICICI required atotal of Rs.18,000 crore to fulfill this requirement. This was a huge amount andgiven the scenario of that time and it was difficult for the institutions to raisesuch an amount. The group planned to raise the required funds partly throughICICI and partly through ICICI Bank.

l Another issue was of fulfilling the priority sector lending requirement. Thisrequirement at the time of merger was at 40 per cent i.e. 40 per cent of thelending was to be made to priority sectors.

Benefit to the Players

l The main objective of adopting the path of Universal Banking is thatfinancial institutions are finding it increasingly hard to survive in a scenario ofhigh cost of borrowing and decreasing spread with interest rates going down.Cost of borrowing for a financial institution through bonds is much higher thana bank, which can raise current and saving deposits. As per regulations,financial institutions cannot raise these deposits. Post merger it would bepossible to do so.

l Also increasing disintermediation had made things increasingly difficult forICICI Ltd. Some of the customers of ICICI Ltd. were in a position to accessfunds at much lower cost than from ICICI Ltd. and ICICI Ltd. could not afford

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to lend at that rate as its own cost of funds was high. Once converted into abank, its access to cheap funds would enable it to lend at competitive rates.

l ICICI Ltd. as a combined entity would be better equipped to handle issuesarising from potential asset liability mismatches due to more stable deposit base.

l Post merger ICICI Bank would be able to significantly enhance its fee basedincome based on the strength of its balance sheet. Before the merger, ICICI Ltd.could not carry out certain activities as it was not a bank and therefore loses outon the fee based income. ICICI Bank on the other hand was constrained becauseof the limited size of its balance sheet. The sheer size of the balance sheet postmerger would boost the fee based income.

l The high margin retail loan portfolio before the merger was with the varioussubsidiaries. Post merger this was to be transferred to ICICI Bank.

The Negative Side of the Merger

l The assets quality of ICICI Bank, which has been its major strength, would beaffected post merger. ICICI Ltd. had NPAs of 5.2 per cent for FY01 as againstICICI Bank’s NPAs of 1.4 per cent.

l Before the merger, ICICI Ltd. could claim a deduction upto 40 per cent of itsprofits from its long term lending by transferring the amount to special reserve.Post merger, this benefit was to stand withdrawn in the case of incremental loans.

l Average cost of borrowing for ICICI Ltd. for financial year 2001 was 11.71 percent. Its Gross yield was 13.54 per cent for the same period. Either way ICICILtd. would have to take a hit in the bottom-line in the initial years.

l By bringing down its loan portfolio and diverting these funds for the reserverequirement it would have to forego some of the interest spread.

l CRR would get a return of 6.5 per cent and amount in SLR would generate areturn of about 9.5 per cent. Even in the case of fresh funds the cost ofborrowing would be higher and the return on those funds would be less.

Table 16.4: Some Financial Parameters at the time of Merger

Particular ICICI Ltd. ICICI Bank

MP at the time of merger (Rs.) 51 101

EPS (Rs.) 15.4 11.9

Book Value (Rs.) 102.8 65.5

MP/ Book Value 0.50 1.54

PE ratio 3.3 8.5

ICICI group has pioneered the concept of universal banking in India. IFCI Ltd is alsoin the process of merging with PNB. The concept of universal banking has foundfavour with many global players. Some of the international players, which haverealized the benefits of universal banking are ABN-AMRO, Citigroup, HSBC, UBSetc. No doubt in the times to come the benefits of this will start flowing in.

16.9 SUMMARY

As a result of economic changes and liberalization, the corporate sector has beenundergoing major changes and restructuring themselves to face these challenges.Corporate restructuring can take place in three different ways; restructuring ofbusiness portfolios, financial restructuring, and organisational restructuring. Mergerscould be of three types; vertical mergers, horizontal mergers, and conglomerate

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Special Issues mergers. Before the liberalization process started in India, there used to be bankmergers as and when a bank lands itself into problems. However, the merger of TimesBank into HDFC Bank started a new wave of merger of healthy banks in order to getsynergic benefits. After the Khan Group recommendations the DFIs have also startedthinking of merging with banks in order to have easy and cheap access to funds.

16.10 KEY WORDS

Narrow Banks mean banks which place their funds only in short-term, risk-freeassets or demand deposits of banks are matched by safe and liquid assets. They haveaccess to deposit insurance as well as to the payment system.

Universal Banks: Banking that includes investment services in addition to servicesrelated to savings and loans.

Merger: Merger is a combination of two or more companies into one company. InIndia, we call mergers as amalgamations, in legal parlance. The acquiring companyacquires the assets and the liabilities of the target company. Typically, shareholders ofthe amalgamating company get shares of the amalgamated company in exchange fortheir existing shares in the target company.

Takeover: Takeover can be defined as the acquisition of controlling interest in acompany by another company. It does not lead to the dissolution of the companywhose shares are being acquired. It simply means a change in the controlling interestof a company through the acquisition of its shares by another group.

16.11 SELF ASSESSMENT QUESTIONS

1. Why do banks go for mergers? Explain the reasons with suitable examples.

2. Explain the trends in bank restructuring in India?

3. Distinguish between mergers and Takeovers.

4. Describe the procedure for Bank Amalgamations as laid down by theBankingRegulation Act, 1949.

5. Discuss the major recommendations of Khan Group.

6. Discuss the different types of Bank mergers that are taking place in India inrecent time.

16.12 FURTHER READINGS

Ravi Sankar, K.,2003, Financial Analysis of Takeovers, Anmol Publishers (pvt.)Ltd., New Delhi.

