Cross Border M&A in Banking

One more reason for M&A which has sprung up in the recent years is Indian Banks seeking international presence. In the last two decades, there has been a jump in the Indian diaspora working abroad. A new recent trend is the increase in the interest of foreign expats to work in India. Both these communities seek banking products in remittances and other cross border retail products. Further firms are looking for funds overseas for various purposes ranging from capital expenditure to leveraged M&A financing. Hence, Indian banks are setting up branches and subsidiaries overseas and foreign banks are expanding their operations in India. These bank branches (set up abroad) further target the local population to be profitable and hence target local acquisitions. Evidently, this results in an M&A opportunity for Foreign Banks to acquire an Indian Bank and also Indian Banks to acquire foreign banks. For example, ICICI Bank has made an acquisition of a bank in Europe in 2006 to establish itself in a geographical area. Over the last several years internationally active banks have shifted from international banking to global banking. Some banks, rather than taking deposits in one jurisdiction and lending in other, have pursued the strategy of taking deposits and offering consumer loans, mortgages and corporate loans within a variety of national markets through a local presence. Other banks have pursued a capital market strategy, seeking to fund their portfolios of local securities locally as well. Whether adopting a globe consumer earlobe wholesale model, banks are increasingly looking to serve customers through a local presence funded locally. The ambition to build a global (or multinational) bank so defined defers from that to build and international bank, define as a bank that takes deposits in one country and makes loans in another. Even after shifting to global banking, Country risk remains same. Although the most compressive time series evidence for the long term shift in business from cross border to serve local markets happens to cover US in corporate banks, what follows demonstrates that the global strategy is by no means confined to banks based in the United States. Indeed, Canadian, Irish, Spanish and UK banks are more globalised than US banks. Looking at the data by local banking market, the shift is very uneven, with European a major exception and Asian markets more globalize then they are generally considered to be.

From International To Global Banking

While different banks have shifted from international banking strategy towards global banking strategies at different paces, the overall trend was already evident by at least the mid-1980s. Cross borders business, in a particular lending to developing countries funded with euro currency deposits, had propelled the expansion of banks foreign assets during the 1960s and 1970s. By contrast, during the 1980s and 1990s, locally funded business tended to expand more rapidly than cross borders positions. Data covering banks incorporated in United States illustrate the growth of foreign banks locally funded business. Whereas US banks cross borders claims increased by 55%(percent) to $548 bn between 1982 and 2001, there local claims rose yearly 400% to $385 bn, reaching a ratio of 0.7.Although it spears

that cross borders claim significantly outgrew local claims in 1997,this reflects a series brake that year from the inclusion of derivative position. Since this brake, the ratio has narrowed the more broadly measured local claims have continued to grow faster then the cross border claims.

Some Examples of Cross Border M&A by Indian Banks

With a motive to gain an entry in Russia, ICICI Bank has acquired a bank in Russia with a single branch The State Bank of India (SBI) has acquired 51% shareholding in a Mauritian bank, viz.,Indian Ocean International Bank Ltd. (IOIBL), which will be integrated with SBI's international business as a subsidiary.

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Alignment of Operations of Foreign Banks with Global Trends:

A few foreign banks operating in India have been restructuring themselves when their parent banks abroad have undergone restructuring process. Examples in this category are formation of Standard Chartered Grindlays Bank as a result of acquisition of ANZ Grindlays bank by Standard Chartered Bank. Similarly, due to merger between two Japanese banks viz., Sakura Bank and Sumitomo Bank Ltd. Indian operations of Sakura Bank have been merged with Sumitomo Bank in 2001. The second phase of WTO commitments commencing from April 2009 warrants that, inter alia, foreign banks may be permitted to enter into merger and acquisition transactions with any private sector bank in India, subject to the overall investment limit of 74% (RBI, 2005). This may lead to further consolidation in the Banking sector.

Standard Chartered Acquires ANZ Grindlays Bank (November '00)

Intent Standard Chartered wanted to capitalise on the high growth forecast for the Indian economy. It aimed at becoming the world's leading emerging markets bank and it thought that acquiring Grindlays would give it a well-established foothold in India and add strength to its management resources. For ANZ, the deal provided immediate returns to its shareholders and allowed it to focus on the Australian market. Grindlays had been a poor performer and the Securities Scam involvement had made ANZ willing to wind up. Benefits Standard Chartered became the largest foreign bank in India with over 56 branches and more than 36% share in the credit card market. It also leveraged the infrastructure of ANZ Grindlays to service its overseas clients. For ANZ, the deal, at a premium of US $700 million over book value, funded its share buyback in Australia (a defence against possible hostile takeover). The merger also greatly reduced the risk profile of ANZ by reducing its exposure to default prone markets.

Drawbacks The post-merger organisational restructuring evoked widespread criticism due to unfair treatment of former Grindlays employees. There were also rumours of the resulting organisation becoming too large an entity to manage efficiently, especially in the fast changing financial sector.

