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Monday, March 30, 2015

Banking & Research XII - Mergers

In today’s economy, it is becoming evident that the current ways of doing business are not good enough to stay competitive in tomorrow’s market: Organizations have to invent new ways of competing. In the world of continuous redefinition of industry boundaries and commingling of technologies, businesses have to strive for ‘opportunity share’ in future markets. Suffice it to say, what is needed today is strategic clarity based on established principles. Strategic decisions such as divestments, new product launches, acquisitions, consolidation, etc., though in vogue for long, have become more relevant today than in the past for creating additional space for the existing firms to claim additional pie in the ‘opportunity share’. Mergers and acquisitions have thus become universal tools to create new synergies and economies of scale.

Against this world scenario, it is heartening to hear the finance minister say, “Consolidation is the name of the game,… If two or more banks come together, we will support them and we need world class banks. We have to think global and act local.” His comments are just in consonance with what the theoreticians in finance have been often saying: Mergers and Acquisitions are the best fit strategy for quick growth and, in turn, for maximization of the share holder’s wealth. Secondly, the announcement is pretty timely: With the opening up of the service sector to global competition under WTO agreements, it is essential to accomplish ‘scale of economies’ in the banking industry to compete with the global players.

To be meaningful, ‘business-driven’ mergers have to observe two cardinal principles: One, doing the homework to select the right company and two, applying an effective and replicable integration process, once the deal is struck. It also calls for a match between the vision of the acquirer and of the acquired firms, as otherwise, they are prone to be at loggerheads and hence the generation of quick results for the shareholders and long-term wins for shareholders, employees, customers, and business partners, remain a question mark. Experiences also indicate that as high as 60% of the mergers and acquisitions concluded in 1990s have failed in capturing the expected value. This highlights the fact that although merger, as a strategy, sounds theoretically pretty good, its success demands ample ingenuity in its execution. As put by an analyst, “a larger part of what makes a deal successful after you complete it, is what you do before you complete it”.

Efficiency theories under mergers suggest that mergers provide a mechanism by which capital can be used with more efficiency and the productivity of the firm can be increased through ‘economies of scale’. The ‘theory of differential efficiency’ states that if the management of bank “A” is more efficient than the management of bank “B”, and if bank “A” acquires bank “B”, the efficiency of bank “B” is likely to be brought up to the level of bank “A”. According to this theory, the increased efficiency of bank “B” is considered the outcome of ‘merger’. So, if the proposed mergers are to be successful, there must be a set of well managed banks which have the potential to upgrade the efficiency levels in the acquired/merged bank that is said to be inefficiently managed.

Another most important theory of mergers is the ‘synergy theory’, which states that when two banks combine they should be able to produce a greater effect than what the two operating independently could. This synergy could be ‘financial synergy’ or ‘operating synergy’. Peter Drucker said, “what matters today most to run a business is neither capital nor knowledge but the ability to form powerful partnerships”. This comment unambiguously tells us that partnerships between a strong market leader and a weakling make more sense than that between equals. A merger of two should always give ‘five’, as no extra benefit accrues out of becoming a ‘four’.

Interestingly, the article, “Measuring Financial Distress of IDBI Using Altman Z-Score Model”, analyzes the scope for success of the merger of IDBI with IDBI Bank that is slated for October 2005. The author estimates the financial distress of IDBI using the Altman Z-score model. The study reveals that IDBI is not all that sound and may go bankrupt soon, and hence the author opines that merging a weak organization with a strong one may not make sense, and that this calls for further in-depth analysis of tangibles and intangibles of IDBI and IDBI Bank, to comment whether the proposed merger is beneficial.

A thriving financial system of a country promotes savings and allocates resources efficiently besides functioning as an efficient channel for transmitting monetary policy signals. Integration of markets is said to be a conditional precedent for effective transmission of monetary policy signals even with a lag. The article, “Money Market Integration in India: A Time Series Study”, attempts to test the efficiency and extent of integration between the Indian money market and forex market, using the co-integration method. The study reveals that a fair degree of integration among the financial markets has been achieved at the short end. The author however opines that an absolute level of integration can only be expected in the long-term.

Unlike in the US market, banking system in India is the prime provider of capital for the corporates. Even after launching of financial reforms and the resulting deregulation, this trend is continuing as in the past. Against this backdrop, the article, “Determinants of Bank Finance to Corporates: Evidence from Indian Companies”, attempts to find out the determinants of bank finance to the Indian corporate sector. The study used the technique of generalized method of moments (GMM) estimation to find out the underlying reasons for such popularity of bank loans among corporates. The study revealed that variables such as the size of the company and debt equity ratio have positively impacted bank lending to corporates while variables such as return on assets, Tobin’s Q ratio, and Altman Z-score are negatively related to the bank finance to corporates.

Logically, it is evident that the variations in the yield, spread between risky and risk-free bonds, should reflect changes in the expectations about the likelihood of loss from default. Empirical evidence that asserts such theoretical underpinnings is of interest not only for the participants in the financial markets, but also for banking supervisors and central banks as they are equally interested in having reliable measures of default estimates. With this as the background, the article, “Exploring the Relationship between Credit Spreads and Default Probabilities”, examines the relationship between the credit spreads for a sample of investment grade bonds issued by industrial companies in UK and the default probabilities generated by the Bank of England’s Merton model of corporate failure. The authors concur with what the literature under the subject reveals: A theoretical relationship between credit spreads and default expectations does not exist in the real world.

Payment systems are undergoing a continuous change across the globe: Cheques have replaced money and cards have partially replaced cheques and today technology is emerging as an alternative to the cards. The article, “Modeling Institutional Change in the Payments System, and its Implications for Monetary Policy” appraises the future of fiat money. The findings reveal that central banks’ fiat money being cheaper than electronic barter, is likely to dominate. The authors argue that the joint demand for fiat money rising from nonbank public and the banking sector, will ensure survival of central banks. They however opine that institutional change in the payment system will impact central bank operations quantitatively but not qualitatively. 

Courtesy: IUPJBM VOl IV No 3 


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