Mattoo, P.K, 1998, Corporate Restructuring: An Indian Perspective, MacmillanIndia, New Delhi.

Shiva Ramu, 1998, Corporate Growth through Mergers and Acquisitions,Response Book, New Delhi.

Weston J. Fred, Chung Kwang S, and Hong Susan E., 1998, Mergers,Restructuring, and Corporate Control ,Prentice-Hall of India, New Delhi.

Alexandra M. post, 1994 Anatomy of a merger: the causes and effects of Mergersand Aacquisitions, Prentice Hall, Englewood cliffs, New Jersey.

Report of the Narasimham Committee on Banking Sector Reforms.

Report of the Working Group for Harmonizing the Role and Operations of DFIs and Banks.

Report of the Working Group on Restructuring of Weak Public Sector Banks.

Banking Regulation Act, 1949.

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Appendix 16.1

Summary Report of the Working Group onRestructuring Weak Public Sector Banks

Introduction

1. The Reserve Bank of India, in consultation with the Government of India, set upthe present Working Group under the chairmanship of Shri M.S. Verma, formerChairman, State Bank of India, and presently Honorary Adviser to the Reserve Bankof India, to suggest measures for revival of weak public sector banks. The terms ofreference were (a) criteria for identification of weak public sector banks, (b) to studyand examine the problems of weak banks, (c) to undertake a case by case examinationof the weak banks and to identify those which are potentially revivable, and (d) tosuggest a strategic plan of financial, organisational and operational restructuring forweak public sector banks.

International Experience

2. During the last twenty years, over 130 countries, developed and developing, haveexperienced banking crises in one form or the other. The Working Group has tried tounderstand the strategies adopted by some of these countries in the handling of thecrises. Restructuring of a banking system needs to address macro systemic issuespertaining to factors responsible for ensuring banking soundness and also the microlevel, individual bank problems. While there is no unique solution to banking crisesthat could be prescribed and applied across the board to all countries, there are somecommon threads that seem to run through all cases of successful restructuring.Initially, each bank needs to be restored to a minimum level of solvency throughfinancial restructuring. Thereafter, only longer term operational and systemicrestructuring can help them maintain their competitiveness and enable them to ensuresustained profitability. Only a comprehensive approach to restructuring can have alasting effect on the cost, earnings and profits of the banks to be restructured.

Public Sector Banks: An Overview

3. Till the adoption of prudential norms relating to income recognition, assetclassification, provisioning and capital adequacy, twenty-six out of twenty-sevenpublic sector banks were reporting profits (UCO Bank was incurring losses from1989-90). In the first post-reform year, i.e., 1992-93, the profitability of the PSBs as agroup turned negative with as many as twelve nationalised banks reporting net losses.By March 1996, the outer time limit prescribed for attaining capital adequacy of 8 percent, eight public sector banks were still short of the prescribed level.

4. The emphasis on maintenance of capital adequacy and compliance with therequirement of asset classification and provisioning norms put severe pressure on theprofitability of PSBs. Deregulation of interest rates on deposits and advances hasintensified competition and PSBs now have to contend with competition not only fromother public sector banks but also from old/new private sector banks, foreign banksand financial institutions. While some public sector banks have succeeded in adjustingto the changing business environment and managed competition some others have notbeen able to do so, and have displayed serious weaknesses.

5. The malady has been deep in the case of three banks, viz., Indian Bank, UCOBank and United Bank of India. Continuous decline in profitability and efficiency ofthese banks and their dependence on capital support from government are causes forconcern. They are trapped in a vicious circle of declining capability to attract goodbusiness and increasing need for capital support.

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Special Issues 6. It is likely that the seeds of weakness are latent in some other public sector banksas well. The problem of weak banks, which could have spill over effect on the systemitself, therefore, assumes serious proportions.

7. The Committee on Banking Sector Reforms (CBSR) had recommended that aweak bank would be one (a) where accumulated losses and net NPAs exceed the networth of the bank or (b) one whose operating profits less the income onrecapitalisation bonds has been negative for three consecutive years. To identify abank’s weakness or strength with a fair degree of certainty, the Group hasrecommended the use of the following seven parameters in conjunction with the twosuggested by the CBSR: (i) capital adequacy ratio, (ii) coverage ratio, (iii) return onassets, (iv) net interest margin, (v) ratio of operating profit to average working funds,(vi) ratio of cost to income, and (vii) ratio of staff cost to net interest income (NII) +all other income.

Identification of Weak Banks

8. All the public sector banks were evaluated on the above seven parameters keepingthe median as the threshold in five of the parameters. For capital adequacy ratio, thethreshold was 8 per cent and in respect of the coverage ratio it was kept at 0.50 per cent.

9. Indian Bank did not meet any of the parameters in both the years. UCO Bank andUnited Bank of India could comply with the capital adequacy prescription but failed inall the other six parameters. These banks, along with Indian Bank, were the onlybanks to have received capital infusion during the last two years and would not haveattained minimum capital adequacy otherwise.

10. The above approach serves the immediate objective of setting the criteria foridentifying weakness in banks in general and for locating potentially weak banks. TheWorking Group, therefore, recommends building a database in respect of banks on anongoing basis for the purpose of benchmarking and on that basis identifying signals ofweakness.

