024-Nimesh Kapadia-M&A in Banks

MMS-Finance Nimesh Kapadia
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1] BANKING INDUSTRY DYNAMICS
1.1] Economic Backdrop and Banking Environment:
India firmly established itself amongst the fastest growing economies in the world
during 2003-04. Good corporate results, increase in outward foreign investment by Indian
companies as well as increase in foreign investment inflows reflects increasing business
confidence.
With broad based economic recovery spread across all sectors, the economic
environment remained conducive to growth. Following strong Q3 growth, GDP growth for
2003-04 has been projected at 8.1%, driven largely by the farm sector which expanded by
9.1% (-5.2% in 2002-03), robust growth in services which rose by 8.2% (7.2% in 2002-03)
and an upturn in the manufacturing segment of the industrial sector at 7.1% (6.2% in 2002-
03). From a macroeconomic point of view, balance of payments and inflation have indeed
been managed well. The annual rate of inflation (WPI year-on-year) which slid down to 4%
in August 2003, increased in the third quarter but witnessed some softening thereafter and
stood at 4.5% by end-March 2004 against 6.5% a year ago.
1.2] Global Economy And Indian Trade:
Global economic outlook improved significantly during the year. The IMF has
projected world economic growth at 4.6% in 2004, up from 4.1% projected in September
2003, indicating widespread global recovery. This trend, along with strong growth in the US
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economy, augurs well for Indian exports. India’s exports grew by 17.1% during 2003-04 on
top of a 20.3% growth in 2002-03. In recent years, the export basket has become diversified
with manufactures accounting for around three-fourth of total exports. The direction of
exports has also widened, with growth in exports to major markets as well as Asia, Africa
and the Middle East. India’s competitiveness in services exports include, apart from
software, trade, transportation and construction.
During 2003-04, imports increased by 25.3% against the growth of 17.0% during
2002-03. Reflecting the underlying industrial recovery in the economy, nonoil imports
showed a higher increase of 29.4% as compared with 13.7% in the previous year. With the
lowering of import duties, arising from duty cuts and preferential Free Trade Agreements, the
import demand is expected to rise further.
1.3] Foreign Exchange Reserves:
During 2003-04, India’s foreign exchange reserves recorded the highest accretion in
any single year and crossed US$ 120 billion mark. Even after repayment of high cost foreign
currency loans of US $ 6.8 billion and US$ 5.2 billion in foreign currency made available by
RBI to SBI for redemption of Resurgent India Bonds (RIB), India’s foreign exchange
reserves increased by a record US $ 37.6 billion from US $ 75.4 billion at end-March 2003 to
US $ 113.0 billion by end- March 2004.
1.4] Monetary and Liquidity Conditions:
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The money markets were characterised by comfortable liquidity during 2003-04
arising out of sustained capital flows, contraction in food credit
as also easing of monetary conditions. During 2003- 04, money supply (M3) increased by
16.4% as compared with 12.8% in the previous year, after adjusting for mergers.
1.5] Indian Banking Environment:
The growth in aggregate deposits of scheduled commercial banks at 17.3% in 2003-
04 was higher than 13.4% in 2002-03, adjusted for mergers.
However, scheduled commercial banks’ credit recorded a lower rise of 14.6% during 2003-
04 as compared with 16.1%, net of mergers, in 2002-03, mainly due to contraction in food
credit following higher offtake of foodgrains. After remaining sluggish in the initial months
of 2003-04, there were visible signs of credit pick up in the subsequent months.
Consequently, non-food credit increased by 17.6% during 2003-04 as compared with 18.6%,
net of mergers, in 2002-03. While housing and retail led the growth in non-food credit,
industrial credit picked up from September 2003. There was also a substantial flow of bank
credit to the priority sector, which rose by 25% during 2003-04 as well as for housing and
infrastructure, which increased by 42% each..
There was a continuous softening of interest rates during the year. Taking a cue from
RBI’s guidelines relating to benchmark prime lending rate (PLR) in early January 2004,
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several commercial banks reduced their PLRs. Indian manufacturing has absorbed the excess
capacity built up in the midnineties and is geared up for fresh investments, which is expected
to fuel further growth. Stiff competition in retail finance in metro cities has shifted the focus
of banks to tier two cities.
1.6] RBI’s Monetary Policy
The overall stance of RBI’s monetary policy during 2003-04 was provision of
adequate liquidity to meet credit growth and to support investment demand in the economy
while keeping inflation under control. Continuing its stance of preference for a soft and
flexible interest rate environment within the framework of macroeconomic stability, RBI cut
the Bank Rate by 25 basis points to 6.0% in April 2003, the Cash Reserve Ratio by 25 basis
points to 4.5% in June 2003 and the Repo Rate by 50 basis points to 4.5% in August 2003.
During the year, RBI also announced measures to improve credit delivery mechanism
including micro-credit, deepening of money markets and securities markets, and supervision
of banks and other financial institutions. Financial sector reforms have resulted in increased
efficiency, higher productivity and enhanced competitiveness in the banking sector which is
also reflected in better asset quality, increased capital adequacy and improved profitability of
banks. To meet challenges in the changing environment, banks are streamlining business
processes, strengthening credit delivery and micro-credit operations and reinforcing risk
management along with consolidation of their operations.
As a shareholder, the government needs bank consolidation. Despite the big bull run
we have had, on the whole banks in India are relatively poorly valued. Public sector banks
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are rated at a multiple of three to four times as opposed to eight or nine which could be
typical for the private sector or 10 to 15 which is typical elsewhere.
Consolidation is needed for customers also. Intermediation costs in India remain high
because there is relative inefficiency in the system. Whether it is the small and medium
enterprise segment or the mass market retail segment or even the agricultural segment – all
are under-served. We have sub-scale banks that cannot invest and serve their customers. .
The challenge of the branch network, the people and the technology – all three will have to
be sequenced as part of the process of consolidation.
I would also argue that you probably need consolidation for the sake of the employees
in the banking system. We have a very large pool of unskilled labour in the banking system
which employs a million people. What we mean by “unskilled” is people that need to be
retrained for modern banking. As part of consolidation, what has to happen is the retraining
and re-skilling of the work force.
1.7] Consolidation Of The Sector :
To understand this, look first at what’s happened between 1969, when the first set of
14 private banks was nationalised, and now. During these years, the banking landscape
changed dramatically. In 1969, India had 89 commercial banks. By March 2004, this number
had climbed to 290. In 1969, there were 73 scheduled commercial banks (SCBs). Now, there
are 90 of them, excluding the 196 regional rural banks (RRBs). The total number of branches
during the three-and-a-half decades jumped over eight-fold, from 8,262 to 69,071. The
growth has been phenomenal in rural India where the number of branches zoomed from
1,833 to 32,227. In contrast, the number of branches in the metropolitan cities grew at a
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slower pace, from 1,503 to 9,750. The total deposits of all scheduled commercial banks shot
up by almost 332 times and their advances soared 240.50 times. nobody denies that India is
under-serviced. A country of 1.1 billion people has only about 250 million account holders.
But if one excludes those with multiple accounts, especially in metropolitan and urban bank
branches, the number would drastically come down. Despite lazy banking (a term Reserve
Bank of India deputy governor Rakesh Mohan coined for commercial bankers who prefer to
invest money only in zero risk government securities), the industry has been growing by 15-
17 per cent annually, versus the 1-2 per cent growth rate of European banks. So enormous
opportunities exist. India’s financial sector is going to boom in a growing economy where
millions of people will join the workforce and need bank accounts. Banks will, therefore,
need to plan for all this and learn basic survival skills. Globalisation in the context of
financial markets does not mean only acquiring the ability to protect their turfs when foreign
banks invade India but also going abroad and competing in other markets. One useful
prerequisite for that is size.
1.8] Road To The Future:
As net interest margins get thinner, the need for more sophisticated products and low-
cost technology will be felt. If you look at the total banking market in India, excluding rural
and cooperative banks, there are nearly 100 banks. Depending on the government’s view on
how quickly the public sector banks can have private shareholders of any reasonable
influence, probably two or three in the public sector, two or three private banks and two or
three foreign banks will emerge as big banks. The fifth largest bank in China probably is
bigger than the top five Indian banks put together in terms of assets.It means that the ability
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of the Chinese banks to do business, whether domestically or globally, is significantly more
than any one of our banks. I think it is in that context that the finance minister has been
saying that we need to build scale. the State Bank of India is three times the size of Bank of
America. The State Bank is probably reaching 90 million to 100 million customers. Bank of
America has 30 million customers. On this basis, it is three times the size. But if you look at
assets, Bank of America has more than a trillion dollars of assets. So it has the muscle. Its
ability to cut costs is significantly higher because it is earning that much more. In terms of
size and scale, the big Indian banks are pygmies. The combined assets of the five largest
Indian banks – the State Bank of India, ICICI Bank, Punjab National Bank, Canara Bank and
Bank of India – on March 31, 2003 were less than the assets of the largest Chinese bank,
China Construction Bank, which is roughly 7.4 times the size of the State Bank of India. The
Banker’s list of the top 1000 banks of the world (July 2004) has 20 Indian banks. Only six of
them come in the top 500 group. The State Bank is positioned 82nd, ICICI Bank 268th,
Punjab National Bank 313th, Canara Bank 405th, Bank of Baroda 425th and Bank of India
474th. Even in the Asian context, only one Indian bank – State Bank of India – figures in the
top 25 banks based on Tier I capital, even though Indian banks offer the highest average
return on capital among Asian peers. So the focus should be on scale.
There is another dimension to the story. The government has pumped Rs 22,516.12
crore worth of ecapitalisation bonds in public sector banks. If one takes into account the
government’s Rs 9,000 crore largesse to the Industrial Development Bank of India (IDBI),
the sum works out to Rs 31,516.12 crore. The government has also pumped money into
financial institutions as well as the state-owned mutual fund, the Unit Trust of India. Till
now, Rs 55,681.65 crore has been invested in cementing the cracks in the Indian financial
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sector. A few public sector banks have returned Rs 690.75 crore worth of capital to the
government. So its net outgo is Rs 54,990.90 crore. In simple terms, these bailouts amount to
a transfer of funds from the exchequer to the financial system, from taxpayers to bankers.
With the rise in interest rates, the vulnerability of the Indian banks will once again be
exposed and some banks may once again need government help to stay afloat. This is
because Indian banks have been able to reduce their net non-performing assets (NPAs) by
making huge provisions with the money made on their bond portfolios. Once treasury profits
drop, they will lack the wherewithal to tackle NPAs.
Economies such as Brazil and Spain have been through it, where fundamentally what you
look to create is two or four national champions in the public and private sector which are the
anchors of the system. You do actually have two or three foreign banks which start playing a
major role and you fundamentally define the policy framework within which you are
comfortable.
There is a total misconception that India is well served. Our loan assets are a very
small percentage of the GDP. We don’t have profitability because it is split among so many
people and you don’t have multiple products from the same bank. The market opportunity is
phenomenal and the decision makers are the powers that be.
Total loans as a percentage of GDP in India is 28.6 per cent, of which business loans are 23.2
per cent, the retail loans are only 5.4 per cent. Out of this, housing loans are only 2.7 per cent
of GDP and non-housing are 2.7 per cent. If you look at Australia, loans are 114 per cent of
GDP, for Hong Kong 138 per cent of GDP, for Taiwan 149 per cent of GDP, Singapore 102
per cent of GDP and Malaysia 136 per cent of GDP. That is why we are under-served. The
existing banking system in India is already world class and foreign banks can add value in
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terms of bringing in FDI and giving the international investor the confidence that India has
changed and is moving very fast.
The State Bank group is a group of nine. We can merge this group into one, or we can
continue to have the present position with the difference that the technological platform of
the entire group will be one. Business processes across the group will be the same. So what
will happen is, although there will be nine faces of the bank, a virtual merger will be in place.
Eight to ten big banks will dominate the industry over the next five years or so. Foreign
banks should be allowed to play a role in this consolidation game and the regulator must set
the rules for them in a transparent manner without delay.
1.9] Challenges Of The Banking Sector In India:
Evidence from across the world suggests that a sound and evolved banking system is
required for sustained economic development. India has a better banking system in place vis
a vis other developing countries, but there are several issues that need to be ironed out. We
try and look into the challenges that the banking sector in India faces.
A View On The Interest Rates :
Interest rate risk can be defined as exposure of bank's net interest income to adverse
movements in interest rates. A bank's balance sheet consists mainly of rupee assets and
liabilities. Any movement in domestic interest rate is the main source of interest rate risk.
Over the last few years the treasury departments of banks have been responsible for a
substantial part of profits made by banks. Between July 1997 and Oct 2003, as interest rates
fell, the yield on 10-year government bonds (a barometer for domestic interest rates) fell,
from 13 per cent to 4.9 per cent. With yields falling the banks made huge profits on their
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bond portfolios. Since then, the interest rate on 10-year paper has risen by about two
percentage points. That is, in one year, rates have recovered one-fourth the ground they lost
in six years. The rapid rise in interest rates spells the end of the splurging on bonds that most
banks did. Around half (around Rs 3,00,000 crore) of the total bank investment of Rs
6,72,068 crore in government securities is held in the ‘trading porfolio’ which is required to
be “marked to market” on a daily basis. That is, the prices of securities need to be aligned
with market prices, irrespective of the cost of acquiring them, even if the banks are not
selling them. This means that half the total portfolio is hit every time interest rates rise (and
prices fall). Securities under the ‘held to maturity’ (HTM) category – a basket of gilts valued
at their cost of acquisition – are not required to be marked to market. Bond dealers say with
every one basis point rise in yields the value of securities is eroded – one paise for a one-year
maturity paper. Assuming the average duration of the investment portfolio is four years, a
110 basis points rise in yields leads to an erosion of Rs 13,200 crore on a Rs 3,00,000 crore
portfolio. This erosion in value after October 2003 has wiped out a substantial portion of the
unrealised gains of banks’ investments in gilts. Senior bankers say the the problem will
become particularly acute if the yield on the 10-year security crosses 8 per cent.
The Reserve Bank of India (RBI) has stepped in to bail out banks. It has allowed
them to shift securities in their statutory liquidity ratio (SLR) bundle to the HTM category.
Not surprisingly, most banks are adopting that option even it means taking a one-time hit at
the time of the transfer. It is money well spent because once these securities are safely parked
in the HTM category, banks wouldn’t have to bother with mark-to-market anymore. That
taken care of, banks are now lobbying hard with the central bank to allow them to use the
sums salted away in the investment fluctuation reserve (IFR) to square off the mark-to-
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market losses, before arriving at the profit and loss (P&L) numbers. Under existing norms,
IFR can be used only after a bank finalises its P&L account. The IFR is a cushion built by the
banks to protect them against an adverse fluctuation in interest rates.
Most of the banks have created an IFR of 3-5 per cent of their investment book.
While unrealised gains on the investment portfolio and the IFR can offset the rise in rates to
some extent, banks’ treasury income will unquestionably tumble. In fact, at least two banks –
Corporation Bank and HDFC Bank – posted treasury losses in the first quarter of the current
financial year. Bankers are, however, hopeful that the fall in treasury income will be
compensated by the rise in interest income on advances.
The silver lining in all this is that credit growth has picked up. From the beginning of
the current financial year to September 17, non-food credit has grown by 9.5 per cent, up
from 2.7 per cent last year. In consequence, banks’ investments in government and other
approved securities has increased by only 3 per cent in the current financial year so far as
against 15 per cent in 2003-2004.Bbanks have to pick industries to lend money to keeping in
mind the need for a net interest margin of 250-300 basis points. Credit is the focus.
Nevertheless, treasury functions will get diversified into customer business in terms of bond
syndications and foreign exchange management. Retail business like distribution of
government bonds and collection of taxes will be very competitive.
Interest Rates And Non-Performing Assets:
The best indicator of the health of the banking industry in a country is its level of
NPAs. Given this fact, Indian banks seem to be better placed than they were in the past. A
few banks have even managed to reduce their net NPAs to less than one percent (before the
merger of Global Trust Bank into Oriental Bank of Commerce, OBC was a zero NPA bank).
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But as the bond yields start to rise the chances are the net NPAs will also start to go up. This
will happen because the banks have been making huge provisions against the money they
made on their bond portfolios in a scenario where bond yields were falling. Reduced NPAs
generally gives the impression that banks have strengthened their credit appraisal processes
over the years. This does not seem to be the case. With increasing bond yields, treasury
income will come down and if the banks wish to make large provisions, the money will have
to come from their interest income, and this in turn, shall bring down the profitability of
banks.
Competition In Retail Banking:
The entry of new generation private sector banks has changed the entire scenario.
Earlier the household savings went into banks and the banks then lent out money to
corporates. Now they need to sell banking. The retail segment, which was earlier ignored, is
now the most important of the lot, with the banks jumping over one another to give out loans.
The consumer has never been so lucky with so many banks offering so many products to
choose from. With supply far exceeding demand it has been a race to the bottom, with the
banks undercutting one another. A lot of foreign banks have already burnt their fingers in the
retail game and have now decided to get out of a few retail segments completely.
The nimble footed new generation private sector banks have taken a lead on this front and the
public sector banks are trying to play catch up. The PSBs have been losing business to the
private sector banks in this segment. PSBs need to figure out the means to generate profitable
business from this segment in the days to come.
The Urge To Merge:
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In the recent past there has been a lot of talk about Indian Banks lacking in scale and
size. Most of the PSBs are either looking to pick up a smaller bank or waiting to be picked up
by a larger bank.
The central government also seems to be game about the issue and is seen to be encouraging
PSBs to merge or acquire other banks. Before a merger is carried out cultural issues should
be looked into. A bank based primarily out of North India might want to acquire a bank
based primarily out of South India to increase its geographical presence but their cultures
might be very different. So the integration process might become very difficult.
Technological compatibility is another issue that needs to be looked into in details before any
merger or acquisition is carried out.
The banks must not just merge because everybody around them is merging. As
Keynes wrote, "Worldly wisdom teaches us that it's better for reputation to fail
conventionally than succeed unconventionally". Banks should avoid falling into this trap.
1.10] Impact of Basel-II Norms:
Banking is a commodity business. The margins on the products that banks offer to its
customers are extremely thin vis a vis other businesses. As a result, for banks to earn an
adequate return of equity and compete for capital along with other industries, they need to be
highly leveraged.
The primary function of the bank's capital is to absorb any losses a bank suffers (which can
be written off against bank's capital). Norms set in the Swiss town of Basel determine the
ground rules for the way banks around the world account for loans they give out. These rules
were formulated by the Bank for International Settlements in 1988.
