The period of study, 1994-2006, post liberalization period has been selected to focus on major commercial bank mergers in India while providing sufficient data to compare/evaluate the pre and post-merger corporate performance/financial performance of the acquiring Indian commercial banks. Further, the period was chosen keeping in view the availability of three-year post-merger data of the acquiring banks. Further, examples of overlapping mergers during the window period were excluded from the sample. The resulting list was further filtered to exclude i) merging banks with incomplete data and ii) mergers where the target banks were either co-operative banks or Local Area Banks (LABs).
After the above interventions, a sample of 11 commercial bank mergers was considered for analysis purposes. The commercial banks were selected such that the data were available for the pre-merger period for acquiring and acquired banks and post-merger data were available for the combined entity. The data of each bank included in the sample for the entire window period (-3, +3) years were taken from the data base of CMIE, Prowess. The details of sample finally selected for data collection and analysis are furnished in Table-A
Financial economists have used a number of measures to evaluate acquisition success. Probably the most common is the change in the company's value at the time of announcement of the acquisition. This attempts to measure the market's expectation of the change in the value from the acquisition. In addition to the stock market based studies, financial economists also use accounting-based studies. These involve looking at the change over time (usually one to five years) in some measure of earnings, cash flow, margins or productivity. The implicit assumptions in these studies, again, are that the acquisition is important enough to drive the changes and that no other factors are important on average.(Steven N Kaplan,2006).The central objective of all post merger studies is to singularly address the question ,whether the acquirers show improved performance after the merger or not?
Numerous studies have examined the effects of bank mergers on bank operating efficiency and profitability. The results generally suggest that mergers do not improve cost efficiency or profitability (John H Boyd and Stanley L. Graham: Consolidation in U.S. banking: Implications for efficiency and risk).The typical methodology employed in the accounting based studies is to compare the performance of combined entity with control groups, which are broadly of two types. They could either be before-and-after comparisons or comparisons with firms that have not experienced any merger but are similar in terms of size and industry to which they belong. Both these methodologies have their strengths and weaknesses. We are in favor of opting for the first approach, often called as "change model" for two reasons. Firstly, the matched sample of non-acquiring banks may not exhibit firm level characteristics of the acquiring banks. Secondly, each bank responds to changes in industry/economy in different ways depending upon its inherent capabilities.
For comparing pre- and post merger corporate performance, our study uses three years data before and three years data after the merger year for hypotheses testing. Merger year is denoted as (TO) while pre and post-merger years are denoted as (T-3, T-2.T-1) and (T+1, T+2, T+3) respectively. The year To has been excluded from the analysis for the year's figures are unduly affected by one-time merger costs making it difficult to compare them with the figures of other years.
Sources of data and Data Collection
The present study basically depends on secondary data. Data on operating performance for three years before and three years after the year of merger for each acquiring commercial bank were obtained from Prowess database of the Centre for Monitoring Indian Economy (CMIE). Data has also been collected from the websites of Indian Banks Association (IBA), Mumbai and the Reserve Bank of India (www.rbi.org.in) in addition to books, journals, business magazines and news papers.
Data Analysis
The present study attempts to analyze the financial performance of sample commercial banks involved in mergers during the period 1994 to 2006. To evaluate the financial performance, statistical tools like ratio analysis, mean, standard deviation and t-test have been employed.
Variables
Analysis of Financial Performance of Commercial Banks in India
The financial performance of the 11 sample acquiring commercial banks before and after the merger has been analyzed with the help of various financial ratios which characterize a commercial bank's performance.
In order to test the validity of null hypothesis stated above, the following parameters/ratios have been selected to test the results of pre and post merger periods (Average of three years).