Causes of Weakness

11. The causes of weakness need to be addressed properly so that the remedialmeasures adopted prove effective and actually succeed in improving the functioning ofthe weak banks. The weaknesses relate to three areas: operations, human resourcesand management.

12. Operational failures mainly relate to high level and fresh generation of NPAs,slow decision making with regard to fresh sanction of advances and compromiseproposals and loss of fund-based advances and fee income. Declining market share inkey areas of operations, limited product line and revenue stream, absence of costcontrol and effective MIS and costing exercise, weak internal control andhousekeeping, poor risk management and insufficient customer acquisition due tomediocre service, low level of technology and non-competitive rates are the other causes.

13. The operations of subsidiaries and foreign branches, which are a drain on two ofthe banks, lead bank and RRB responsibilities and locational disadvantages are alsorelated issues.

14. Overstaffing, low productivity and a high age profile are the main HR relatedissues. Restrictive practices in deployment of staff have further aggravated the cost ofoverstaffing. In the three identified banks, staff cost as a proportion of total operatingincome has been above the industry median. Another area of concern is the level ofskill and low levels of motivation. Skills in foreign exchange, treasury managementand other specialised areas are not significant enough to generate business in theseareas on a sustained basis.

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15. Training facilities are not adequate to meet the training requirements of the staffof the banks and motivation and morale of employees at all levels is low.

16. Under management related issues, lack of succession planning, short tenures andfrequent changes in top management, inadequate support from the Board of Directorsand the lackadaisical implementation of earlier SRPs and MOUs are causes ofweakness. Even after infusion of Rs. 6,740 crore in the three banks over the last sevenyears, their basic weaknesses persist. Unconditional recapitalisation from theGovernment of India has proved to be a moral hazard as no worthwhile attempt hasbeen made by the banks to gain adequate good business or to reduce costs.

Past Efforts at Restructuring

17. The restructuring efforts initiated so far have not had the desired impact. Hardoptions have been avoided and the steps taken so far have only had the objective ofmaintaining the capital adequacy ratio of the banks with the assistance of Governmentof India. The banks have failed to develop the required resilience or strength tobecome competitive in the true sense.

Present Position of the Weak Banks

Indian Bank

18. Indian Bank continued to incur operating losses in 1998-99 also. The capitaladequacy which had turned positive and reached 1.41 per cent in March 1998 withcapital infusion of Rs. 1,750 crore from the Government of India turned negativeagain in March 1999. The decline in other income continued during 1998-99 as well.The bank did not make any provision for liabilities arising on account of theproposed wage revision. The deterioration on the NPA front is unabated. Gross NPAwent up from Rs. 3,428 crore as on 31 March 1998 to Rs. 3,709 crore as on31 March 1999, i.e., 37 per cent of gross advances. This was the highest amongpublic sector banks.

UCO Bank

19. UCO Bank’s operating profit improved marginally in 1998-99. However, if theinterest income on recapitalisation bonds is excluded, the bank would have incurredoperating loss of Rs. 91 crore in 1997-98 and Rs. 157 crore in 1998-99.Recapitalisation by the government to the tune of Rs. 200 crore helped the bankachieve capital adequacy of 9.63 per cent in 1998-99. The bank has not madeprovision for liability on account of wage revision. Gross NPAs as on 31 March 1999aggregated Rs. 1,716 crore (23 per cent). Net NPAs at Rs. 715.63 crore were higheras compared to Rs. 705 crore as on 31 March 1998. The inability of the bank toregister any improvement in the net NPA position is a matter for concern.

United Bank of India

20. United Bank of India’s operating profit decreased substantially in 1998-99.Operating income increased mainly on account of extraordinary income by way ofinterest received on income tax refund. Further, if the interest income onrecapitalisation bonds is excluded, the bank would have incurred operating loss ofRs. 89 crore in 1997-98 and Rs. 117 crore in 1998-99. Recapitalisation by theGovernment of India to the tune of Rs. 100 crore helped the bank achieve capitaladequacy of 9.60 per cent in 1998-99. The bank has not made provision during1998-99 for future pension liability and wage revision. The gross NPAs of the bank ason 31 March 1999 increased in absolute terms to Rs. 1,549 crore (32 per cent) fromRs. 1,451 crore as on 31 March 1998 (34 per cent). Net NPAs also went up toRs. 573 crore (15 per cent) as on 31 March 1999 from Rs. 472 crore (14 per cent) ason 31 March 1998.

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Special Issues Assessment of Revival Plans Prepared by the Banks

21. The plans prepared by the banks at the Working Group’s instance were no betterthan the earlier ones that had failed in that they continue to be based on ambitiousprojections of growth in business and income for which the banks are not equipped interms of skill or technology. The plans do not reflect the growing compulsions ofhaving to achieve steady growth in income and sustained control of expenditure withinas short a time as possible. Therefore, the restructuring plans drawn up by the banksdo not meet the objectives. It is felt that, as long as government assurance as tocontinued capital infusion is there, the banks would only look at soft optionsregardless of the time and cost involved.

Future Course of Action

22. The restructuring exercise has to be comprehensive and must address operationaland financial restructuring simultaneously. There is no room for half way measures orgradualism. It is tempting to confine restructuring to financial aspects since solvencyis immediately restored and there is a visible impact on the balance sheet. But, ifoperational aspects are not attended to, long term sustainability cannot be ensured.This will only lead to additional problems necessitating further and costlierrestructuring down the road.