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Essentially, these rules tell the banks how much capital the banks should have to cover up for
the risk that their loans might go bad. The rules set in 1988 led the banks to differentiate
among the customers it lent out money to. Different weightage was given to various forms of
assets, with zero per centage weightings being given to cash, deposits with the central
bank/govt etc, and 100 per cent weighting to claims on private sector, fixed assets, real estate
etc.
The summation of these assets gave us the risk-weighted assets. Against these risk weighted
assets the banks had to maintain a (Tier I + Tier II) capital of 9 per cent i.e. every Rs100 of
risk assets had to be backed by Rs 9 of Tier I + Tier II capital. To put it simply the banks had
to maintain a capital adequacy ratio of 9 per cent. The problem with these rules is that they
do not distinguish within a category i.e. all lending to private sector is assigned a 100 per
cent risk weighting, be it a company with the best credit rating or company which is in the
doldrums and has a very low credit rating.
This is not an efficient use of capital. The company with the best credit rating is more likely
to repay the loan vis a vis the company with a low credit rating. So the bank should be setting
aside a far lesser amount of capital against the risk of a company with the best credit rating
defaulting vis a vis the company with a low credit rating.
With the BASEL-II norms the bank can decide on the amount of capital to set aside
depending on the credit rating of the company. Credit risk is not the only type of risk that
banks face. These days the operational risks that banks face are huge. The various risks that
come under operational risk are competition risk, technology risk, casualty risk, crime risk
etc. The original BASEL rules did not take into account the operational risks. As per the
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BASEL-II norms, banks will have to set aside 15 per cent of net income to protect
themselves against operational risks.
So to be ready for the new BASEL rules the banks will have to set aside more capital
because the new rules could lead to capital adequacy ratios of the banks falling. How the
banks plan to go about meeting these requirements is something that remains to be seen. A
few banks are planning initial public offerings to have enough capital on their books to meet
these new norms. For further understanding refer to a section full on capital adequacy ratio
determination.
Closing Points:
Over the last few years, the falling interest rates, gave banks very little incentive to lend to
projects, as the return did not compensate them for the risk involved. This led to the banks
getting into the retail segment big time. It also led to a lot of banks playing it safe and putting
in most of the deposits they collected into government bonds. Now with the bond party over
and the bond yields starting to go up, the banks will have to concentrate on their core
function of lending.The banking sector in India needs to tackle these challenges successfully
to keep growing and strengthen the Indian financial system.
1.11] Banking Products Stooping To Conquer:
Banks are innovating in myriad ways to shop around . You can, however, usefully
cast an eye at one way of shopping without revealing your credit card number. HDFC Bank’s
‘NetSafe’ card is a one-time use card with a limit that’s specified, taken from a person’s
credit or debit card. Even if he fails to utilise the full amount within 24 hours of creating the
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card, the card simply dies and the unspent amount in the temporary card reverts to his
original credit or debit card.
Innovation has become the hottest banking game in town. Want to buy a house but don’t
want to go through the hassles of haggling with brokers and the mounds of paperwork.
Standard Chartered, for instance, has property advisors to guide a customer through the entire
process of selecting and buying a house. They also lend a hand with the cumbersome
documentation formalities and the registration. You can leverage your new house or car these
days with banks like ICICI Bank and Stanchart ready to extend loans against either, till it’s
about five years old. Loans are available to all car owners for almost all brands of cars
manufactured in India that are up to five years old. All banks offer pretty much the same
suite of asset and liability products. Take, for example, the once staid deposits. Some bank
accounts combine a savings deposit account with a fixed deposit. A sweep-in account, as it is
called, works like this: the account will have a cut-off, say, Rs 25,000; any amount over and
above that gets automatically transferred to a fixed deposit which will earn the customer a
clean 2 per cent more than the returns that a savings account gives. Kotak Mahindra Bank
introduced a variant of the sweep-in account. If the balance tops Rs 1.5 lakh, the excess runs
into Kotak’s liquid mutual fund. “Even if the money is there only for the weekend, a liquid
fund can earn you a clean 4.5 per cent per annum. That’s not a small gain considering that
your current account does not pay you any interest. ABN Amro sent the home mortgage
market afire with its 6 per cent home loan offering last year. The product offers a 6 per cent
interest rate for two years after which the interest rate is reset in tune with the prevailing
market rate. All the other big home loan players slashed their rates after this was announced.
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Look at the home saver product and its variants from Citibank, HSBC and Stanchart.
The interest rate on the loan is determined by the balance you maintain in the savings account
with the bank. The home builder can maintain a higher balance in his or her savings account
and bring down the interest rate on the home loan. The rate is calculated on a daily basis on
the net loan amount. Banks are also attempting to reach out to residents of metropolitan cities
where people are pressed for time (what with long commuting hours, traffic jams and both
spouses working), beyond conventional banking hours. ICICI Bank, for example, introduced
eight to eight banking hours, seven days of the week, in major cities. HDFC Bank even has a
24-hour branch at Mumbai’s international airport.
ICICI Bank, State Bank of India and Bank of India now have mobile ATMs or vans
that go along a particular route in a city and are stationed at strategic locations for a few
hours every day. This saves the bank infrastructure costs since it has one mobile ATM
instead of multiple stationary ones. Even money is delivered to customers at home. Kotak
Mahindra Bank, a late entrant into private banking, delivers cash at the doorstep. A customer
can withdraw a minimum of Rs 5,000 and up to a maximum of Rs 2 lakh and get the money
at home. The list of banks offering a similar service includes Citibank, Stanchart, ABN Amro
and HDFC Bank. HDFC Bank brings even foreign exchange, whether travellers cheques or
cash, to your doorstep courtesy its tie-up with Travelex India. All one has to do is call up the
branch or HDFC Bank’s phone banking number.
Banks are also innovating on the company and treasury operations fronts. In
corporate loans, plain loans are passe. Mumbai inter-bank offered rate (MIBOR)-linked and
commercial paper-linked interest rates on loans are common. MIBOR is a reference rate
arrived at every day at 4 pm by Reuters. It is the weighted average rate of call money
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business transacted by 22 institutions, including banks, primary dealers and financial
institutions. The State Bank of India was the first to usher in MIBOR-linked loans for top
companies. ICICI Bank carried out the world’s first ever securitisation of a micro finance
portfolio last year. The bank securitised Rs 4.2 crore for Bharatiya Samruddhi Finance Ltd
for crop production.
2] REASON FOR MERGERS
A merger refers to a combination of two or more companies into one company . it
may involve absorbtion or consolidation . In an absorbtion, one company acquires another
company. In a consolidation, two or more companies combine to form a new company. In
India mergers are called amalgamations in legal parlance. The acquiring company ( also
referred to as amalgamated company or the merged company ) acquires the assets and the
liabilities of the acquired company.( also referred to as amalgamating company or the
merging company of the target company).typically, the shareholders of the amalgamating
company receives shares of the amalgamated company in exchange for their shares in the
amalgamating company.
A merger must have three or four objectives. There has to be increased market share,
increased geography or reduction in expenses and, last but not the least, it has to be attractive
to the shareholders. Mergers are classified into several type a) Horizontal b) Vertical and
c) Conglomerate. A horizontal merger represents a merger of firms engaged in the same line
of business. A vertical merger represents a merger of firms engaged at different stages of
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production in an industry. A conglomerate merger represents a merger of firms engaged in
unrelated lines of activities.
2.1] Plausible reasons:
The most plausible reason for merger in favour of mergers are : economies of scale, strategic
benefit, complementary resources, tax shield , utilization of surplus funds, and managerial
effectiveness.
Economies Of Scale:
When two or more firms combine certain economies are realized due to the larger
volume of operations of the combined entity. These economies arise because of more
intensive utilization of production capacities, distribution networks, engineering services,
research and development facilities, data processing systems, etc. Economies of scale are
most prominent in the case of horizontal mergers where the scope of more intensive
utilization of resources is greater. In vertical merger the principle sources of benefit are
improved coordination of activities, lower inventory levels, and higher market power of the
combined entity. Even in conglomerate merger there is scope for reduction or elimination of
certain overhead expenses.
Can there be diseconomies of scale ? yes, if the scale of operations and the size of
organization become too large and unwieldy. Economists talk of optimal scale of operation at
which the unit cost is minimal. Beyond the optimal point the unit cost tends to increase.
Strategic Benefit :
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If the firm has decided to enter or expand in a particular industry, acquisition of a
firm engaged in that industry, rather than dependence on internal expansion, may offer
several strategic advantages. 1) As a pre-emptive move it can prevent a competitor from
establishing a similar position in that industry.2) It offers a special timing advantage because
the merger alternative enables a firm to leap frog several stages in the process of expansion.
3) It may entail less risks and even less costs .4) In a saturated market, simultaneous
expansion and replacement (through a merger) makes more sense than creation of additional
capacity through internal expansion.
Complementary resources:
If two firms have complementary resources, it may make sense for them to merge .
For example a small firm with an innovative product may need the engineering capability
and marketing reach of a big firm. With the merger of two firms it may be possible to
successfully manufacture and market the innovative product. Thus the two firms are worth
more together than they are separately.
Tax shields:
When a firm with accumulated losses and unabsorbed depreciation merges with a
profit making firm, tax shields are utilized better. The firm with accumulated losses and /or
absorbed depreciation may not be able to derive the tax advantage for a long time . However
when it merges with a profit making firm, its accumulated losses and unabsorbed
depreciation can be set off against the profits of the profit making firm and tax benefits can
be quickly realized.
Utilisation of surplus funds:
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A firm in a mature industry may generate a lot of cash but may not have opportunities
for profitable investment. Such a firm ought to distribute generous dividends and even buy
back its shares, if the same is possible. However, most managements have a tendency to
make further investments, even though they may not be profitable. In such a situation, a
merger with another firm involving cash compensation often represents a more efficient
utilization of surplus funds.
Managerial effectiveness:
One of the potential gains of merger is an increase in managerial effectiveness. This
may occur if the existing management team, which is performing poorly, is replaced by a
more effective management team. Often a firm, plagued with managerial inadequacies, can
gain immensely from superior management that is likely to emerge as a sequel to the merger.
Another allied benefit of the merger may be in the form of a greater congruence between the
interest of the managers and the share holders.
Dubious Reasons For Mergers:
Often mergers are motivated by a desire to diversify, low financing costs, and achieve
a higher rate of earnings growth. Though this objective looks worthwhile they are not likely
to enhance value .
Diversification:
A commonly stated motive for mergers is to achieve risk reduction through
diversification. The extent to which risk is reduced depends on the correlation between the
earnings of the merging entities. While negative correlation brings greater reduction in risks,
positive correlation brings lesser reduction in risks.
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Corporate diversification may offer value in two special cases : 1) If a company is
plagued with problems which can jeopardize its existence and its merger with another
company can save it from potential bankruptcy. 2) If investors do not have the opportunity of
home made diversification because one of the companies is not traded in the marketplace ,
corporate diversification may be the only feasible route to risk reduction.
Low financing costs:
The consequence of large size and greater earning stability is to reduce cost of
borrowing for the merged firm. The reason for this is that the creditors of the merged firm
enjoy better protection than the creditors of the merging firms independently. If two firms A
and B mergers, the creditors of the merged firm ( call it AB) are protected by the equity of
both the firms. While the additional protection reduces the cost of debt, it imposes an extra
burden on the share holders, share holders of firm A must support the debt of firm B and vice
a versa. In an efficiently operating market, the benefit to share holders from the lower cost of
debt would be offsetting by the additional burden borne by them as a result there would be no
net gain.
Earnings growth:
A merger may create an appearance of growth in earnings this may stimulate a price
increase if the investors are fooled.
2.2] Mechanics Of A Merger:
A merger is an complicated transaction, involving fairly complex legal, tax, and
accounting considerations. While evaluating a merger proposal, one should bear in mind the
following legal, tax , and accounting provisions.
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Legal procedure:
The procedure of amalgamations normally involves the following steps :
1) Examination of Object Clause: the memorandum of association of both the companies
should be examined to check if the power to amalgamate is available. Further, the object
clause of the amalgamated company ( transferee company) should permit it to carry on the
business of the amalgamating company(transferor company). If such clause do not exist
necessary approvals of the share holders, board of directors, and company law board are
required.
2) Intimation to stock exchange: the stock exchanges where the amalgamated and the
amalgamating companies are listed should be informed about the amalgamating proposal.
From time to time, copies of all notices, resolutions, and the order should be mailed to the
concerned stock exchanges.
3) Approval of the draft amalgamation proposal by the respective boards: The draft
amalgamation proposal should be approved by the respective boards of directors. The board
of each company should pass a resolution authorizing the director/executive to pursue the
matter further
4) Application to the high court: one of the draft amalgamation proposal is approved by the
respective boards, each company should make an application to the high court so that it can
convene the meeting of shareholders and creditors for passing the amalgamation proposal.
5) Dispatch of notice to shareholders and creditors: in order to convene the meetings of
shareholders and creditors, a notice and an explanatory statement of the meeting, as approved
by the high court, should be dispatched by each company to its shareholders and creditors so
that they get 21 days advance intimation. The notice of the meetings should be published in 2
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news papers (one English and one vernacular). An Affidavit confirming that the notice has
been dispatch to the shareholders/ creditors and that the same has been published in news
papers should be filed in the court.
6) Holdings of meetings of shareholders and creditors: A meeting of shareholders should be
held by each company for passing the scheme of amalgamation. At least 75%( in value) of
shareholders , in each class, who vote either in person or by proxy ,must approve the scheme
of amalgamation. Likewise, in a separate meeting , the creditors of the company must
approve of the amalgamation scheme . here too at 75% ( in value) of the creditors who vote
must approve of the amalgamation scheme.
7) Petition to the courts for confirmation and passing of court orders : Once the
amalgamation scheme is passed by the shareholders and creditors, the companies involved in
the amalgamation should present a petition to the court for confirming the scheme of
amalgamation. The court will fix a date of hearing. A notice about the same has to be
published in two newspaper . It has also to be served to the Regional Director, Company Law
Board. After hearing the parties concerned and asserting that the amalgamation scheme is fair
and reasonable. The court will pass an order sanctioning the same. However the court is
empowered to modify the scheme and pass orders accordingly.
8) Filling the order with the registrar: certified true copies of the court order must be filed
with registrar of companies within the time limit specified by the court.
9) Transfer of assets and liabilities: After the final orders have been passed by the High
Courts, all the assets and the liabilities of the amalgamating company will, with effect from
the appointed date, have to be transferred to the amalgamated company.
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10) Issue of shares and Debentures: The amalgamated company after fulfilling the provisions
of the law, should issue shares and debentures of the amalgamated company. The new shares
and debentures so issued will then be listed on the stock exchange.
2.3] Tax Aspect Of Mergers:
Income tax defines amalgamation as follows: “Amalgamation” in relation to
companies means the merger of one or more companies with another company or merger of
two or more companies to form one company in such a manner that : 1) All the properties of
the amalgamating company or companies just before the amalgamation become the
properties of the amalgamated company by virtue of the amalgamation. 2) All the properties
of the amalgamating company or companies just before the amalgamation , become the
liabilities of the amalgamated companies by virtue of the amalgamation; and 3)
Shareholders holding not less than 3/4th (in value) of the shares in the amalgamation company
or companies become shareholders of the amalgamated company by virtue of amalgamation.
Having noted the definition of amalgamation under the Income Act , let us consider the
important tax provisions relating to amalgamation.
Depreciation:
For tax purposes the depreciation chargeable by the amalgamated company has to be
based on the return down value of the asset before amalgamation. For accounting purposes,
however, the depreciation charge may be based on the consideration paid by the assets.
Accumulated Losses and Unabsorbed Depreciation:
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If the following conditions are satisfied, then the accumulated loss and unabsorbed
depreciation of the amalgamating company shall be deemed to be loss/ depreciation of the
amalgamated company for the previous year in which the amalgamation if effected: a) The
amalgamating company owns an industrial undertaking or a ship; b) the amalgamated
company continues to hold at least ¾th in value of assets of the amalgamating company
which is acquired as a result of amalgamation for 5 yrs. from the effective date of
amalgamation; c) The amalgamated company continues the business of the amalgamated
company for a minimum period of 5 yrs.and d) The amalgamated company fulfill such other
conditions as may be prescribed to ensure the revival of the business of the amalgamating
company or to ensure that the amalgamation is for genuine buz purpose. In case the above
specified conditions are not fulfilled, then that part of carry forward of loss and unabsorbed
depreciation remaining to be utilized by the amalgamated company shall be treated as the
income in the year in which the failure to fulfill the conditions occurs.
Capital Gain Tax :
No Capital Gain Tax is applicable to the amalgamated company or its shareholders if
they get shares in the amalgamated company.
Other Provisions:
Other relevant tax provisions are :a) The amalgamated company is liable to pay the
taxes of the amalgamating company. 2) Expenses of amalgamation are not tax deductible.3)
Taxes on the income of the amalgamating company, paid or payable, and income tax
litigation expenses are tax deductible expenses for the amalgamated company. 4) Bad dept
arising out of the debt of amalgamating company taken over by the amalgamated company
are not deductible for tax purposes. 5) The amalgamated company is entitled to get the refund
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of taxes paid by the amalgamating company. 6) The carried forward long term capital losses
of the amalgamating company cannot be carried forward by the amalgamated company.
2.4] Accounting For Amalgamations:
According to the Accounting Standard 14( AS14) on accounting foe amalgamations
issued by the institute of Chartered Accountants Of India , an amalgamations can be in the
nature of either uniting of interest which is referred to as ‘amalgamations in the nature of
merger’ or ‘acquisition’ . The conditions to be fulfilled for an amalgamation to be treated as
an amalgamations in the nature of merger are as follows:
1) All assets and liabilities of the transferor company before amalgamation should become
the assets and liabilities of the transferee company.
2) Share holders holding not less than 90% of the face value of the equity shares of the