Future of M&A in Indian Banking

In 2009, further opening up of the Indian banking sector is forecast to occur due to the changing regulatory environment (proposal for upto 74% ownership by Foreign banks in Indian banks). This will be an opportunity for foreign banks to enter the Indian market as with their huge capital reserves, cutting-edge technology, best international practices and skilled personnel they have a clear competitive advantage over Indian banks. Likely targets of takeover bids will be Yes Bank, Bank of Rajasthan, and IndusInd Bank. However, excessive valuations may act as a deterrent, especially in the post-sub-prime era. Persistent growth in Indian corporate sector and other segments provide further motives for M&As. Banks need to keep pace with the growing industrial and agricultural sectors to serve them effectively. A bigger player can afford to invest in required technology. Consolidation with global players can give the benefit of global opportunities in funds' mobilisation, credit disbursal, investments and rendering of financial services. Consolidation can also lower intermediation cost and increase reach to underserved segments. The Narasimhan Committee (II) recommendations are also an important indicator of the future shape of the sector. There would be a movement towards a 3-tier structure in the Indian banking industry: 2-3 large international banks; 8-10 national banks; and a few large local area banks. In addition, M&As in the future are likely to be more marketdriven, instead of government-driven.

Conclusion
Based on the trends in the banking sector and the insights from the cases highlighted in this study, one can list some steps for the future which banks should consider, both in terms of consolidation and general business. Firstly, banks can work towards a synergy-based merger plan that could take shape latest by 2009 end with minimisation of technology-related expenditure as a goal. There is also a need to note that merger or large size is just a facilitator, but no guarantee for improved profitability on a sustained basis. Hence, the thrust should be on improving risk management capabilities, corporate governance and strategic business planning. In the short run, attempt options like outsourcing, strategic alliances, etc. can be considered. Banks need to take advantage of this fast changing environment, where product life cycles are short, time to market is critical and first mover advantage could be a decisive factor in deciding who wins in future. Post-M&A, the resulting larger size should not affect agility. The aim should be to create a nimble giant, rather than a clumsy dinosaur. At the same time, lack of size should not be taken to imply irrelevance as specialised players can still seek to provide niche and boutique services.

Difficulties in valuation of Banks

Banks do not make money the way everyone else does. For traditional banks, the core of the business is simple: the bank earns money on the interest paid to it through loans, which is at a higher rate than the interest it pays to depositors. The spread between these two rates is where the bulk of revenues comes from. Because it is a pain for people and businesses to switch bank accounts, many banks also make incremental revenue by charging fees to customers (like ATM fees, maintenance fees, overdraft fees, etc.). Since banking is not capital intensive in a buildings-and-equipment sense, the cash flow generated can be put back to work into more loans, which leads to more interest spread income. Investment banks are somewhat different. While most have a traditional banking arm, these banks earn the majority of their revenues by helping businesses raise capital by underwriting debt (usually through bonds), advising on business transactions, and buying and repackaging securities. While most businesses are valued primarily based on revenues, earnings, and cash flow, these are not effective methods for valuing a bank. Traditional banks have little control over the interest spread, which leads to fluctuating levels of revenue and earnings. Investment banks can see business levels vary depending on the prevailing interest rate and climate for large deals. The primary way to value a bank is by looking at its book value, or the net value of its assets. Historically, the rule of thumb has been to look for banks trading at under 2 times book value. This ensures you are not paying too much for the bank's assets, while still accounting for future growth. The difficulty arises in determining what these assets are truly worth. For traditional banks, this primarily consists of valuing outstanding loans. In essence, the loan is worth the principal plus the interest to maturity, minus a provision for inevitable loan defaults. The assets of investment banks are largely the same, except instead of consumer loans we're talking about corporate debt. This is a very simple way to look at things. One reason for the recent collapse is the invention of exotic debt securities that are even more difficult to value. Before making a loan or underwriting debt, there is a process that needs to be performed to protect against default. First, the bank needs to accurately evaluate the creditworthiness of the borrower through documentation and credit history. Then it needs to ensure that the loan is collateralized by an asset that can be sold to recoup the principal amount. Lastly, it needs to put aside an allowance for revenue losses due to loan or debt defaults, which are unavoidable. That's a lot of assumptions, and when you have to make a lot of assumptions, inevitably mistakes will be made which leads us to the core problem... The problem with banks is that bad assumptions snowball into unrecoverable problems! When banks get lax on lending standards, as we saw during the real estate boom of the early decade, loans are given to non-creditworthy borrowers, asset values are overstated (leaving loans under-collateralized), but loan default allowances remain the same. As more and more loans default, the default allowances are greatly exceeded, leading to additional write-downs. Eventually, management does not have the capital to cover these write-

downs. When this bad news gets out, things snowball. The stock price falls, making raising capital through issuing equity increasingly difficult. Depositors can get spooked and rush to pull their assets, compounding the problem. At this point, there is no way to survive outside of undesirable actions such as taking on more debt, selling assets at fire-sale prices, or diluting shareholders by selling massive amounts of equity. All of this leads to more tanking stock prices and unhappy shareholders. If the bank is unable to complete one or more of these actions, it may even go bankrupt. Perhaps the scariest part of all of this is that it can happen in a matter of months. Consider Lehman Brothers (LEH), which had never even reported a quarterly loss in nearly 160 years until June, and just 3 months later is filing for bankruptcy protection. Even in the best of circumstances, investors have very little solid ground to stand on when valuing a financial institution. That 2x book value rule? Well, you are valuing assets that are theoretical in value. Nobody knows what a loan is really worth. When you add in the absurd amount and style of loans owned by most banks, it becomes impossible to tell which loan values are real or not. How many people really know how to value a credit swap, a collateralized debt obligation (CDO), or a mortgage-backed security that is composed of possibly thousands of real estate loans.