23. Future restructuring strategies must incorporate the core principles of manageablecost, least burden on the exchequer, sharing of losses equitably and strong internalgovernance. There should be an independent agency that will constantly monitor theprogress of restructuring.

24. Bank restructuring has been attempted mainly by using one or more of thefollowing modalities: merger or closure, change in ownership, narrow banking and acomprehensive operational and financial restructuring. The Working Group hasexamined the applicability of each of the above options in the present Indian context.

Merger or Closure

25. Merger would be advantageous only if it takes into account the synergies andcomplementing strengths of the merging units. The Working Group does notrecommend merger as a possible solution in reviving the weak banks without firstpreparing them for it.

26. Closure has a number of negative externalities affecting depositors, borrowers,other clients, employees and, in general, the areas served by the banks being closed.This is an extreme option and would need to be exercised after all other options ofsuccessful restructuring are ruled out.

Change in Ownership

27. Privatisation is an acceptable course as this process alone can reduce thegovernment’s responsibility of capitalising the three banks further and, in the long run,enable it to recoup, fully or partially, the investment made in their capital. This willremove the moral hazard implicit in the present situation that government support willalways be available and make the three banks responsive to the rules of marketeconomy. The three banks will then also have a sense of accountability to all thestakeholders and appreciate the need for good performance.

28. However, in their present state, it is just not possible to consider theirprivatisation because the cost of restructuring is prohibitively high and no privategroup can normally be expected to bring in the kind of resources that the three banksrequire at present. These banks are also not likely to succeed in accessing the capitalmarket given their present position. Their present staffing pattern and level of skillsand technology will be deterrents to any investor.

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Narrow Banking

29. All the three weak banks have pursued some form of narrow banking, withoutsuccess, for reasons such as inability to lend to quality customers, as a matter ofdeliberate policy, high levels of NPAs and “fear psychosis”. Preferring governmentsecurities to fresh lending creates dissatisfied borrowers who tend to change theirbank. Banks’ ability to generate non-interest income is linked to the size and quality oftheir advances portfolio. A restriction on this results in a fall in fee income. Such atwo-pronged loss in income adds to the weakness of the bank making its recovery evenmore difficult. Further, resorting to narrow banking does not protect a bank against allrisks as even investments in gilts are open to market risks. In any case, narrowbanking can at best be only a temporary phase and cannot by itself be adopted as arestructuring strategy.

Comprehensive Operational and Financial Restructuring

30. With the three other options not being found suitable to the present environment,the only other option left for consideration is that of a comprehensive operational andfinancial restructuring. The Group has tried to answer the question whether this optionof restructuring is available in the case of the three identified weak banks.

31. The three banks are obviously beset with serious weaknesses and have not beenable to turn around despite repeated recapitalisations almost all through the 1990sadding up to a massive sum of Rs. 6,740 crore. They continue to depend upon thegovernment for further recapitalisation and Indian Bank alone will need another Rs.1,000 crore urgently to gain the prescribed minimum capital adequacy of 9 per centwith no guarantee that at the end of the current year, they will once again not needfurther infusion of capital to maintain this ratio. The position of the other two banks isonly marginally better as they do not need capital infusion immediately. However,their future operations too are unlikely to continue without further infusion of capital.It does not, therefore, make economic sense to let them continue in the present mannerfor, after all, the government cannot undertake to capitalise them endlessly.

32. It is, therefore, time to take a long term view and ensure that the present state ofaffairs does not get prolonged. The choice is, therefore, limited to either closing themor subjecting them to such extensive operational, organisational and financialrestructuring as can effectively restore their competitive efficiencies.

33. In view of the very extensive network and large client base of each of these banks,as also the other attendant negative externalities, closure is to be considered only asthe last option. The choice of comprehensive restructuring, therefore, requires carefulconsideration. Any such restructuring, however, will mean exercising hard options andinvolve firm, decisive and timely actions. There must be a firm political will backedby firm commitments from the bank management and the employee unions that therestructuring exercise will be completed without any let up or hindrance.

The management and employee unions of the banks will have to come to anagreement before the restructuring exercise begins as regards every importantingredient of the proposed exercise. The crux of the issue is that it is going to be anexpensive one-time exercise and, unless its success is reasonably assured, it will notbe worth undertaking.

34. Subject to what has been stated above, the Group has developed a four-dimensional comprehensive restructuring programme covering operational,organisational, financial and systemic restructuring. These are as under:

1. Operational restructuring involving

i) basic changes in the mode of operations,

ii) induction of modern technology,

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Special Issues iii) resolution of the problem of high non-performing assets and

iv) drastic reduction in cost of operations.

2. Organisational restructuring aimed at improved governance of the banks andenhancement in management involvement and efficiency.

3. Financial restructuring with conditional recapitalisation.

4. Systemic restructuring providing for, inter alia, legal changes and institutionbuilding for supporting the restructuring process.

Operational Restructuring

35. In a well-researched document published by the IMF in 1997, one of itscontributors, Gillian Garcia, has identified the following as key elements ofoperational restructuring:

a) Formulating a business plan that focuses on core products and competencies.

b) Reducing operating costs by cutting staff and eliminating branches whereappropriate, ceasing unprofitable activities, and disposing of unproductiveassets.

c) Implementing new technology and improving systems of accounting,asset valuation, and internal controls and audit.

d) Establishing and enforcing internal procedures for risk pricing, creditassessment and approval, monitoring the condition of borrowers, ensuringpayment of interest and principal, and active loan recovery.

e) Creating internal incentive structures to align the interests of directors,managers, and staff with those of the owners.