transferor company (excluding the proportion held by the transferee company) should
become in the transferee company
3) The consideration payable to the aforesaid shareholders should be discharged by the
transferee company by the issue of equity shares. Cash can be paid in respect of fractional
shares .
4) The buz. Of the transferor company is intended to be carried on by the transferee
company.
5) The transferee company intends to incorporate into its balance sheet the book values of
assets and liabilities of the transferor company without any adjustment except to the extene
needed to ensure uniformity of accounting policies. An amalgamation which is not in the
nature of merger is treated as an “acquisition”
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2.5] Accounting Methods:
The accounting treatment of an amalgamation in the books of the transferee company
is depended on the nature of amalgamation as stated above. For a merger, the “ pooling of
interest” methods is to be used and for an acquisition “purchased methods is to be used.
Under the pooling of interest method the balance sheet of the combined entity is
arrived at by a line by line addition of the corresponding items in the balance sheets of the
combining entities. Hence, there is no asset write up and/or goodwill. Under the purchased
method the acquiring company treats the acquired company as acquisition investment and
hence reports its tangible assets at fair market value. So there is often an asset write up .
further if the considerations exceeds the share market of the tangible assets, the difference is
reflected as “goodwill, that has to be amortized over a period of 5 yrs.
Since there is often an asset write up as well as some goodwill the reported profit
under the purchase method is lower because of higher depreciation charged as well as
amortization of goodwill.
2.6] Cash Verses Stock Compensation:
Whether to pay for an acquisition in cash or in stock is an important decision . the
choice depends on three factors in the main.
Overvaluation: If the acquiring firms stock is overvalued relative to the acquired companies
stock, paying in stock can be less costly than paying in cash .
Taxes: From the point of view of the shareholders of the acquired firm, cash compensation is
a taxable transaction whereas stock compensation is not.
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Sharing of risk and rewards: If cash compensation is paid, shareholders of the acquired
company neither bear the risks nor enjoy the rewards of the merger. On the other hand, if
stock compensation is paid shareholders of the acquired company partake in the risks as well
as the rewards of the merger.
2.7] Types Of Mergers:
Mergers, acquisitions and takeovers have been a part of the business world for
centuries. In today's dynamic economic environment, companies are often faced with
decisions concerning these actions - after all, the job of management is to maximize
shareholder value. Through mergers and acquisitions, a company can develop a competitive
advantage and ultimately increase shareholder value.
There are several ways that two or more companies can combine their efforts. They can
partner on a project, mutually agree to join forces and merge, or one company can outright
acquire another company, taking over all its operations, including its holdings and debt, and
sometimes replacing management with their own representatives. It’s this last case of
dramatic unfriendly takeovers that is the source of much of M&A’s colorful vocabulary.
Hostile Takeover :
This is an unfriendly takeover attempt by a company or raider that is strongly resisted
by the management and the board of directors of the target firm. These types of takeovers are
usually bad news, affecting employee morale at the targeted firm, which can quickly turn to
animosity against the acquiring firm. Grumblings like, “Did you hear they are axing a few
dozen people in our finance department” can be heard in the office . While there are
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examples of hostile takeovers working, they are generally tougher to pull off than a friendly
merger.
Dawn Raid :
This is a corporate action more common in the United Kingdom; however it has also
occurred in the Unites States. During a dawn raid, a firm or investor aims to buy a substantial
holding in the takeover-target company’s equity by instructing brokers to buy the shares as
soon as the stock markets open. By getting the brokers to conduct the buying of shares in the
target company (the “victim”), the acquirer (the “predator”) masks its identity and thus its
intent. The acquirer then builds up a substantial stake in its target at the current stock market
price. Because this is done early in the morning, the target firm usually doesn't get informed
about the purchases until it is too late, and the acquirer now has controlling interest. In the
U.K., there are now restrictions on this practice.
Saturday Night Special :
This is a sudden attempt by one company to take over another by making a public
tender offer. The name comes from the fact that these maneuvers used to be done over the
weekends. This too has been restricted by the Williams Act in the U.S., whereby acquisitions
of 5% or more of equity must be disclosed to the Securities Exchange Commission.
Takeovers are announced practically everyday, but announcing them doesn't necessarily
mean everything will go ahead as planned. In many cases the target company does not want
to be taken over. What does this mean for investors? Everything! There are many strategies
that management can use during M&A activity, and almost all of these strategies are aimed at
affecting the value of the target's stock in some way. Let's take a look at some more popular
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ways that companies can protect themselves from a predator. These are all types of what is
referred to as "shark repellent".
Golden Parachute:
This measure discourages an unwanted takeover by offering lucrative benefits to the
current top executives, who may lose their job if their company is taken over by another firm.
Benefits written into the executives’ contracts include items such as stock options, bonuses,
liberal severance pay and so on. Golden parachutes can be worth millions of dollars and can
cost the acquiring firm a lot of money and therefore act as a strong deterrent to proceeding
with their takeover bid.
Greenmail :
A spin-off of the term "blackmail", greenmail occurs when a large block of stock is
held by an unfriendly company or raider, who then forces the target company to repurchase
the stock at a substantial premium to destroy any takeover attempt. This is also known as a
"bon voyage bonus" or a "goodbye kiss".
Macaroni Defense:
This is a tactic by which the target company issues a large number of bonds that come
with the guarantee that they will be redeemed at a higher price if the company is taken over.
Why is it called macaroni defense? Because if a company is in danger, the redemption price
of the bonds expands, kind of like macaroni in a pot! This is a highly useful tactic, but the
target company must be careful it doesn't issue so much debt that it cannot make the interest
payments. Takeover-target companies can also use leveraged recapitalisation to make
themselves less attractive to the bidding firm.
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People Pill :
Here, management threatens that in the event of a takeover, the management team
will resign at the same time en masse. This is especially useful if they are a good
management team; losing them could seriously harm the company and make the bidder think
twice. On the other hand, hostile takeovers often result in the management being fired
anyway, so the effectiveness of a people pill defense really depends on the situation.
Poison Pill :
With this strategy, the target company aims at making its own stock less attractive to
the acquirer. There are two types of poison pills. The 'flip-in' poison pill allows existing
shareholders (except the bidding company) to buy more shares at a discount. This type of
poison pill is usually written into the company’s shareholder-rights plan. The goal of the flip-
in poison pill is to dilute the shares held by the bidder and make the takeover bid more
difficult and expensive. The 'flip-over' poison pill allows stockholders to buy the acquirer's
shares at a discounted price in the event of a merger. If investors fail to take part in the
poison pill by purchasing stock at the discounted price, the outstanding shares will not be
diluted enough to ward off a takeover. An extreme version of the poison pill is the "suicide
pill" whereby the takeover-target company may take action that may lead to its ultimate
destruction.
Sandbag:
With this tactic the target company stalls with the hope that another, more favorable
company (like “a white knight”) will make a takeover attempt. If management sandbags too
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long, however, they may be getting distracted from their responsibilities of running the
company.
White Knight :
This is a company (the “good guy”) that gallops in to make a friendly takeover offer
to a target company that is facing a hostile takeover from another party (a “black knight”).
The white knight offers the target firm a way out with a friendly takeover.
3] CAPITAL ADEQUACY RATIOS FOR BANKS
Simplified Explanation And Example Of Calculation
3.1] Introduction:
Capital adequacy ratios are a measure of the amount of a bank's capital expressed
as a percentage of its risk weighted credit exposures. An international standard which
recommends minimum capital adequacy ratios has been developed to ensure banks can
absorb a reasonable level of losses before becoming insolvent. Applying minimum capital
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adequacy ratios serves to protect depositors and promote the stability and efficiency of
the financial system.
Two types of capital are measured - tier one capital which can absorb losses
without a bank being required to cease trading, e.g. ordinary share capital, and tier two
capital which can absorb losses in the event of a winding-up and so provides a lesser
degree of protection to depositors, e.g. subordinated debt.
Measuring credit exposures requires adjustments to be made to the amount of assets
shown on a bank's balance sheet. The loans a bank has made are weighted, in a broad brush
manner, according to their degree of riskiness, e.g. loans to Governments are given a 0
percent weighting whereas loans to individuals are weighted at 100 percent.
Off-balance sheet contracts, such as guarantees and foreign exchange contracts,
also carry credit risks. These exposures are converted to credit equivalent amounts which
are also weighted in the same way as on-balance sheet credit exposures. On-balance sheet
and off-balance sheet credit exposures are added to get total risk weighted credit exposures.
The minimum capital adequacy ratios that apply are:
tier one capital to total risk weighted credit exposures to be not less than 4 percent ;
total capital (tier one plus tier two less certain deductions) to total risk weighted credit
exposures to be not less than 8 percent.
Banks registered in New Zealand are required to publish quarterly disclosure
statements which include a range of financial and prudential information. A key part of these
statements is the disclosure of the banks' "capital adequacy ratios". These ratios are a
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measure of the amount of a bank's capital in relation to the amount of its credit exposures.
They are usually expressed as a percentage, e.g. a capital adequacy ratio of 8 percent means
that a bank's capital is 8 percent of the size of its credit exposures. Capital and credit
exposures are both defined and measured in a specific manner which is explained in this
article.
An international standard has been developed which recommends minimum capital
adequacy ratios for international banks. The purpose of having minimum capital adequacy
ratios is to ensure that banks can absorb a reasonable level of losses before becoming
insolvent, and before depositors funds are lost.
Applying minimum capital adequacy ratios serves to promote the stability and
efficiency of the financial system by reducing the likelihood of banks becoming insolvent.
When a bank becomes insolvent this may lead to a loss of confidence in the financial system,
causing financial problems for other banks and perhaps threatening the smooth functioning of
financial markets. Accordingly applying minimum capital adequacy ratios in New Zealand
assists in maintaining a sound and efficient financial system here.
It also gives some protection to depositors. In the event of a winding-up, depositors' funds
rank in priority before capital, so depositors would only lose money if the bank makes a loss
which exceeds the amount of capital it has. The higher the capital adequacy ratio, the higher
the level of protection available to depositors.
The next para provides an explanation of the capital adequacy ratios applied by the Reserve
Bank and a guide to their calculation.
3.1] Development of Minimum Capital Adequacy Ratios:
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The "Basle Committee" (centred in the Bank for International Settlements), which
was originally established in 1974, is a committee that represents central banks and financial
supervisory authorities of the major industrialised countries (the G10 countries). The
committee concerns itself with ensuring the effective supervision of banks on a global basis
by setting and promoting international standards. Its principal interest has been in the area of
capital adequacy ratios. In 1988 the committee issued a statement of principles dealing with
capital adequacy ratios. This statement is known as the "Basle Capital Accord". It contains a
recommended approach for calculating capital adequacy ratios and recommended minimum
capital adequacy ratios for international banks. The Accord was developed in order to
improve capital adequacy ratios (which were considered to be too low in some banks) and to
help standardise international regulatory practice. It has been adopted by the OECD countries
and many developing countries. The Reserve Bank applies the principles of the Basle
Capital Accord in New Zealand.
Capital:
The calculation of capital (for use in capital adequacy ratios) requires some
adjustments to be made to the amount of capital shown on the balance sheet. Two types of
capital are measured in New Zealand - called tier one capital and tier two capital.
Tier one capital is capital which is permanently and freely available to absorb losses
without the bank being obliged to cease trading. An example of tier one capital is the
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ordinary share capital of the bank. Tier one capital is important because it safeguards both
the survival of the bank and the stability of the financial system.
Tier two capital is capital which generally absorbs losses only in the event of a
winding-up of a bank, and so provides a lower level of protection for depositors and other
creditors. It comes into play in absorbing losses after tier one capital has been lost by the
bank. Tier two capital is sub-divided into upper and lower tier two capital. Upper tier two
capital has no fixed maturity, while lower tier two capital has a limited life span, which
makes it less effective in providing a buffer against losses by the bank. An example of tier
two capital is subordinated debt. This is debt which ranks in priority behind all
creditors except shareholders. In the event of a winding-up, subordinated debt holders
will only be repaid if all other creditors (including depositors) have already been repaid.
The Basle Capital Accord also defines a third type of capital, referred to as tier three
capital. Tier three capital consists of short term subordinated debt. It can be used to provide a
buffer against losses caused by market risks if tier one and tier two capital are insufficient for
this. Market risks are risks of losses on foreign exchange and interest rate contracts caused by
changes in foreign exchange rates and interest rates. The Reserve Bank does not require
capital to be held against market risk, so does not have any requirements for the holding of
Tier three capital.
The composition and calculation of capital are illustrated by the first step of the
capital adequacy ratio calculation example shown later in this article.
Credit Exposures
Credit exposures arise when a bank lends money to a customer, or buys a financial
asset (e.g. a commercial bill issued by a company or another bank), or has any other
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arrangement with another party that requires that party to pay money to the bank (e.g. under a
foreign exchange contract). A credit risk is a risk that the bank will not be able to recover the
money it is owed.
The risks inherent in a credit exposure are affected by the financial strength of the
party owing money to the bank. The greater this is, the more likely it is that the debt will be
paid or that the bank can, if necessary, enforce repayment.
Credit risk is also affected by market factors that impact on the value or cash flow of
assets that are used as security for loans. For example, if a bank has made a loan to a person
to buy a house, and taken a mortgage on the house as security, movements in the property
market have an influence on the likelihood of the bank recovering all money owed to it. Even
for unsecured loans or contracts, market factors which affect the debtor's ability to pay the
bank can impact on credit risk.
The calculation of credit exposures recognizes and adjusts for two factors:
On-balance sheet credit exposures differ in their degree of riskiness (e.g. Government Stock
compared to personal loans). Capital adequacy ratio calculations recognize these differences
by requiring more capital to be held against more risky exposures. This is done by weighting
credit exposures according to their degree of riskiness. A broad brush approach is taken to
defining degrees of riskiness. The type of debtor and the type of credit exposures serve as
proxies for degree of riskiness (e.g. Governments are assumed to be more creditworthy than
individuals, and residential mortgages are assumed to be less risky than loans to companies).
The Reserve Bank defines seven credit exposure categories into which credit exposures must
be assigned for capital adequacy ratio calculation purposes.
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Off-balance sheet contracts (e.g. guarantees, foreign exchange and interest rate
contracts) also carry credit risks. As the amount at risk is not always equal to the nominal
principal amount of the contract, off-balance sheet credit exposures are first converted to a
"credit equivalent amount". This is done by multiplying the nominal principal amount by a
factor which recognises the amount of risk inherent in particular types of off-balance sheet
credit exposures. After deriving credit equivalent amounts for off-balance sheet credit
exposures, these are weighted according to the riskiness of the counterparty, in the same way
as on-balance sheet credit exposures. Nine credit exposure categories are defined to cover all
types of off-balance sheet credit exposures.
The credit exposure categories and the risk weighting process are illustrated by the
second step of the calculation example.
Minimum Capital Adequacy Ratios
The Basle Capital Accord sets minimum capital adequacy ratios that supervisory authorities
are encouraged to apply. These are:
tier one capital to total risk weighted credit exposures to be not less than 4 percent;
total capital (i.e. tier one plus tier two less certain deductions) to total risk weighted
credit exposures to be not less than 8 percent;
There are some further standards applicable to tier two capital:
tier two capital may not exceed 100 percent of tier one capital;
lower tier two capital may not exceed 50 percent of tier one capital;
lower tier two capital is amortized on a straight line basis over the last five years of its
life.
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If the registered bank is a branch of an overseas bank, then it is the capital adequacy
ratios of the whole overseas bank (and not the branch) which are relevant. Overseas banks
which operate as branches are registered in New Zealand on the condition that they comply
with the capital adequacy ratio requirements imposed by the financial authorities in their
home country and that these requirements are no less than those recommended by the Basle
Capital Accord.
When a registered bank falls below the minimum requirements it must present a plan
to the Reserve Bank (which is publicly disclosed) aimed at restoring capital adequacy ratios
to at least the minimum level required.
Even though a bank may have capital adequacy ratios above the minimum levels
recommended by the Basle Capital Accord, this is no guarantee that the bank is "safe".
Capital adequacy ratios are concerned primarily with credit risks. There are also other types
of risks which are not recognised by capital adequacy ratios e.g.. inadequate internal control
systems could lead to large losses by fraud, or losses could be made on the trading of foreign
exchange and other types of financial instruments. Also capital adequacy ratios are only as
good as the information on which they are based, e.g. if inadequate provisions have been
made against problem loans, then the capital adequacy ratios will overstate the amount of
losses that the bank is able to absorb. Capital adequacy ratios should not be interpreted as the
only indicators necessary to judge a bank's financial soundness.
3.3] Calculation Example:
Because off-balance sheet credit exposures are included in calculations, capital
adequacy ratios cannot be calculated by reference to the balance sheet alone. Even the
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calculation of capital adequacy ratios to cover on-balance sheet credit exposures usually
cannot be done by using published balance sheets, as these will probably not provide
sufficient detail about who the bank has lent to, or the issuers of securities held by the bank.
However, the disclosure statements of the bank should contain the information necessary to
confirm the bank's capital adequacy ratio calculations.
To illustrate the process a bank goes through in calculating its capital adequacy ratios,
a simple worked example is contained in Figures 1 to 5. The steps in the calculation are
explained below. The balance sheet information and the off-balance sheet credit exposures
on which the calculations are based are set out in Figures 1 and 2.
Figure 1
Balance sheet
Assets Liabilities & Equity
Cash 11 Deposits 182
5 Year Govt. Stock 20 Subordinated term debt 2
Lending to Banks 30 Shareholders' Funds
Housing loans with mortgages 52 Ordinary capital 7
Commercial loans 64 Redeemable preference 3
shares
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Goodwill 3 Retained earnings 8
Shareholding in other bank 3 Revaluation reserve 4
Fixed assets 25
General provision for bad debts -2
Total Assets 206 Total Liabilities 206
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Figure 2
Off-Balance sheet exposures

