Mergers in International Banking Industry

Question: Discuss about the Mergers in International Banking Industry. Answer: Introduction Merger is defined as the manner of acquisition of one company by another company by acquiring the majority of shares of latter company. It results into the continuance of the acquiring company and discontinuance of the acquired company. It means the acquiring company continues to exist and works as before whereas the existence of the acquired company comes to an end. The process of merger may involve one or more companies. Merger is regarded as the mode of investment and given as the name of Opportunity Synergy hypothesis. This hypothesis considers the merger as one form of investment wherein it is expected that the future benefits arising out of the merger will be more than the cost. These benefits are effected by two factor namely interest rates and the growth rate of the country. Mergers in the Inernational Banking Industry in the past Decade Over the last two decades beginning in 1980s, the mergers has gained very importance in every sectors whether it is manufacturing or trading or service. The first factor which has led to the need of merger is from United States of America. In the early eighties, the saving and loan institutions have been badly collapsed in United States of America along with the debt crisis prevailing in the Latin America which in turn has led to the process of consolidation among entities (Erel, 2011). This has further been extended with the substantial decline in the profitability in the early 1980s. The four sectors have plagued the banking industry which includes petroleum industry, agriculture sector, real estate and the countries which are then under the clause of developing countries (Alexandra and Ion, 2016). First acquisition has been made in the year 1981, where First American Bank Corporation acquires the City National Bank of Detroit. Almost 400 mergers have taken place every year since 1 980s. During the period from the year 1986 to 1992, many mergers have taken place for Bank America, Security pacific and Chemical Banks Manufacturers Hanover (Catorelli and Goldberg, 2011). The major shift towards the merger cross the border has been made because of intent of having reach to the customers located outside the domestic limits. This shift has received due importance because of the deregulation and privatization. Deregulation means and act which has now been removed from any regulation and rules and privatization means an act of removing the hold of government by providing the power to manage and control the affairs of the firm or company in the hands of the private body. Many deregulation moves have been welcomed by the world which has made the merger more popular. The major deregulation that has been enjoyed in almost all over the world is the removal of restriction imposed by law in expanding the reach and location of the bank globally (Carletti and Ongena 2016). For instance in Italy, to open the branches the regulations have been removed in the year 1990, European directive allows the bank located in particular European country to operate in any other European countries (Bonaccorsi and Gobbi, 2007) . The second reason is that Companies have gained many benefits from the mergers like reduction in cost, creation of synergies, increase in the customer base, increase in the size of the company and increase in the capital structure of the company. The wave that has bought mergers in the bank is from the rule of too big to fail. This rule has not only implemented by the authorities but also the larger banks are availing the full utilization. Its because the larger banks are least concerned with the loan outstanding from the small firm for whom they itself gives free insurance in case the same is not paid by the borrower. Its because of this reason that acquiring banks possess competitive advantage over the acquired banks. Factor Motivating Mergers Banking sector has also played role in the competition of merger (Scott and Dunkleberg, 2003). Along with the other companies engaged in different sectors, banking sector has also jumped into the crowd of merger and with this the first merger has been started in the United States of America and thereafter extended to European countries. There are many motives behind the mergers and acquisitions. One motive is that has been regarded as dominant motive is profit. The same motive has been described by European Central Bank. As per the plethora of searches, it has been observed that the cost benefit motive is mainly for the firms or banks operating in domestic sectors whereas the motive of having higher profit from economies is for international sectors (Hannan and Pilloff, 2009). Second major motive that is considered before going for merger proposal is to become big enough to capture the market (Cyre, 2010). It means that the acquired company wants to be one of the leading banks and its name shall prevail in the market over others. It is because of this reason the big banks acquire the small banks. Although by being a large bank in the market, sometimes the small bank captures the market very easily by providing more and more facilities to their customers which in turn will create competitor for the large banks. Keeping view of the above possibilities, large banks start the process of having merger with the small banks at an early stage and in this way captures the market very easily. Third motive of having the merger is that the process results in long run profitability of the target banks. This is mainly because of the fact that after acquisition all the lenders, their financial position as on date and financial performance over the year is reviewed and monitored on continuous basis and monitored effectively and efficiently. It in turn results into the reduction of the loans which have been due for repaid for longer period. Due to this, the process of extending loans to the fake companies or small firms which does not possess any credit worthiness will automatically decline gradually and thus increases the profitability ratio by reducing the quantum of bad loans in the loans of the bank. The merger also reduces the tax burden of the acquiring company which in turn increases the return on equity and provides the higher amount available for distribution to shareholders as dividend else ploughed back into the business. Factors for Choosing Good Merger Partner Before proceeding for any merger proposal, the leading bank or acquiring bank shall consider certain factors and shall obtain certain necessary information about the target or acquired company. Type of Services - First major factor that the acquiring bank shall consider is to know the detail of services being offered by the bank. Small bank sometimes provide services which is different to the large banks and which is not even provided by the large banks and also there are services which are provided by the large banks in better way