The Working Group considers the above to be a very good and concise statement ofoperational restructuring requirements. The plan evolved by the Working Group forrestructuring of the three banks is also on similar lines.

36. Operational restructuring for the weak banks is two pronged: one of increasingincome and the other of reducing costs. Income has to be increased by revamping thebanks’ mode of doing business and by reducing the effect of current and future NPAson their earnings. Cost reduction will have to be achieved by dropping the lines ofbusiness and products that are proving to be a drag on their profitability and effectingreduction in staff costs which account for most of the operating costs incurred by theweak banks.

Change in mode of Operations

37. None of the weak banks is identified with any special business or customer niche.Each of them, therefore, needs to develop strengths in chosen areas and build its skillsand business strategy around those strengths. By trying 12 to be all-India banks, theyare neither any more dominant in the area of their concentration nor are they able tomake a mark countrywide.

38. The growth of these banks’ credit portfolios has been extremely limited and theirfee-based earnings minimal. They need to take urgent steps to reintroduce creditculture and ensure a rapid growth in non-fund based earnings by laying stress on afew selected services, particularly, movement and management of funds.

39. These banks had left the traditional areas of business in which they hadexperience and moved into areas for which they neither had skills nor the experienceand this has been their undoing. They need to go into areas in which they have theexperience and can develop expertise in a short time. The appropriate markets forthem will be the middle and lower segments of the credit market.

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40. Unions have pleaded for allocation of a share of the PSU and other governmentdepartments’ related business. Such an approach is not practical nor is it desirableespecially in the present deregulated environment where the banks need to stand ontheir own and where these bodies themselves are autonomous in their functioning.

Foreign Branches and Subsidiaries

41. Both UCO Bank and Indian Bank would find it extremely difficult to run theirforeign branches in the short and medium term. The position even now is tenuous andwould get exacerbated if any of these operations runs into the slightest of difficulty orif the local regulators stipulate conditions regarding capital adequacy which the banksmay not be able to meet. This could pose a problem for not only the three banks butalso for the Indian banking system. These branches need to be taken off their hands byselling them to13 prospective buyers including other Indian public sector banks. Theresources raised could fund some of the various demands of the restructuringoperations.

42. The subsidiaries of Indian Bank are likely to be a continued drag on its viabilityand would add to the cost of restructuring. A decision to close them needs to be takenat the earliest. An effort could also be made to find buyers for the bank’s holdings inthe subsidiaries.

Adoption of Modern Technology

43. Public sector banks, particularly the weaker ones, are losing ground and share ofbusiness to the technologically well-equipped new private sector as well as foreignbanks. The weak banks do not have either the skills or the resources to implement andmaintain complex IT solutions of the kind that are required to meet the challenges. Adesirable solution would be to have common networking and processing facilities.Such common facilities may be outsourced from an existing reputed company. Theservice provider could also be invited to follow a ‘Build Own Operate Transfer’ modelfor this purpose.

44. Implementation of an IT solution in the above manner will, among other things,enable introduction of extended working hours and shifts and improve overallcustomer service. In the first stage itself, which may be spread over twelve to eighteenmonths, the IT solutions should target coverage of over 70 per cent of theparticipating banks’ present business. This would require that around 250 to 300 ofthe largest branches from each of the three banks be linked to the proposedoutsourcing. The Working Group has estimated the total cost for this at Rs. 300 crorewhich may come by way of assistance from the government or from multilaterallending institutions.

NPA Management

45. NPAs have been the most vexing problem faced by the weak banks with additionsto NPAs often outstripping recoveries. A significant portion of the NPAs are chronicand/or tied up in BIFR cases. There are also loans given to state and central publicsector units which have failed to repay. The operations of Debt Recovery Tribunalsare such that they have not so far made a dent in the NPA position of banks. The routeof compromises has also not been very successful despite setting up of SettlementAdvisory Committees. It is necessary that measures are found to ensure an earlyresolution of chronic NPAs. Where guarantees have been given by the central or stategovernments and where these have been invoked by the banks, these demands needto be met.

46. Separate institutional arrangements for taking over problem loans have played akey part in bank restructuring in different countries with varying degrees of success.

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Special Issues The Committee on Financial System (1991) and the CBSR (1998) had made similarrecommendations. Such separation of NPAs is an important element in acomprehensive bank restructuring strategy.

47. It would be desirable to develop a structure which will combine the advantages ofgovernment ownership and private enterprise. The broad structure would be that of agovernment-owned Asset Reconstruction Fund (ARF) managed by an independentprivate sector Asset Management Company (AMC). Assets belonging to public sectorbanks can be transferred to the ARF. The ARF will be constituted with the objectiveof buying impaired loans from the weak banks and to recover or sell them after somereconstruction or in an ‘as is where is’ condition. The ARF may be set up by theproposed Financial Restructuring Authority under a special Act of the Parliamentwhich while protecting it against obstructive litigation from the borrowers could alsoprovide for quick and effective enforcement of its rights. The ARF may be required toacquire assets of the face value of about Rs. 3,000 crore. The capital needed by theARF would be in the region of Rs. 1,000 crore.