Nominal
Principal Amount
Direct credit substitute (guarantee of financial obligations) 10
Asset sale with recourse 18
Commitment with certain draw down (forward purchase of assets) 23
Transaction related contingent item (performance bond) 8
Underwriting facility 28
Short term self liquidating trade related contingency 30
6 month forward foreign exchange contract (replacement cost = 4) 100
4 year interest rate swap (replacement cost = 4) 200
Total 417
Note: The foreign exchange contract and interest rate swap are with banks. All other
transactions are with non-bank customers.
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First Step - Calculation of Capital
The composition of the categories of capital is as follows:
Tier One Capital:
In general, this comprises:
the ordinary share capital (or equity) of the bank; and
audited revenue reserves e.g.. retained earnings; less
current year's losses;
future tax benefits; and intangible assets, e.g. goodwill.
Upper Tier Two Capital:
unaudited retained earnings;
revaluation reserves;
general provisions for bad debts;
perpetual cumulative preference shares (i.e. preference shares with no maturity date whose
dividends accrue for future payment even if the bank's financial condition does not support
immediate payment);
perpetual subordinated debt (i.e. debt with no maturity date which ranks in priority behind all
creditors except shareholders).
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Lower Tier Two Capital:
subordinated debt with a term of at least 5 years;
redeemable preference shares which may not be redeemed for at least 5 years.
Total Capital:
This is the sum of tier 1 and tier 2 capital less the following deductions:
equity investments in subsidiaries; shareholdings in other banks that exceed 10 percent of
that bank's capital;
unrealised revaluation losses on securities holdings.
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Figure 3 shows an example of a calculation of capital.
Figure 3
Calculation of capital
Tier 1
Ordinary capital 7
Retained earnings 8
less Goodwill -3
Total tier 1 capital 12
Tier 2
Upper tier 2
General bad debt provision 2
Revaluation reserve 4
Lower tier 2
Subordinated debt 2
Redeemable preference shares 3
Total tier 2 capital 11
Deduction
Shareholding in other bank -3
Total capital 20
Second Step - Calculation of Credit Exposures
On-Balance Sheet Exposures
The categories into which all credit exposures are assigned for capital adequacy ratio
purposes, and the percentages the balance sheet numbers are weighted by, are as follows:
Credit Exposure Type Percentage Risk Weighting
Cash 0
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Short term claims on governments 0
Long term claims on governments (> 1 year) 10
Claims on banks 20
Claims on public sector entities 20