than that of small banks. Its because many successful acquisitions have happened only due to the understanding of business of Target Company that has been made by the acquiring company before the acquisition. The understanding of the business develops the relation which helps in making the better negotiations. History - Second factor that the acquiring bank should consider is the history of the target bank and how long it has served the customers. Financial Position and Performance - Third factor which shall be considered is the Financial Statements of the target company. Financial statements include the Audited Balance Sheet as on date, Statement of Profit or Loss for the period, Cash Flow Statement and the Statement showing changes in equity. It shall be reviewed properly by the acquiring company. Its because from the financial statements, the company will be able to find out the financial position of the company as well as the financial performance over the period. Financial position includes determination of the short term and long term liquidity of the company. Short term liquidity means whether the bank will be able to repay the short term deposits made by customers or not and will be able to recover the short term loans granted to different borrowers. Long term liquidity means whether the bank will be able to repay all its liabilities in the near future and also will be able to recover the loans granted to various borro wers in the near future. For ascertaining the liquidity position the company shall have the calculated figures for the ratios like Current Assets ratio, Liquid Assets Ratio, Long term Solvency Ratio, Loan Ratio, Debt Equity ratio and Return on Equity Ratio, etc. Each of the ratios provides different parameters along with which the company can make decision as to whether to go with the merger proposal or not. For instance if current ratio is good and long term solvency ratio is verse then the acquiring company will have chance of having the better negotiations as it will create the grounds for the company to discuss more about why the target bank shall not be acquired at least price. Secondly, if loan ratio is good, then it will create the platform for the target company to put a call for best price from the acquiring company (Panetta and Shum, 2009). Apart from these negotiations, through these ratios, the acquiring company will have an insight of actual working of the company about their customer base, their capability of loan arrangement facilities including stock limits, their facilities and process for retaining the customers, their policies for attracting new customers. Customer base - Other factor that the bank shall consider is the reach of the target bank to its customers. It means whether the acquired bank is geographically located over the world and internationally. If the target bank is geographically located and the acquiring company has project which can enhance the operations if it operates from that part of the world then it will be favorable for the acquiring bank. Further if the objective of the acquiring bank is similar to the facility which is being operated from that part then it will add more benefit to the former. Further during the debt crisis in Latin America and sudden collapse of the banks in Europe and United States, the more focus has been placed on reaching the customers across the world due to which various legislation framework has been removed in order to ease the banking system and reach of the various banks to the customers (Jagtiani, 2008). Thus, the major factor is whether the target bank has strong data base and effic ient reach to customers. Economic Viability - The fifth factor which every acquiring company shall consider is the economic viability of the project. This study describes whether the merger proposal will reap benefits to the acquiring company or not. This study is performed by professionals and on the basis of their report the company makes decision as to whether the bank shall be acquired will all its liabilities and assets or not or some modifications are required like recovery of debts due from long time to be made before merger, payment of the due liabilities in time and before merger, etc. Performance of the Assets - The last major factor which the bank shall consider is the proportion of the Non Performing assets in relation to the Standard assets of the bank. Non Performing assets are the assets which are classified on the basis of the period of default made in the payment of deposits. If any bank have high composition of Non Performing Assets then there will be more chances for the acquiring company to make a deal at the lowest prices or it may also be possible that the acquiring bank may reject the proposal for merger as the high proportion of Non Performing Assets shows mismanagement of funds of the bank and in turn hits the true and fair view of the financial statements of the bank. Conclusion The need of having the banks of each country at each locations and each part of the world have led to the transformation in banking practices and banking norms. The merger has first started in United States of America and then applied by all the firms, companies and banks operating all over the world. Many factors have been discussed which have led the mergers in banking and other sectors. Also the factors have been discussed which shall be considered while going for any merger proposal. Thus, to conclude the study, the mergers in banking industry have created new platform upon where each and every customers can rely upon. References Bonaccorsi P and Gobbi G, (2007), Winners or Losers? The effects of Banking Consolidation on Corporate Borrowers, The Journal of Finance 62(2), 669-695. Carletti E and Ongena S, (2016), :The Impact on Merger Legislation on Bank Mergers, Swiss Finance Institute Research Paper, No. 16-33. Panetta F, Shivardi and M Shum, (2009), Do Mergers Improve Information? Evidence from the Loan Market, Journal of Money, Credit and Banking. Scott J and W C Dunkleberg, (2003), Bank Mergers and Small Firm Financing, Journal of Money, Credit and Banking. Erel I, (2011), The Effect of Bank Mergers on Loan Prices : Evidence from US, Review of Financial Studies. Alexandra and Ion, (2016), Mergers and Acquisitions in the Banking Sector during the Financial Crisis, available at https://seaopenresearch.eu/Journals/articles/SEA_11_31.pdf accessed on 09/01/2017 Jagtiani J, (2008), Understanding the effects of the Merger Boom on community bank, Federal Reserve Bank of Kansas City, Economic Review, Vol 93. Hannan T and Pilloff S, (2009), Acquisition Targets and Motives in the Banking Industry Journal of Money Credit and Banking, Vol. 41. Cyree K, (2010), Why do Bank acquires Value in Non Public bank mergers and acquisitions?,The Quarterly Review of Economics and Finance, Vol. 50. Cetorelli N and Goldberg L, (2011), Global Banks and International Shock Transmission :Evidence from the Crisis, IMF Economic Review, Vol. 59.