48. The payment in respect of the assets purchased from the weak banks may bemade by the ARF by issuing special bonds for the purpose bearing a suitable rate ofinterest. It may also be guaranteed by the government in order to improve its liquidity.The bonds may, however, be issued to the weak bank with an initial lock-in period ofat least two years. These bonds as also those which will be issued for raising fundsagainst the security of assets purchased by the ARF may have a maturity of five years.

49. The ARF should purchase from the banks loans, which are NPAs as on a certaindate, say, 31 March 2000. The responsibility of recovering loans, which becomeNPAs after that date should remain totally with the banks concerned. It will, therefore,be adequate for the ARF to have a life of not more than seven years. The ARF maybuy NPAs only from the banks which have been identified as weak, though the optionof buying loans from other banks should not be closed. It should be possible to set upmore such funds later if the need arises.

50. The transfer price has to be fair to both the buyer and the seller. It would bedifficult to prescribe rigid arrangements or a floor price for the transfer of NPAs andeach case may have to be decided on merits. So long as pricing is arrived at by mutualagreement and in a transparent manner, the Group does not consider it necessaryeither to prescribe a floor price or a formula therefor.

51. The management of the ARF would be entrusted to an independent AssetManagement Company, a private sector entity, which will employ and avail of theservices of top class professionals. The AMC can be compensated for the services itprovides in the form of service commission on the value of assets managed coupledwith incentives for recoveries if these are higher than an agreed benchmark.

52. In the ownership of the AMC, while the government would have a fair share ofup to 49 per cent, may be even dominant, majority shareholding will be non-government. The other shareholders could be institutions like SBI, LIC, GIC, UTIand IFCI whose participation does not add to government shareholding and alsoparties from the private sector. The initial capital requirement of the AMC is notlikely to be more than Rs. 15 crore and it would, therefore, not be difficult to attractnon-government participants therein. It would also be possible to attract participationof multilateral agencies like IFC or ADB. The possibility of an existing FundManager, in public or private sector, offering to manage the ARF may also beexplored.

53. To the extent that NPAs are taken off the books of the three banks and are movedon to the Asset Reconstruction Fund, the Fund would be paying them for the assetstaken over by way of bonds bearing interest. This interest earning will add to theconcerned bank’s income which to a considerable extent will help the bank in meeting

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their staff expenses. Assuming that NPAs will be transferred at a rate so as to bringthem down to the average level of NPAs in PSBs which is around 15 per cent, theannual income for Indian Bank, UCO Bank and United Bank of India can be expectedto be augmented by around Rs. 91 crore, Rs. 44 crore and Rs. 24 crore respectively.

Reduction in Cost of Operations

54. Cost income ratio of the Indian Bank, UCO Bank and the United Bank of Indiafor the year 1998-99 worked out to 141.22, 93.94 and 89.90 per cent respectivelyshowing clearly that the cost of their operations has reached unsustainable levels andthat, unless the situation is corrected immediately, survival of these banks could be injeopardy.

55. The cost of operations of the three banks is clearly unsustainable and isthreatening long term viability and survival of these banks. When it comes to costmanagement and reduction, non-staff expenses are far less critical than staff expenses.These comprise of expenses incurred on items governed by market conditions overwhich banks have little or no control.

56. Management of costs necessarily boils down to management of staff expenseswhich in the year 1998-99 accounted for 76.37 per cent and 80.60 per cent of the totaloperating income (NII + all other income) in UCO Bank and United Bank of Indiarespectively. In the case of Indian Bank, the position was much worse at 107.79 percent. Other similarly placed public sector banks have this ratio generally below 45 percent. Banks which have to allocate a comparatively lower portion of their overallincome towards their staff costs obviously have a tremendous competitive advantageover the others.

57. Since chances of increasing income in the short term are remote, the weak bankshave little choice but to take all possible measures to reduce their staff costs and bringit in line with at least the average performing public sector banks in terms of itspercentage to total operating income (net interest income + non-interest income).

58. The three banks have not factored in the wage revision that is to become effectivefrom November 1997. No provision in respect of the increase (12.25 per cent) hasbeen made and should it become applicable to them not only will the yearly wage billfor the future years go up but substantial amounts will also go towards arrears for theperiod beginning from the date from which the revision becomes effective.

59. With the added income from transfer of NPAs in the form of interest on therelative bonds, the requirement of staff reduction would get suitably modified and hasbeen estimated to be of the order of 30 to 35 per cent in the three banks. Consideringall factors involved, the Group is of the view that initially a reduction in the staffstrength of the order of 25 per cent may serve the purpose and should, therefore, beaimed at. This reduction in staff strength would help the banks reduce staff costscorrespondingly which going by the expenses incurred in the year 1998-99, wouldwork out approximately to Rs. 107 crore, Rs. 121 crore and Rs. 85 crore in the caseof Indian Bank, UCO Bank and United Bank of India respectively.

60. This step is unavoidable since continuing with the present strength couldjeopardise the survival of the three banks. In order to control their staff costs, the threebanks will have to resort to a voluntary retirement scheme (VRS) covering at least 25per cent of the staff strength. It is estimated that a reasonable VRS for the three banksaimed at 25 per cent reduction would cost between Rs. 1,100 and Rs. 1,200 crore.