Residential mortgages 50
All other credit exposures 100
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Off-Balance Sheet Credit Exposures
(1) Calculation of Credit Equivalents
Listed below are the categories of credit exposures, and their associated "credit
conversion factor". The nominal principal amounts in each category are multiplied by the
credit conversion factor to get a "credit equivalent amount":
Credit Exposure Type Credit Conversion
Factor (%)
Direct credit substitutes 100
e.g. guarantees, bills of exchange, letters of credit, risk
participations
Asset sales with recourse 100
Commitments with certain draw down 100
e.g. forward purchases, partly paid shares

Transaction related contracts 50
e.g. performance bonds, bid bonds

Underwriting and sub-underwriting facilities 50
Other commitments with an original maturity more than 1 year 50
Short term trade related contingencies e.g. letters of credit 20
Other commitments with an original maturity of less than 1 year or 0
which can be unconditionally cancelled at any time
The final category of off-balance sheet credit exposures, market related contracts (i.e.
interest rate and foreign exchange rate contracts), is treated differently from the other
categories. Credit equivalent amounts are calculated by adding the following:
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Current Exposure - This is the market value of a contract i.e.. the amount the bank could
get by selling its rights under the contract to another party (counted as zero for contracts with
a negative value); and
(b) Potential exposure i.e.. an allowance for further changes in the market value, which is
calculated as a percentage of the nominal principal amount as follows:
Interest rate contracts < 1 year 0%

Interest rate contracts > 1 year 0.5%
Exchange rate contracts < 1 year 1%
Exchange rate contracts > 1 year 5%
Although the nominal principal amount of market related contracts may be large, the
credit equivalent amounts are usually small, and so may add very little to the amount of
credit exposures to be risk weighted.
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(2) Calculation of Risk Weighted Credit Exposures
The credit equivalent amounts of all off-balance sheet exposures are multiplied by the
same risk weightings that apply to on-balance sheet exposures (i.e. the weighting used
depends on the type of counter party), except that market related contracts that would
otherwise be weighted at 100 percent are weighted at 50 percent.
Figure 4 shows an example of a calculation of risk weighted assets.
Figure 4
Calculation of risk weighted exposures
On-balance sheet
Exposure type Amount X Risk weighting = Risk weighted
exposures
Cash 11 0% 0
5 Year Govt Stock 20 10% 2
Lending to banks 30 20% 6
Home loans 52 50% 26
Commercial loans 64 100% 64
Fixed assets 25 100% 25
Total 123
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Off-balance sheet
Exposure type Amount X Credit X Risk = Risk
conversion weighting weighted
factor exposures
Guarantee 10 100% 100% 10
Asset sale with 18 100% 100% 18
recourse
Forward purchase 23 100% 100% 23
Performance bond 8 50% 100% 4
Underwriting 28 50% 100% 14
Trade contingency 30 20% 100% 6
Exposure type (Replacement + Potential X Risk = Risk
cost exposure) weighting weighted
exposure
Forward FX contract 4 1 20% 1
Interest rate swap 4 1 20% 1

