Consolidation: A Need For The Indian Banking Industry

Posted in Finance Articles, Total Reads: 9257 , Published on August 15, 2012

This article highlights the need for consolidation in the Indian Banking Industry in wake of the growth in Indian economy, changes in banking regulations and increase in competition from foreign banks. It discusses the benefits of consolidation in terms of growth, integration of financial services, synergies, strategic benefits, ease of market entry and regulatory intervention.

It highlights the various challenges related to consolidation such as people issues which arise as a result of cultural misfit, technological issues which arise because the merging banks are at different stages of technological implementation and issues related to free capital account convertibility. The report concludes that the gain from mergers are the increase in size of the banks, the strengthening of the performance of the banks, effective absorption of new technologies, capability to meet the demand for sophisticated products and services and strengthening of risk management systems. The article supports consolidation as a way forward for the Indian banking industry.


The question of restructuring the Indian banking industry has been a bone of contention for both the Government of India as well as the Reserve Bank of India. At present the Indian banking industry is highly fragmented in terms of size, competitiveness and other structural features which in turn reduce its operational efficiency and distribution efficiency.

Most of the mergers in the pre-reform period have been forced ones. The post-reform era has witnessed both forced and voluntary mergers (Exhibit 1). The forced mergers have been caused by the financial ill health of the acquired banks. Banks witnessing erosion in net worth, huge NPAs and decline in capital adequacy ratio have been forced by the regulatory authority to undergo merger (Jayadev and Sensarma, 2007). Oriental Bank of Commerce’s acquisition of Global Trust Bank is an example of forced merger. Voluntary mergers have expansion, diversification and growth as the main motives. HDFC’s acquisition of Times Bank and ICICI’s acquisition of Madura Bank are a few examples of voluntary mergers. India has also witnessed cross- border acquisitions in the recent past. SBI’s acquisition of a Mauritian bank is one such example.

Exhibit 1: Number of forced and voluntary mergers from 1961-2006


Number of Mergers

(1961-1968) Pre-nationalization


(1969-1992) Nationalization


(1993-2006) Post-reform

  • Forced Mergers
  • Market driven Mergers
  • Convergence of Financial Institutions into Banks
  • Regulatory Compulsions






Total number of mergers


Need for Consolidation:

To emphasize the need for consolidation, we can compare State Bank of India and Bank of America. SBI has a customer base of 90 to 100 million while BoA has a customer base of 30 million. But BoA’s assets are about a trillion US dollars while SBI’s assets are only about 93.75 billionUS dollars. This shows that big banks are able to reduce costs and enhance revenues more easily than small banks. Also, when Tata Steel was acquiring Corus Group Plc (Corus) for 12.11 billion US dollars, no Indian PSB was big enough to finance the acquisition. Hence Indian banks need to enhance their balance sheets to enable wider extension of credit and meet the demands of fast economic development.

The proposed Basel III norms lay down a more stringent capital and liquidity requirement (RBI, 2012). Incorporation ofBasel III norms would require additional capital. Big banks with their huge capital reserves will be able to meet these requirements more easily. Also, the second phase of WTO commitment which commenced in April, 2009 has cleared the way for foreign banks to undertake merger and acquisition activity in India.  Mergers will enable the Indian banks to compete effectively with these foreign banks which have huge capital reserves, skilled personnel and cutting edge technology.

Also, the various committees appointed by the Government of India have advocated consolidation. They argue that we need to have three to four large nationalized banks in order to improve the operational efficiency and distribution efficiency. The Narasimhan Committee II (Narasimhan Committee Report, 1998) has specifically emphasized the need to have Indian banks which are comparable in size with global leading banks. The Narasimhan  committee proposed a three tier banking structure in India with around 3-4 large banks to take a stand in global scenario, 8-10 banks to provide national coverage and the rest to take care of  local coverage.

Benefits of Consolidation:

Consolidation has been fruitful in the past. The following are the major benefits of consolidation:

Growth: The loan to GDP ratio for Indian banks is about 30 percent which is very low in comparison to banks in other emerging South East Asian economies. Organic growth takes time.Therefore dynamic banks prefer consolidation to grow in size and reach. Consolidation leads to growth in business prospects as well as reduces operating costs.ICICI Bank Limited’s merger with Bank of Madura is an example where the motive behind consolidation was growth. IBL wanted to expand its branch network from 106 to 400 without acquiring RBI’s permission.

The merger helped IBL to increase its branch network to 378 with 97 branches in the rural sector. It provided IBL an additional customer base of 1.2 million and an asset base of Rs. 16,000 crore. This enabled IBL to enter into the small and medium segment markets and provided IBL the opportunity to cross sell various products. The merger also provided IBL the opportunity to reorient its asset profile and create a robust micro-credit system.