61. The rightsizing of staff will have to be achieved by the individual banksstructuring their schemes in such a way that they are able to maintain the requiredbalance between the different categories of staff and do not lose the desirableexperience and skills they possess. The scheme will have to be voluntary but the rightto accept or reject individual applications should rest with the management.

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Special Issues The scheme should aim at separation of employees in the age group of 45 and aboveespecially those in the 50-55 age group. The scheme should be in operation for aperiod not exceeding six months. The banks will need to undertake considerableretraining and relocation of the post-VRS staff strength. Such reskilling and relocationshould be made a precondition for future recapitalisation.

62. In order that the VRS and the needed reduction in staff costs have a real impacton the operating results of the banks concerned, it would also be necessary to place acap on the staff expenses of the three banks. Towards this, the Working Grouprecommends that a freeze on all future wage increase including the one presentlyunder contemplation, i.e., with effect from November 1997, be put in place. This maycontinue for a period of five years.

63. If VRS does not lead to the needed reduction in the banks’ operating costs, therewill be no alternative left but to resort to an across-the-board wage cut of an orderwhich will result in a similar reduction in costs. It is with this urgency in mind that theWorking Group has suggested keeping the VRS open for a limited period of sixmonths.

64. The only other source of sustenance in these cases is recapitalisation supportfrom the government but this too is not readily available because of the increasingpressures and other compelling demands on the government’s resources. If, therefore,the banks are to survive, most efforts and sacrifices will have to be their own. Outsidesupport can only be limited and short term and will be predicated upon what the bankscan do themselves.

Organisational Restructuring

65. The complex administrative structure of the weak banks is a serious limitationimpairing their decision making process. Each of these layers is delay laden andwithout any clarity of policies and purpose. Even though some delayering has beenattempted in some banks, especially, UCO Bank, the administrative structurecontinues to be diffused. Delayering alone would not speed up decision making unlessaccompanied by clearly laid out policies and procedures, skills and adequatediscretionary powers at the different levels of decision making.

66. The three banks have a larger network of branches than what their levels ofbusiness call for. There is also the question of concentration of branches in specificareas with which United Bank of India and UCO Bank are faced. There is an urgentneed to consider rationalisation of branches in all the three weak banks.

67. The weak banks must take a hard and careful look at the branches the levels ofbusiness of which are below 50 per cent of the level of nationalised banks in similararea and after convincing themselves about their unviability decide to discontinue theiroperations. By continuing such operations, hoping that these will improve in future orby showing them artificially as profitable using a transfer pricing mechanism whichfavours them unduly, the problem will be compounded and elude solution even infuture. It, therefore, stands to reason that the banks merge two or more unviableoperations into one viable operation.

68. Absence of dynamic leadership for long periods has been a major contributor tothe consistent deterioration in the functioning of the three banks. There is a need forappointing CMDs who are especially suited to their jobs and are more in the nature ofwartime generals possessing special skills and attitude required for restructuring. Theyshould have a sufficiently long tenure of, say, four to five years and should be in theage group of 50-52 years. In order to ensure uninterrupted progress of therestructuring plan and to commit the top management thereto fully, this tenure maynot be ordinarily curtailed. The right persons for these jobs should be provided withincentives, both monetary and non-monetary, for achieving the restructuring mission

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successfully even if giving such incentives means making a departure from existingnorms. If in the four or five year career of a person as CMD of a weak bank the bankshows a definite improvement, he could be considered for heading one of the primebanks/financial institutions in the country.

69. A line of succession should be developed well in time and a system put in placewhereby, save exceptions, an ED would succeed the outgoing CMD. Excepting invery small banks, there should be two EDs. One of the two EDs could be responsiblefor driving the restructuring process leaving the CMD free to pursue other strategicgrowth issues.

70. The boards need to be reconstituted to include eminent professionals,industrialists and financial experts with the necessary training, experience andbackground. There should be a clear distinction between the roles of ownership, whichthe government has, and that of management, which it does not. The government may,therefore, consider withdrawing from the banks’ boards its own serving officers andreplace them with independent nominees having relevant knowledge and experience.

71. Leadership is lacking in the middle levels of these banks because of inadequaciesin skills both in the traditional areas of bank operations as well as in new andspecialised areas such as credit, treasury operations, foreign exchange and IT. While alonger term training and reskilling programme will have to be undertaken, the bankswould also need to resort to some recruitment in the senior and middle levels ofmanagement from the market.

72. The training facilities are inadequate to meet the needs that would arise followingthe restructuring efforts. These will have to be considerably strengthened. Trainingfacilities created by more than one bank could be pooled for optimum utilisation of thelimited training skills available. A sub-allocation out of the capital support earmarkedfor VRS may be made for re-skilling and training.

Financial Restructuring

73. Financial restructuring has to be undertaken to ensure solvency. Capital infusionin the three identified weak banks has so far aggregated Rs. 6,740 crore. Furthercapital infusion in the case of Indian Bank is imperative to ensure its continuedoperations. Financial restructuring should aim at raising CAR to at least one per centabove the minimum required so that the banks can continue with their normal creditbusiness.

74. To the extent immediate cash funds are not being made available, the presentmode of recapitalisation by way of recapitalisation bonds may be continued. A portionof the additional capital requirement would need to be provided in cash in the form ofeither preference capital or long term subordinated debt. On this, the banks shouldhave an obligation of giving a return. Without this, they will fail once again toappreciate the necessity of developing minimum competitive efficiency and theirobligation to service capital. Recapitalisation must be accompanied by strictconditions relating to operating as well as managerial aspects of the recipient bank’sworking. Conditions should also apply to the manner in which these funds can bedeployed.