Total 77
Total risk weighted 200
exposures
Third Step - Calculation of Capital Adequacy Ratios
Capital adequacy ratios are calculated by dividing tier one capital and total capital
by risk weighted credit exposures.
Figure 5 shows an example of a calculation of capital adequacy ratios.
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Figure 5
Calculation of capital adequacy ratios
Tier 1 capital to total 12 divided by 200 = 6%
weighted exposures =
Total capital to total risk 20 divided by 200 = 10%
weighted exposures =
Conclusions:
Capital adequacy ratios measure the amount of a bank's capital in relation to the
amount of its risk weighted credit exposures. The risk weighting process takes into account,
in a stylised way, the relative riskiness of various types of credit exposures that banks have,
and incorporates the effect of off-balance sheet contracts on credit risk. The higher the capital
adequacy ratios a bank has, the greater the level of unexpected losses it can absorb before
becoming insolvent.
The Basle Capital Accord is an international standard for the calculation of capital
adequacy ratios. The Accord recommends minimum capital adequacy ratios that banks
should meet.
4] Basel II Operational Risk Capital Charges
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This report considers the potential competitive impact of the Basel II capital charge
for operational risk. Some have expressed concerns that this new charge could lead to an
increase in total minimum regulatory capital for processing banks, as they face more
operational risk relative to credit risk than most other banking organizations. Some believe
that processing banks could be placed at a competitive disadvantage vis-à-vis some of their
competitors who do not face a similar charge for operational risk. To address these concerns,
we consider the processing banks main business activities: custody, general processing, and
asset management. We find that in custody, the main competitors are banks, almost all of
which are expected to face an operational risk charge under Basel II. In processing, many
non-bank competitors display a minimal degree of financial leverage, and thus appear to have
higher capital levels than the processing banks would be required to have under Basel II. In
asset management, many competitors are expected to face Basel II-based capital charges for
operational risk, or already have much higher capital ratios than the processing banks.
4.1] Introduction:
Over the past decade, financial institutions have been developing statistical models to
assess their overall risk profile, and to ensure that capital is sufficient to cover unexpected
losses. In addition to serving as risk management and measurement tools, economic capital
models are used to guide investment decisions and determine executive compensation. As
financial institutions have increased the sophistication of their economic capital models, they
have also expanded the range of risks they attempt to measure. One area where significant
progress is being made in this regard is the measurement of operational risk. Traditionally,
operational risk exposure was either measured in an ad hoc manner (e.g., as a fixed percent
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of revenues) or was not measured at all. Many banks have now incorporated operational risk
in their economic capital models, and are using the models’ output to allocate operational
risk capital across the organization. Some are even publicly disclosing estimates of their
aggregate operational risk exposure, together with the capital that they hold for operational
risk. As banks have developed improved economic capital models, regulators have
undertaken a concerted effort to incorporate the improvements into regulatory capital
requirements. The intent is to use the principles of economic capital to better align minimum
regulatory capital requirements with banks’ actual risk exposures. As part of this effort to
leverage banks’ progress in economic capital modeling, Basel II, the current proposal to
revise the capital regulations for depository institutions, introduces an explicit minimum
regulatory capital charge for operational risk.
Custody:
Custody is a primary business line for each of the four processing banks. At its most
basic level, custody is defined as the business of providing safekeeping and settlement for
client assets. Custodians are responsible for holding a broad range of financial assets,
including equities and bonds on behalf of their clients, and for handling the back-office
portion (settlement) of a securities trade which involves the exchange of a financial
instrument for cash. Typical custody clients include pension and retirement funds, asset
managers, insurance companies, and banks. A custodian’s size and the breadth of its global
network are two important factors in determining its success in the global custody market, as
custody involves significant economies of scale and scope. Almost all custodians are banks.
The top ten custodians include two other U.S. banks (J.P. Morgan Chase and Citigroup) and
four European banks (UBS, BNP Paribas, HSBC, and Societe Generale). The bank
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infrastructure also provides Indian banks with access to the discount window, which provides
the benefit of an emergency source of liquidity, and thus a competitive advantage vis-à-vis
non-bank competitors, since the ability to transfer funds and securities rapidly and with
certainty is highly valued by custodial customers.
Asset Management:
Asset management is the process of investing client assets according to specified
objectives, monitoring such investments, and changing investment allocations as market
factors change. AUM, the volume of funds invested on behalf of clients, is the standard
measure of market share in the asset management industry. the top asset managers include
not just banks, but also insurance affiliates and non-depository firms specializing in asset
management. Each of the entity types that conduct asset management is subject to different
regulatory requirements regarding operational risk capital. This will make the analysis of the
operational risk capital charge more complex as compared to global custody, where most
competitors were banks. the asset management market can be broken down into three
submarkets based on the type of client served: institutional asset management, mutual fund
management, and private wealth management. The following sections provide an overview
of each.
Institutional Asset Management: Institutional asset managers provide investment
management services, typically in the form of separate accounts, to clients such as pension
funds, financial institutions, and foundations and endowments. firms are typically classified
along multiple dimensions within the institutional asset management market. Two of the
most important such dimensions are asset classes offered (e.g., equity, fixed income, cash),
and types of strategies offered (e.g., active vs. passive, quantitative vs. fundamental).
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Mutual Fund Management:
A mutual fund pools money from shareholders and invests it in a diversified portfolio
of securities. Mutual funds are structured as investment companies and are owned by the
fund shareholders. The mutual fund market can be segmented along multiple dimensions.
Like institutional asset managers, mutual fund managers can be classified by asset classes
and strategies offered. However, the mutual fund market could also be segmented by
distribution channel. For example, some mutual fund companies own their distribution
channel; some distribute via commissioned brokers; and some distribute via mutual fund
supermarkets. size does offer several benefits in this market, as larger firms are typically
more well-known, and there may be scale economies in mutual fund marketing and
distribution.
.Private Wealth Management:
Private wealth managers provide investment management services to wealthy
individuals and families. The predominance of banks in this market may be explained by
cross-selling (e.g., banks have other products besides asset management that high net worth
individuals are interested in) or by marketing (e.g., being a bank is a natural advantage in a
market where stability and dependability are key attributes of any player).
Processing: Processing includes all other material non-credit business lines undertaken by
the processing banks. Banks may enjoy a competitive advantage when custody-related
activities are bundled with the core custody product. Many clients also prefer to obtain
processing services from their custodian, as it can be more efficient from both management
and cost perspectives. Most processing activities are closely related to custody, where banks
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have special advantages. On the other hand, customers can purchase processing services
separately from non-bank providers, and in certain instances have done so.
4.2]Capital Regulation Faced by Processing Banks and Their Competitors:
The Basel Accords
In 1988, the Basel Committee on Banking Supervision issued the Basel I framework
governing capital adequacy for internationally active banks. The Committee sought to
strengthen the soundness and stability of the international banking system and to foster
regulatory consistency across different countries, thereby reducing an existing source of
competitive inequality. Basel I set minimum regulatory capital at 8 percent of risk-weighted
assets, and also specified two tiers of capital. Tier 1 capital is primarily equity capital and
retained earnings, and must represent at least 4 percent of risk-weighted assets. Tier 2 capital
includes such elements as loan loss reserves, hybrid capital instruments, and subordinated
debt. Basel I incorporated only crude proxies for risk: the calculation of risk-weighted assets
captured primarily credit risk based on a simple classification of exposures into four buckets.
Banks’ internal economic capital models, being more risk-sensitive than Basel I, derived
different capital assessments than the regulatory framework. In general, regulatory capital
exceeded economic capital for banks’ less risky assets, while economic capital exceeded
regulatory capital for the more risky assets. On average, regulatory minimum capital was
probably exceeded by economic capital at the typical bank. The minimal risk-sensitivity of
the Basel I capital weights – with their resultant deviations from economic capital estimates –
encouraged banks to move safer assets off balance sheet through securitizations. Because of
this regulatory arbitrage, regulatory capital ratios have become increasingly disconnected
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from banks’ true financial risk profiles. The new Basel Accord is intended to use the
principles of economic capital to better align minimum regulatory capital with banks’ actual
risk exposures. Banks will beexpected to have sufficient capital to cover significant but not
catastrophic losses. Basel II will require banks to use formal procedures (e.g., internal
ratings) to measure credit risk, and will require them to hold capital for unexpected losses
based on those procedures.17 Another major innovation is the introduction of an explicit
capital charge for operational risk.
Basel II lays out a series of increasingly sophisticated approaches for measuring both
credit and operational risk. The most sophisticated are the Advanced Internal Ratings Based
(AIRB) approach for credit risk, and the Advanced Measurement Approach (AMA) for
operational risk. The intent of the Basel Committee is to calibrate the simpler approaches to
yield a higher capital charge than would be expected under the advanced approaches, thus
encouraging banks to migrate to the AIRB and AMA. It is expected that for many banking
organizations using the advanced approaches, the sum of the credit and operational risk
charges may result in a somewhat lower total minimum regulatory capital charge than under
Basel I, particularly if the portfolio exposures at the particular bank are less risky than
average. The Advanced Measurement Approach allows a bank to hold regulatory capital for
operational risk based on its own internal procedures, provided that these conform to a
general framework laid out by the regulators. One key element of this framework is the
formal definition of operational risk, which is the risk of loss resulting from inadequate or
failed internal processes, people and systems or from external events.
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To convey a less formal and more intuitive understanding of what operational risk is
and why it is important, we also consider four causal categories into which operational losses
can be classified. The first such category is fraud, which includes activities such as rogue
trading, embezzlement, and theft. The second category consists of lawsuits arising from
improper business practices; this category is very broad, and the alleged behavior can range
from anti-competitive practices to false advertising to employee discrimination. A third
category covers losses caused by system failures (e.g., computer and telecommunications
equipment breakdowns) and process failures (e.g., “fat finger” trades and model errors). The
final category covers losses arising from physical causes such as terrorism, natural disasters,
and workplace safety. Banks will also be required to incorporate four major elements into
their operational risk quantification methodology. These are:
• Internal loss data:. Institutions must collect data on their own operational loss history. The
data must cover at least five years, and should cover all loss types and all material business
lines.
• External loss data: The term “external loss data” refers to data on operational losses that
have occurred at other financial institutions.
• Scenario analysis: Scenario analysis refers to a systematic process for obtaining expert
opinions regarding the likelihood and potential impact of large operational losses. Like
external data, scenario analysis is meant to supplement internal data in cases where a bank’s
own experience is limited.
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Business environment and internal control factors.: Banks are required to monitor and
measure both the external business environment and the internal control environment, and to
adjust capital for changes that have not been reflected in the other three components of the
framework (internal data, external data, and scenarios).
The rules allow banks considerable flexibility in combining these four elements, and
impose no minimum standards on how much weight should be given to each. However,
banks are required to consider each when estimating their Aggregate Loss Distribution
(ALD), which represents the total losses they may face over a one year period. Basel II
requires a bank to hold capital for unexpected losses (UL) from operational risk, where UL is
defined as the difference between the mean and the 99.9 th percentile of the ALD.
4.3] Would the Operational Risk Charge Imply an Increase in Total Actual
Capital Held?
Economic capital, is the amount of capital that bank management believes it should
hold to reflect the risks arising from the bank’s various positions and activities. To
implement economic capital, banks have generally taken the approach of setting capital such
that losses would exceed capital with no more than a small probability. In the context of
market risk, such an approach is typically referred to as Value at Risk (VaR). The use of VaR
models for market risk is now almost universal among large complex banks. Similar
techniques have been applied to credit risk, and more recently to operational risk. Regulatory
capital, is the minimum amount of capital that regulators require a bank to hold, and is
defined under both Basel I and Basel II in terms of a minimum capital ratio of 8 percent of
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risk weighted assets. Under Basel II, there is also a supervisory minimum capital ratio that is
expected of banks, a minimum that varies with the supervisors’ evaluation of risk profiles.
Banks must be well-capitalized in order to conduct various activities, and must cease such
activities if their capital falls toward the regulatory minimum. A capital concept is a market-
determined capital, which is the amount of capital that market participants require an
institution to hold. In principle, market capital should equal economic capital, but the two
may differ because of a lack of transparency or because of investor uncertainty. Rating
agencies play a key role in determining a bank’s market capital. Many banks aim to hold
sufficient capital to maintain target risk profiles (e.g., a AA debt rating), and adjust capital if
rating agencies and analysts view actual capital to be inconsistent with the desired profile.
Buffer capital is necessary to absorb unexpected shocks to the balance sheet and earnings
(e.g., unexpected losses from market risks undertaken, from investments made, or from
business operations) without either facing more expensive or reduced funding, or being
required by the supervisor or by statute to raise additional capital under adverse conditions.
Note that regulatory minimum capital and the total actual amount of capital held are the only
capital concepts that can readily be observed by the public. Note also that the Basel II
operational risk capital charge directly affects only regulatory capital. It would affect the
other measures only if these measures did not already include capital for operational risk. By
design, regulatory minimum capital is the smallest of all the capital concepts (and does not
include any buffer capital) so as to minimize the risk that regulatory rules would affect
business decisions.
If a bank is not allocating economic capital and/or the market is not requiring it to
hold sufficient total actual capital, or if the excess regulatory capital buffer shrinks too far,
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then the new capital standards for operational risk may lead to an increase in actual capital
held. In this case, the bank would see its costs increase. Meanwhile, competitors who are
already practicing economic capital – as well as non-regulated competitors – would not see a
change in their capital holdings.
4.4] Conclusion:
Basel II replaces Basel I’s implicit capital charge on operational risk with an explicit
charge. Certain banks likely to adopt Basel II are concentrated in business lines that involve
minimal credit risk, and could thus face an increase in regulatory capital requirements
because of the new explicit regulatory capital charge for operational risk. Some have argued
that as a result, the new operational risk capital charge would put these processing banks at a
competitive disadvantage vis-à-vis non-AIRB banks, foreign banks, and non-banks with
whom they compete. Most global custodians are banks, almost all of which are expected to
adopt Basel II. The likelihood that the operational risk charge would have a competitive
impact on the processing banks thus appears small. In institutional asset management, the
main competitors not subject to a regulatory charge for operational risk will be stand-alone
asset managers. However, the stand-alone asset managers’ high equity-to-assets ratios
suggest that the market already requires them to hold economic capital sufficient to cover
their operational risk exposures. The processing banks do not have a dominant presence in
the mutual fund market. The main competitors not subject to an operational risk charge will
be stand-alone asset managers, who are highly capitalized and might not need to raise
additional capital even if subject to Basel II.
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Although the minimal leverage displayed by non-banks does not eliminate the
potential for a competitive impact on banks, it does affect the interpretation of this possible
impact – in the unlikely event it should occur. As none of these non-bank firms has access to
the safety net or faces any regulatory capital requirements, their relatively high equity-to-
assets ratios can be considered a proxy for the capital the market requires for asset
management and processing activities. Thus, even if the operational risk charge leads to an
increase in total actual capital held by banks under Basel II, it appears that the new
requirements would still be less than the amount of economic/market capital held by
prudently-run asset management and processing firms that do not have access to the benefits
of the federal safety net provided to banks.
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5] MERGER OF ICICI & ICICI BANK
5.1] History of ICICI:

The Industrial Credit and Investment Corporation of India Limited (ICICI)
incorporated at the initiative of the World Bank, the Government of India and
1955 : representatives of Indian industry, with the objective of creating a development
financial institution for providing medium-term and long-term project financing to
Indian businesses. Mr.A.Ramaswami Mudaliar elected as the first Chairman of
ICICI Limited
: ICICI emerges as the major source of foreign currency loans to Indian industry.
Besides funding from the World Bank and other multi-lateral agencies, ICICI also
among the first Indian companies to raise funds from International markets.
1956 : ICICI declared its first Dividend at 3.5%.
1960 : ICICI building at 163, Backbay Reclamation was inaugurated.
1961 : The first West German loan of DM 5 million from Kredianstalt was obtained by
ICICI.
1967 : ICICI made its first debenture issue for Rs.6 crore, which was oversubscribed.
1969 : First two regional offices in Calcutta and Madras were opened.
1972 : Second entity in India to set-up merchant banking services.
1977 : ICICI sponsors the formation of Housing Development Finance Corporation.
Managed its first equity public issue

1982 : Becomes the first ever Indian borrower to raise European Currency Units.
: ICICI commences leasing business.
1986 : ICICI first Indian Institution to receive ADB Loans. First public issue by an
Indian entity in the Swiss Capital Markets.

: ICICI along with UTI sets up Credit Rating Information Services of India
Limited, (CRISIL) India's first professional credit rating agency.

: ICICI promotes Shipping Credit and Investment Company of India Limited.
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(SCICI)
: The Corporation made a public issue of Swiss Franc 75 million in Switzerland,
the first public issue by any Indian equity in the Swiss Capital Market.
1987 : ICICI signed a loan agreement for Sterling Pound 10 million with Commonwealth
Development Corporation (CDC), the first loan by CDC for financing projects in
India.
1988 : ICICI promotes TDICI - India's first venture capital company.
1993 : ICICI sets-up ICICI Securities and Finance Company Limited in joint venture
with J. P. Morgan.
: ICICI sets up ICICI Asset Management Company.
1994 : ICICI sets up ICICI Bank
1996 : ICICI becomes the first company in the Indian financial sector to raise GDR.
: ICICI announces merger with SCICI.
: Mr.K.V.Kamath appointed the Managing Director and CEO of ICICI Ltd
1997 : ICICI was the first intermediary to move away from single prime rate to three-tier
prime rates structure and introduced yield-curve based pricing.

: The name "The Industrial Credit and Investment Corporation of India Limited "
was changed to "ICICI Limited".