Universal banking model and integration of financial services: Due to the flexibility provided to banks by RBI in credit delivery, the DFIs(Developmental Financial Institutions) which were opened with the aim of improving allocation efficiency of resources have become redundant. Hence it is better to have a universal banking model by merging various financial entities like banks and financial institutions. In 2002, ICICI merged with its subsidiary ICICI Bank Limited to integrate its services. Another example is IDBI’s merger with IDBI Bank Ltd. in 2004.

Synergy benefits:Synergies lead to revenue enhancement and cost reduction.Consolidation helps to get a jumpstart by allowing banks to build on an already established platform. Oriental Bank of Commerce’s merger with Global Trust Bank is an example where the motive behind consolidation was synergy benefits. GTB being a private sector bank had a much advanced IT platform with a centralized banking infrastructure in place whereas OBC was lagging behind in computerization and high end technology. This merger therefore helped OBC get a jumpstart in its quest to introduce cutting edge banking technology and solution. In turn GTB gained on non-interest income because of OBC’s thrust on retail.

Strategic benefits: Banks with complimentary business interests can merge together to strengthen their market position.HDFC Bank’s merger with Centurion Bank of Punjab is an example where the motive behind consolidation was business complimentarity.This merger enabled HDFC Bank to build a strong SME (strong and medium enterprises) portfolio, thereby complementing its bent towards corporate entities. CBoP’s products were simple and low cost which complemented HDFC Bank’s products which were sophisticated and costly. The Pre-merger and post merger financial performance ratios of HDFC also validate the improvement in performance after merger (Exhibit 2).

Exhibit 2:Pre-merger and post merger financial performance ratios of HDFC Bank

Ease of market entry: Cash rich firms acquire already established players to enter into new markets. This provides them an already existing platform on which they can build upon easily. Standard Chartered’s merger with ANZ Grindlays is an example where the motive behind consolidation was market entry. To be the leading bank in emerging markets, Standard Chartered wanted to establish its foothold in India. ANZ Grindlays’s well established foothold in India and its willingness to wind up its India operations made it a plausible acquisition target for Standard Chartered. This merger made Standard Chartered the largest foreign bank in India and provided it the opportunity to utilize ANZ Grindlays’s infrastructure to service its overseas clients (Business Today, 2002).

Regulatory Intervention: RBI in certain cases forces the merger of ill banks to safeguard the interests of the depositors and to prevent financial destabilization.Mostly banks witnessing erosion in net worth, huge NPAs and decline in capital adequacy ratio have been forced to undergo merger. GTB had bad loans of about Rs. 1,500 croreand had accumulated losses of about Rs. 260 crore (BS Bureaus, 2004). Hence RBI forced the merger of GTB with OBC. This step ensured that the clients GTB were effectively transferred to OBC and did not lose their deposits.


Consolidation poses certain stiff challenges. The management of the merged entity needs to look into these post merger issues carefully.

People issues: The mergers of banks pose human resource management problems. The cross cultural integration is an important post merger issue to be handled by the management of the two banks. The merger of ICICI Bank Limited with Bank of Madurais an example where merger led to people issues because of cultural misfit between the two banks. Also, BoM had a trade union system unlike IBL. Some of the measures that can be taken by the management to ensure employee satisfaction are changes in compensation, policies or work conditions.

Technology integration:Integration of technology platforms poses a stiff challenge as the merging banks use different working platform and  are at different stages of technology implementation. The merger of IBL with BoM caused problems inintegration of working platforms as IBL followed Banks 2000 software package while BoM followed ISBS software package (ICICI or Bank of Madura: Who will benefit?).

Free capital account convertibility: Free convertibility offers opportunity for banks to gain enormous profits. But research at the World Bank suggests that free convertibility comes with a risk of financial crisis and misallocation of resources. This is evident from the East Asian financial crisis of 1997-98 which was a consequence of the herd behavior of foreign fund managers.


The benefits of consolidation far outweigh its drawbacks. The major gains from merger are the increase in size of the banks, the strengthening of the performance of the banks, effective absorption of new technologies, capability to meet the demand for sophisticated products and services, strengthening of risk management systems and the ability to arrange funding for major development works.Consolidation leads to cost reduction and revenue enhancement. It enhances the reach of the banks to the underserved segment and also reduces the cost of intermediation.

The changing regulatory environment has paved the way for foreign banks to enter Indian market with their huge capital reserves, skilled personnel and cutting edge technology. Mergers will enable Indian banks to compete effectively with these foreign banks by enhancing their capital reserves and improving their operational efficiency and distribution efficiency.

This article has been authored by Piyush Kanodia from IIM Ahmedabad.

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