75. Additional capital is required to meet the cost of (a) moving some portion of theNPAs out of the books, (b) cost of modernisation of technology, (c) HRD related costsincluding that of VRS, relocation and training and (d) capital adequacy. Fundsrequired under (b) and (c) will have to come by way of cash. Requirements for itemsunder (a) and (d), however, can be met through recapitalisation bonds as hitherto.Funds should become available only when the banks undertake the specific activitiesfor which these have been earmarked.

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Special Issues 76. Recapitalisation should be under an agreement, between the government on theone side and the bank’s Board of Directors, its management and staff and employeeunions on the other, laying out the restructuring goals. The agreement, while statingclearly the extent of government’s involvement and the responsibilities of the bank,should also contain details of the bank’s obligations to perform and report, precisemilestones for performance and measures that will follow non-performance, treatmentof NPAs and near term improvements in operating results. It would also be desirableto assign selected financial indices for the bank to follow within a timeframe. Theperformance under this agreement will have to be monitored closely.

77. The overall cost of restructuring the three banks over the next three years isestimated by the Working Group to be of the order of Rs. 5,500 crore. A purpose-wisebreak-up of the required amount is given below:

a. Technology Upgradation Rs. 300-400 crore

b. VRS Rs. 1,100-1,200 crore

c. NPA Buyout Rs. 1,000 crore

d. For Capital Adequacy Rs. 3,000 crore

The estimate could turn out to be inadequate if some hidden surprises surface or somedelays or other roadblocks are encountered in the course of implementing theprogramme.

Systemic Restructuring

78. In order to ensure success in restructuring of weak banks, Government of Indiashould also consider setting up of an independent agency, say, Financial RestructuringAuthority (FRA), to co-ordinate and monitor the progress of the programme. It willrepresent the owner, in this case the Government of India and, vested with dueauthority from the government, be able to give the banks undergoing restructuring,guidance and instructions for proper implementation of the programme includingcourse corrections wherever necessary. It will approve bank specific restructuringprogrammes, enter into agreements with individual banks covering the terms andconditions of the programmes and follow up its progress with the bank and otherconcerned agencies. Among other things, it will also act as an owner of the AssetReconstruction Fund on behalf of the government and ensure its proper governance.It would be desirable to set up such an authority under an Act of the Parliament sothat with the force of law behind it the FRA enjoys a distinct individuality. The FRAis not being conceived as a permanent body as it is expected that, with the completionof the restructuring process of the weak banks, it would have outlived the utility of itsexistence and would be wound up with the winding up of the ARF it will own.

79. It will facilitate the process substantially and help effective implementation of therestructuring programme if within the Reserve Bank of India, a special wing is formedfor regulating and supervising weak banks. On a number of issues like depositinsurance, regulation of subsidiaries, risk management, disclosures and regulatorycompliance, the treatment of weak banks would need to be different from those ofmuch stronger normal banks. This arrangement would also help early detection of andattention towards weaknesses emerging in other banks pre-empting a systemwidespread of their problems.

80. Prolonged litigation prompted by legal lacunae in different commercialenactments is one of the main reasons for the increase in the size of the banks’ NPAs.Some of these enactments are several decades old and, in quite a few cases, out of linewith the present day realities. These provisions need to be amended urgently and somenew enactments are called for in order to cater to the requirements of the changed andfar more complex current economic and business environment.

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81. Countries like Thailand and Malaysia which have undertaken extensive bankrestructuring recently have within a short period enacted amendments to theirbankruptcy laws and improved provisions for foreclosures and court procedures toensure speedier enforcement of lenders’ claims. Malaysia is also setting up specialisedbankruptcy courts and steps have been taken there to plug loopholes that previouslyallowed borrowers to contract additional debts or dispose of their assets whilerestructuring was being worked out. Our problems are similar and it would be of greathelp to banks’ efforts in managing their NPAs if comparable laws are suitablyenacted/amended urgently.

82. DRTs have helped the recovery process of the banks only in a limited manner.Their functioning is under review. Till necessary amendments to the Recovery ofDebts Due to Banks and Financial Institutions Act, 1993, are made, steps should betaken to remove the administrative and infrastructural problems relating to the DRTsto improve and facilitate their effective functioning. Insofar as the recovery process ofweak banks and the ARF is concerned, an arrangement may be worked out for theDRTs to attend to their cases on a priority basis.

83. The investigations into accountability both at the bank and at the level of non-bank agencies if completed in a time bound manner would go a long way in endinguncertainties and help in the overall improvement of morale of the staff. A time boundapproach is absolutely necessary for creating appropriate conditions in banks ingeneral and in weak banks in particular.

Concluding Remarks

84. The restructuring programme will have to encompass operational, organisational,financial and systemic restructuring and must be implemented in a time bound manner.Any delay will add to the cost of the restructuring. The different measures suggestedby the Group for financial, operational and systemic restructuring are a unifiedpackage and for results to be really achieved have to be implemented as such. A stagehas reached when gradualism will not succeed and if resorted to may cause more harmthan good. By adopting a pick and choose approach, not only a total effect expectedfrom the package will be lost, but even the individual measures picked up forimplementation would lose much of their efficacy.

Documents

Bank Merger and Acquisition