: ICICI announces takeover of ITC Classic Finance.
1998 : Introduced the new logo symbolizing a common corporate identity for the ICICI
Group.
1999 : ICICI launches retail finance - car loans, house loans and loans for consumer
durables.
: ICICI becomes the first Indian Company to list on the NYSE through an issue of
American Depositary Shares.
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2000 : ICICI Bank becomes the first commercial bank from India to list its stock on
NYSE.
: ICICI Bank announces merger with Bank of Madura.
2001 : The Boards of ICICI Ltd and ICICI Bank approved the merger of ICICI with
ICICI Bank.
2002 : Moodys' assign higher than sovereign rating to ICICI.
: Merger of ICICI Limited, ICICI Capital Sercvices Ltd and ICICI Personal
Financial Services Limited with ICICI Bank.
5.1] Overview Of The Bank :
ICICI Bank is India's second-largest bank with total assets of about Rs.146,214 crore
at December 31, 2004 and profit after tax of Rs. 1,391 crore in the nine months ended
December 31, 2004 (Rs. 1,637 crore in fiscal 2004). ICICI Bank has a network of about 505
branches and extension counters and about 1,850 ATMs. ICICI Bank offers a wide range of
banking products and financial services to corporate and retail customers through a variety of
delivery channels and through its specialised subsidiaries and affiliates in the areas of
investment banking, life and non-life insurance, venture capital and asset management. ICICI
Bank set up its international banking group in fiscal 2002 to cater to the cross-border needs
of clients and leverage on its domestic banking strengths to offer products internationally.
ICICI Bank currently has subsidiaries in the United Kingdom and Canada, branches in
Singapore and Bahrain and representative offices in the United States, China, United Arab
Emirates and Bangladesh.
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ICICI Bank's equity shares are listed in India on the Stock Exchange, Mumbai and the
National Stock Exchange of India Limited and its American Depositary Receipts (ADRs) are
listed on the New York Stock Exchange (NYSE).
At October 31, 2004, ICICI Bank, with free float market capitalisation of about Rs.
220.00 billion (US$ 5.00 billion) ranked third amongst all the companies listed on the Indian
stock exchanges.
ICICI Bank was originally promoted in 1994 by ICICI Limited, an Indian financial
institution, and was its wholly-owned subsidiary. ICICI's shareholding in ICICI Bank was
reduced to 46% through a public offering of shares in India in fiscal 1998, an equity offering
in the form of ADRs listed on the NYSE in fiscal 2000, ICICI Bank's acquisition of Bank of
Madura Limited in an all-stock amalgamation in fiscal 2001, and secondary market sales by
ICICI to institutional investors in fiscal 2001 and fiscal 2002. ICICI was formed in 1955 at
the initiative of the World Bank, the Government of India and representatives of Indian
industry. The principal objective was to create a development financial institution for
providing medium-term and long-term project financing to Indian businesses. In the 1990s,
ICICI transformed its business from a development financial institution offering only project
finance to a diversified financial services group offering a wide variety of products and
services, both directly and through a number of subsidiaries and affiliates like ICICI Bank. In
1999, ICICI become the first Indian company and the first bank or financial institution from
non-Japan Asia to be listed on the NYSE.
After consideration of various corporate structuring alternatives in the context of the
emerging competitive scenario in the Indian banking industry, and the move towards
universal banking, the managements of ICICI and ICICI Bank formed the view that the
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merger of ICICI with ICICI Bank would be the optimal strategic alternative for both entities,
and would create the optimal legal structure for the ICICI group's universal banking strategy.
The merger would enhance value for ICICI shareholders through the merged entity's access
to low-cost deposits, greater opportunities for earning fee-based income and the ability to
participate in the payments system and provide transaction-banking services. The merger
would enhance value for ICICI Bank shareholders through a large capital base and scale of
operations, seamless access to ICICI's strong corporate relationships built up over five
decades, entry into new business segments, higher market share in various business
segments, particularly fee-based services, and access to the vast talent pool of ICICI and its
subsidiaries. In October 2001, the Boards of Directors of ICICI and ICICI Bank approved the
merger of ICICI and two of its wholly-owned retail finance subsidiaries, ICICI Personal
Financial Services Limited and ICICI Capital Services Limited, with ICICI Bank. The
merger was approved by shareholders of ICICI and ICICI Bank in January 2002, by the High
Court of Gujarat at Ahmedabad in March 2002, and by the High Court of Judicature at
Mumbai and the Reserve Bank of India in April 2002. Consequent to the merger, the ICICI
group's financing and banking operations, both wholesale and retail, have been integrated in
a single entity. Free float holding excludes all promoter holdings, strategic investments and
cross holdings among public sector entities.
5.3] Steps Before The Merger:
5.4] Control Of NPA’s: ICICI
For ICICI Ltd, the problem of non-performing assets is something that is slowly
getting under control. Ms Kalpana Morparia, Executive Director, ICICI, said that the
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financial institution's net NPAs were only 5.1 per cent, which was among the lowest in the
financial sector. Ninety seven per cent of our gross NPAs of Rs 6,000 crore pertain to
companies in which we had made the first disbursement before 1996. The NPA problem in
the financial sector had its roots deep in history and with globalisation it was inevitable that
some companies would go under. She said ICICI had been following a policy of shielding
itself from the problem of bad debts by accelerated provisioning. Last year, the institution's
accelerated provisions and write-offs amounted to Rs 813 crore. Besides, NPA recognition
was also on shorter term dues, than prescribed by the RBI.
Ms Morparia said that ICICI's NPA strategy was two-pronged, one for a unit which
could be turned around with some capital injection and another for a unit which was
managed badly, but otherwise viable.
She added the recent downgrading of India paper by Standard & Poor and Moody's
had really no relevance for India. She observed that these ratings had no meaning for the
Government's domestic paper, because foreign institutions could anyway not buy
Government paper in India. As regards the ratings for foreign currency bonds, she said that
both S&P and Moody's had only said that they would review the situation later and perhaps
downgrade their ratings. In any case, no financial institution would today be in a position to
make a bond issue abroad, whatever be India's rating. This is because the RBI has said that
the bond issuing companies (such as ICICI) would have to deduct tax before paying the
interest.
Since no investor would be willing to subscribe to a bond issue where he would have
to pay a tax in India, the issuers would only have to build in the tax in the coupon rate. This
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would result in different yields for tax payers and non-tax payers, making trading in the
bonds difficult. This being the case, no Indian company could make a bond issue abroad.
ICICI -- Consolidate, Clean Up Balance Sheet :
After being on an expansion spree over the past few years by setting up subsidiaries,
ICICI Ltd is now in consolidation mode. The term-lending major intends to trim the number
of companies under its fold to about 22 or 23. Currently, there are about 30 companies which
are either the financial institution's subsidiaries or cross-owned by its subsidiaries.
Ms Morparia saying the merger of ICICI Capital Ltd and ICICI Personal Finance
Services is already at an advanced stage and some more mergers are in the pipeline during
the course of the year. ICICI Webtrade is also likely to be merged with ICICI Capital and
ICICI PFS. She said three real estate subsidiaries of the FI are also likely candidates for a
merger. The three companies are ICICI Properties Ltd, ICICI Realty Ltd and ICICI Real
Estate Company Ltd. As per the last annual report of the institution, the three companies
mention they are engaged in identical businesses. The director's reports of all the three
companies also have entries that are similar, almost verbatim. It says: ``As you are aware,
your company had purchased a property in Mumbai in the financial year 1998-99. Your
company has entered into a leave and licence agreement in respect of the same for a period of
three years starting from January 2000.'' Interestingly, the issued and paid-up capital of ICICI
Real Estate is two shares of Rs 10 each, one held by ICICI Ltd and another by one of its
subsidiary. ICICI Properties has an issued and paid-up capital of 200 shares of Rs 10 each,
100 held by ICICI and 100 by subsidiaries.
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ICICI Realty has an issued and paid-up capital of 2,500 shares of Rs 10 each, 1,000
held by the parent and 1,500 by subsidiaries, according to the ICICI annual report for 1999-
2000.Ms Morparia said the institution's ventures with the West Bengal and Kerala
Governments to develop infrastructure may be terminated. ICICI has a venture with the
Kerala Infrastructure Development Corporation (Kinfra) called ICICI Kinfra and another
with West Bengal Infrastructure Development Corporation Ltd called ICICI Winfra. As at
the beginning of the last fiscal, the FI holds 2,28,500 shares of the total issued and paid-up
capital of 3,00,700 shares of ICICI Kinfra. Of the total issued and paid-up equity of
10,00,700 shares of ICICI Winfra, the institution holds 7,60,000 shares.
5.5] Integration A Key Issue In ICICI:
Among the universal bank aspirants, ICICI has been, arguably, the most keen on an
integrated unit offering different kinds of financial intermediation. Other dominant financial
services groups, HDFC, for example, feel that it may be better to operate with different
companies catering to different markets because of the presence of multiple regulators in
financial services.
Different strategies on universal banking exist because insurance, commercial
banking, stock broking and housing finance are areas with their own regulators and capital
requirements. In this backdrop, HDFC appears to be inclined to bring about synergy in the
group's operations but continue as different companies. All the entities in the group extract
the most out of the goodwill associated with the brand, HDFC, but pursue business as
independent entities. DFIs and commercial banks have a single regulator, Reserve Bank of
India (RBI). Their regulatory requirements are however different and a merger between a
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DFI and a commercial bank requires a bit of smoothening . But other critical areas such as
insurance and housing finance are not likely be part of a single merged entity at the moment
because of differences in regulators as well as requirements. Following the current move to
initiate reverse merger, the ICICI group appears to have decided that potential benefits more
than offset dealing with regulatory concerns.
5.6] ICICI-ICICI Bank’s Merger:
The general impression in the stock market is that the beneficiary of the ICICI-ICICI
Bank is the former. However, the swap ratio for the merger indicates that the ICICI
shareholders have also had to bear considerable losses.
Consider The book value per share of ICICI and ICICI Bank at end-September 2001
is Rs 111.81 and Rs 65.53 respectively. However, ICICI's shareholders will get only one
share of ICICI Bank for every two shares held in ICICI. In other words, for surrendering a
book value of Rs 223.62, a shareholder in ICICI will get Rs 65.53. This works out to a
discount of nearly 71 per cent to the book value of ICICI.
According to the management of both companies, relative market prices, discounted
cash flows, and book values were considered before arriving at the swap ratio. However, the
swap ratio for the reverse merger of ICICI with ICICI Bank appears to reflect predominantly
the prevailing stock prices.
The need for a larger weight to the prevailing stock prices is understandable.
However, significantly, the swap ratio ignores ICICI's book value. A 70 per cent discount
may be understandable in the case of a manufacturing company or even in the case of a loss-
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making finance company. For a profit-making finance company whose assets are mainly
moneys lent, the need for such a significant discount raises questions about the quality of the
loans portfolio of ICICI.
The book value of the net assets of ICICI is worth Rs 8,777 crore at end-September
2001. The market value of the shares to be issued by ICICI Bank for taking over these assets
is only around Rs 4,050 crore. It is also significant that the book value does not take into
account the fair value of the investments by ICICI in profit-making companies such as ICICI
Bank, ICICI Infotech, ICICI Venture, ICICI Home Finance and ICICI Investment
Management Company.
ICICI's holdings in ICICI Bank alone are worth Rs 1,040 crore at prevailing market
prices and these holdings will be held in trust for the benefit of the merged entity. A sizeable
portion of the difference in fair value of the net assets of ICICI and the consideration given
by ICICI Bank for the merger may have to be taken as representing provisions for non-
performing loans. Before the shareholders approve the merger, there is a case for finding out
from the management the need for such a large write-down in the assets of ICICI.
5.7] Purchase Method:
For ICICI Bank though, such a sizeable write-down in the assets of ICICI may be
necessary if the shareholders of the bank have to be placated. In this backdrop, the
accounting for the merger in the books of ICICI Bank would provide clues to as to how much
the loans of ICICI have been written-down.
While accounting is normally dismissed as less relevant, in the case of this particular
reverse merger, accounting under Indian GAAP may be particularly relevant for ascertaining
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the capital adequacy of the `universal bank'. In addition, the merger accounting will
determine the impact of the loans portfolio of ICICI on the future profits of the merged
entity.
The ICICI Bank management has said that it would adopt the purchase method to
account for the merger under both Indian GAAP and US GAAP. However, there is a
significant difference in the accounting standards between Indian GAAP and US GAAP.
Under US GAAP, capital reserves (difference between purchase price and net assets taken
over) are not recognised. The assets taken over have to be written down in value. In Indian
GAAP, however, capital reserves are permitted. If ICICI Bank recognises the capital reserve
under Indian GAAP, it may have to make provisions later if some of the loan assets taken
over turn non-performing. This will reduce profitability in years ahead. It will also create a
perception that ICICI Bank shareholders are paying for the non-performing assets of ICICI,
though the swap ratio appears to have considered this aspect. In contrast, if ICICI Bank does
not recognise the capital reserve and adopts the same accounting under both Indian and US
GAAP, it will have implications for the capital adequacy ratios of the universal bank,
particularly the tier-I capital. This is unlikely to be desired by the management of the
companies concerned.
ICICI, BANK MERGER SWAP AT 2:1:
The boards of ICICI Ltd and ICICI Bank have approved a share swap ratio of one
equity share of ICICI Bank for two equity shares of ICICI Ltd for the proposed reverse
merger of the two entities.
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Under the scheme of Amalgamation Okayed by both boards on Thursday, American
depository share (ADS) holders of ICICI will get five ADS of ICICI Bank in exchange for
four ADS of ICICI.
T he Managing Director and Chief Executive Officer of ICICI, Mr K.V. Kamath, said
the swap ratio was based on the recommendations of the accounting firm, Deloitte, Haskins
and Sells. ICICI was advised by investment bankers, JM Morgan Stanley and ICICI Bank by
DSP Merrill Lynch. Mr Kamath said the share exchange ratio was based on a valuation
process incorporating international best practices in respect of the merger of two affiliate
companies.
The merged entity, according to Mr Kamath, who will be its Managing Director and
Chief Executive Officer, would be the second largest bank in India with total assets of about
Rs 95,000 crore. It would have a network of 396 branches of ICICI Bank and 140 retail
centres of ICICI.
The new bank would be known as ICICI Bank and its board would be reconstituted.
Mr N. Vaghul would be its non-executive Chairman. The executive management at the board
level would comprise Mr K.V. Kamath, MD and CEO, Mr H.N. Sinor and Ms Lalita D.
Gupte as Joint Managing Directors and Ms Kalpana Morporia, Mr S. Mukkherji, Ms Chanda
D. Kochhar and Dr Nachiket M. Mor as Executive Directors. ICICI currently holds 46 per
cent of the paid-up equity capital of ICICI Bank. This holding would not be liquidated under
the scheme of amalgamation. It would be held in a trust for the benefit of the merged entity
and divested through appropriate placement in fiscal 2003. The proceeds from the divestment
would accrue to the merged entity. The merger was expected to benefit shareholders of both
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entities. Value for shareholders of ICICI would be enhanced through the merged entity's
access to low-cost deposits and greater opportunities for earning fee-based income.
For shareholders of ICICI Bank, the value comes from the large capital base and scale
of operations, access to ICICI's strong corporate relationships built over five decades, entry
into new business segments, higher market share in various business segments and access to
ICICI and its subsidiaries , Mr Kamath said.
The merged entity would have to provide CRR on around Rs 18,000 crore of
liabilities. As far as priority sector lending was concerned, the bank hoped to start with a 20
per cent norm as against 40 per cent applicable for banks. Mr Kamath said full compliance
with the prudential norms applicable to banks on all of ICICI's existing liabilities was likely
to have an adverse impact on the overall profitability of both entities in fiscal 2002.
At the time of the merger, ICICI Bank would align the Indian GAAP accounting policies of
ICICI to those of ICICI Bank, including a higher general provision against standard assets.
Further, in accordance with international practices in accounting, ICICI Bank has decided to
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adopt the ``purchase method'' of accounting, which is mandatory under US GAAP, to
account for the merger under Indian GAAP as well.
ICICI's assets and liabilities will, therefore, be fair valued for the purpose of incorporation in
the accounts of ICICI Bank on the appointed date.
ICICI merger creates India's second largest bank
India's largest finance company and largest private bank created the nation's first
universal bank, or one-stop provider of virtually all types of financial services. The merged
entity will be India's second-largest bank after state-run colossus State Bank of India, which
along with its subsidiaries accounts for a third of the Indian banking industry's loans and
deposits. The ICICI universal bank will control assets of Rs 940 billion, surpassed only by
SBI's Rs 3.16 trillion and ahead of third-placed state-run Industrial Development Bank of
India with Rs 718 billion.The merged entity has a capital base of Rs 95 billion, 8,300
employees and a huge nationwide branch network.
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As of September 30, ICICI Bank had 396 branches, India's largest ATM network of
601 automatic teller machines, and 3.2 million retail customers, including both depositors
and borrowers.
Other Views:
Size, range and low-cost resources have been recurring themes in ICICI's strategy
over the last few years. Ever since Development Financial Institutions (DFIs) were cut off
from concessional funding in the early 1990s and asked to face heightened competition,
ICICI has relentlessly pursued its goal of becoming an universal bank to survive the changed
environment.
Following significant proportion of loans made in the early and mid-1990s turning
bad, a drive to increase its size and range of activity, and thereby cushion the impact of loans
turning bad, have been the defining features of ICICI's strategy. Currently, the move to
embark on a reverse merger with its offspring, ICICI Bank, seems to be the watershed in its
dream of becoming an universal bank. Simply put, an universal bank means nothing more
than carrying out all aspects of financial intermediation under one roof. For instance,
commercial banking, wholesale lending, retail lending and insurance were traditionally
carried out by unrelated entities. In a new environment where all traditional barriers have
vanished, a universal bank to carry out all kinds of intermediation under one roof as been
viewed as a route to make the best of new opportunities as well as face up to new
competition.
In 1998, a committee comprising commercial banks and DFI examined the ways in
which the role played by them could be harmonised. The report clearly pointed towards
institutions and banks looking at mergers -- both within and across different types of
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financial intermediaries -- and thereby view size as a strategy to thrive in a more competitive
environment.
Growing competition from other financial intermediaries, a harsher environment for
corporates and withdrawal of concessional funding have left DFIs most vulnerable. Banks
such as SBI have been able to venture into the domain of the DFIs armed with low-cost
deposits. On the other hand, the foray of DFIs into the domain of banks have been
handicapped by the lack of access to low-cost deposits. In this environment, universal
banking that includes the likelihood of a reverse merger with ICICI Bank has for long been a
strategy proclaimed by ICICI. The biggest hurdles that the merger is likely to face are
smoothening the difference in regulatory requirements between commercial banks and DFI,
and convincing shareholders. Earlier RBI said that universal banking should not be viewed
as a strategy to address the problems of financial institutions such as non-performing assets.
In the case of shareholder approval, ICICI Bank' shareholders may not necessarily be pleased
because it enjoys a better equity valuation and a better perception. ICICI's image has been
clouded by speculation on the real extent of bad loans in its books.
ICICI's shareholding in ICICI Bank is currently around 46 per cent. Both ICICI and
ICICI Bank are listed in New York Stock Exchange (NYSE), thereby making it easier to
handle merger-related issues there. Though ICICI Bank's balance sheet (as on March 31,
2001) is just 29 per cent the size of ICICI's balance sheet, it will give ICICI a chance to
access lower cost funds and thereby sharpen its competitive edge in many of its lending
businesses.
One area where the impact could be telling is retail consumer financing business such
as commercial vehicle finance, an area dominated by finance companies. ICICI, recently,
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entered commercial vehicle financing and the impact on pricing structure was immediate. In
the case of a merger, finance companies will find it almost impossible to compete with
ICICI.
The attempt at reverse merger between ICICI and ICICI Bank will be the first of its
kind in India. However, there have been other path-breaking moves to capitalise on new
opportunities.
5.8] Reason To Merge:
ICICI wants to merge with its banking subsidiary to obtain access to cheaper funds
for lending, and to increase its appeal to investors so it can raise capital needed to write off
bad loans. As of March 31, ICICI had Rs 637.87 billion in outstanding loans. But net loans
or total loans less dud loans already written off -- stood at Rs 575.06 billion, of which a
further 5.2 per cent or Rs 28.7 billion of loans were classified as doubtful or substandard. By
contrast, only 1.31 per cent of ICICI Bank's loans looked dodgy.
The bad loan figure for the merged entity is estimated at 3.5 per cent, which would be
the second lowest in the Indian banking industry after the three per cent at HDFC Bank, an
investment fund manager favourite.
Like HDFC Bank, which raised $172.5 million in July by issuing American
Depositary Shares, ICICI too needs to raise funds to write off bad loans that could swell,
markets say.
ICICI's asset quality could deteriorate over the next year or two as steel and textile
makers fail which would require more capital Loans and loan guarantees to companies in the
steel and textile industries account for nearly a fifth of ICICI's outstanding loans.
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CHEAP CASH
Another reason for merging is to get access to cheaper funds after the Reserve Bank
of India said it has begun processing applications to create universal banks. It will give the
firm access to low-cost deposits.Current rules prohibit ICICI and other long-term lenders
from raising deposits of less than one-year maturity, which usually pay lower rates of
interest. But that restriction is not applicable to commercial banks. That would enable ICICI
to compete more effectively in the retail finance market dominated by banks, to compensate
for slowing loan demand from corporations and for big projects. Loans to corporations and
the manufacturing sector accounted for 75 per cent of ICICI's total loan portfolio of Rs
637.87 billion in the past year to March, while infrastructure projects accounted for 21 per
cent.
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6] Road map for presence of foreign banks in India
The banking sector in India is robust and its standards are broadly in conformity with
international standards. In further enhancing its efficiency and stability to the best global
standards a two-track and gradualist approach will be adopted. One track is consolidation of
the domestic banking system in both public and private sectors. The second track is gradual
enhancement of the presence of foreign banks in a synchronised manner. The policy
decisions announced on March 5, 2004 on FDI, FII and the presence of foreign banks will be
implemented in a phased manner. This will also be synchronised with the two-track approach
and will be consistent with India’s commitments to the WTO.
In this background, the road map for the implementation of the policy decisions is as
follows:
Phase I: (March 2005 to March 2009)
1) New banks – First time presence
Foreign banks wishing to establish presence in India for the first time could either
choose to operate through branch presence or set up a 100% wholly owned subsidiary
(WOS), following the one-mode presence criterion.
.2) Existing banks – Branch expansion policy
For new and existing foreign banks, it is proposed to go beyond the existing WTO
commitment of 12 branches in a year. The number of branches permitted each year has
already been higher than the WTO commitments. A more liberal policy for underbanked
areas will be followed. Branch licensing procedure will continue to be as per current practice.
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3) Conversion of existing branches to Wholly Owned Subsidiaries
In the first phase, foreign banks already operating in India will be allowed to convert
their existing branches to WOS while following the one-mode presence criterion. The WOS
will be treated on par with the existing branches of foreign banks for branch expansion in
India. The Reserve Bank may prescribe market access and national treatment limitation
consistent with WTO, as also other appropriate limitations to the operations of WOS
consistent with international practices and the country's requirements.
4) Acquisition of Shareholding in Select Indian Private Sector Banks
In order to allow Indian Banks sufficient time to prepare themselves for global
Competition, initially entry of foreign banks will be permitted only in private sector.
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REFERENCES
Books:
Valuation -- Aswath Damodaran
Financial management – Prasanna Chandra
Corporate Finance – Brealey & Myers
Sites:
http://www.icicibank.com
http://www.basel-ii.info/
www.federalreserve.gov/generalinfo/basel2/default.htm
www.economist.com
www.rbi.org.in
84

024-Nimesh Kapadia-M&amp;A in Banks

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024-Nimesh Kapadia-M&amp;A in Banks

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MMS-Finance Nimesh Kapadia

1] BANKING INDUSTRY DYNAMICS

1.1] Economic Backdrop and Banking Environment:

companies as well as increase in foreign investment inflows reflects increasing business

stood at 4.5% by end-March 2004 against 6.5% a year ago.

1.2] Global Economy And Indian Trade:

software, trade, transportation and construction.

import demand is expected to rise further.

1.3] Foreign Exchange Reserves:

US $ 113.0 billion by end- March 2004.

1.4] Monetary and Liquidity Conditions:

The money markets were characterised by comfortable liquidity during 2003-04

arising out of sustained capital flows, contraction in food credit

1.5] Indian Banking Environment:

The growth in aggregate deposits of scheduled commercial banks at 17.3% in 2003-

04 was higher than 13.4% in 2002-03, adjusted for mergers.

infrastructure, which increased by 42% each..

of banks to tier two cities.

1.6] RBI’s Monetary Policy

management along with consolidation of their operations.

typical for the private sector or 10 to 15 which is typical elsewhere.

be sequenced as part of the process of consolidation.

and re-skilling of the work force.

1.7] Consolidation Of The Sector :

prerequisite for that is size.

1.8] Road To The Future:

of the Chinese banks to do business, whether domestically or globally, is significantly more

return on capital among Asian peers. So the focus should be on scale.

drop, they will lack the wherewithal to tackle NPAs.

changed and is moving very fast.

the rules for them in a transparent manner without delay.

1.9] Challenges Of The Banking Sector In India:

A View On The Interest Rates :

banks to protect them against an adverse fluctuation in interest rates.

compensated by the rise in interest income on advances.

syndications and foreign exchange management. Retail business like distribution of

government bonds and collection of taxes will be very competitive.

Interest Rates And Non-Performing Assets:

Competition In Retail Banking:

business from this segment in the days to come.

The Urge To Merge:

merger or acquisition is carried out.

1.10] Impact of Basel-II Norms:

were formulated by the Bank for International Settlements in 1988.

doldrums and has a very low credit rating.

defaulting vis a vis the company with a low credit rating.

themselves against operational risks.

to keep growing and strengthen the Indian financial system.

1.11] Banking Products Stooping To Conquer:

original credit or debit card.

24-hour branch at Mumbai’s international airport.

branch or HDFC Bank’s phone banking number.

business transacted by 22 institutions, including banks, primary dealers and financial

for crop production.

2] REASON FOR MERGERS

A merger refers to a combination of two or more companies into one company . it

may involve absorbtion or consolidation . In an absorbtion, one company acquires another

company. In a consolidation, two or more companies combine to form a new company. In

liabilities of the acquired company.( also referred to as amalgamating company or the

merging company of the target company).typically, the shareholders of the amalgamating

of business. A vertical merger represents a merger of firms engaged at different stages of

production in an industry. A conglomerate merger represents a merger of firms engaged in

unrelated lines of activities.

024-Nimesh Kapadia-M&A in Banks

024-Nimesh Kapadia-M&A in Banks