Classification of financial ratios
Class
Code
Variable/Parameter
Financial Parameters
V2
Aggregate deposits
V3
Average working funds (AWF)
V4
Operating profits
V5
Net profits
Operational Parameters
V6
Total Debt to Net worth
V7
Interest income to AWF
V8
Net interest income to AWF
V9
Operating expenses to AWF
V10
Capital adequacy ratio
V11
Net interest Income to assets
V12
Operating expenses to total expenses
V13
Efficiency Ratio
Profitability Parameters
V14
Interest spread to AWF
V15
Operating profit to AWF
V16
Net profit to AWF
V17
Net Profit to average net worth
V18
Operating profit to average net worth
V19
Asset utilization(AU)
V20
Equity multiplier(EM)
V21
NIM
V22
Burden ratio
Productivity Parameters
V23
Business per employee
V24
Business per branch
V25
Operating profit per branch
V26
Operating profit per employee
V27
Assets per employee
V28
Loans per employee
V29
Net income per employee
FINANCIAL PARAMETERS (Absolute figures in Rs.crores)
Financial Parameter Analysis: Mean Pre Merger and Post-Merger for acquiring banks
Pre-Merger
(3 years avg.)
Post-Merger
(3 year avg.)
t-statistic
(0.05 significance)
p- values
Aggregate Deposits
29759.265
62499.693
-4.548
0.000
Average Working Funds(AWF)
37715.340
76153.234
-4.686
0.000
Operating Profits
734.746
878.520
-0.347
0.262
Net Profits
270.958
655.168
-4.056
0.004
Aggregate Deposits (AD): Total deposits of a bank at the close of the accounting year. Aggregate deposits include deposits from public (fixed, savings and current) and deposits from banks (fixed and current). From a different angle, aggregate deposits equal the total of all demand and time deposits. A high deposit figure signifies a bank's brand equity, branch network and deposit mobilization strength.
Average Working Funds (AWF): The average of the working funds at the beginning and at the close of an accounting year. Working funds are total resources (total liabilities or total assets) of a bank on a particular date. Total resources include capital, reserves and surplus, deposits, borrowings, other liabilities and provisions. A higher AWF shows a bank's total resource strength. This definition of working funds is in line with capital adequacy calculations to include all resources, not just deposits and borrowings and is more pragmatic.
Operating Profit (OP): Net profit before provisions and contingencies. This is an indicator of a bank's profitability at the operating level. In other words Operating Profit is a measure of a bank's operating efficiency.
Net Profit (NP): This is profit net of provisions, amortization and taxes. Net Profit is the basic indicator of a bank's profitability.
Analysis of Financial Parameters: It would be observed that there is significant difference between average pre and post-merger figures of Aggregate deposits, Average Working Funds (AWF) and Net Profits at 5% level of significance, while it is not so in respect of Operating Profits(p-value=0.262). While the percentage growth between average pre and post merger aggregate deposits, average working funds and Net profits is 110%, 102% and 142% respectively, the corresponding growth rate for Operating profit is only 19%, justified by p-value of 0.262. In today's intensely competitive and increasingly deregulated financial markets, both the cost and amount of deposits with the banks are crucial in maintaining a sustainable competitive advantage. The financial management implication of the two features of the deposits- stability and low cost source of funds- make them preferred source of funds by banks. All else being equal, banks with stronger deposit base are more valuable than those with a weak deposit base. The above advantages are reflected in the Net profit that has grown significantly though the Operating profit has not shown such a high growth rate. The above trends are also observed in the graphs shown above.
210.0176
110.0176
201.9158
101.9158
119.5679
19.56785
241.7969
141.7969
OPERATIONAL PARAMETERS
Operational Parameter Analysis: Mean Pre- Merger and Post Merger for acquiring banks
Pre-Merger
(3 years avg. %)
Post-Merger
(3 year avg. %)
t-statistic
(0.05 significance)
p-values
Total Debt to Net Worth
91.682
112.272
-0.442
0.850
Interest Income to AWF
8.584
8.157
0.702
0.206
Net Interest Income to AWF
1.754
2.383
-0.898
0.924
Operating Expenses to AWF
3.695
3.387
1.842
0.005(s)
Capital Adequacy Ratio(CAR)
9.550
11.362
-0.955
0.272
Net Interest Income to Assets
1.754
2.383
-0.898
0.924
Operating expenses to total expenses
35.934
37.185
-0.545
0.049(s)
Efficiency Ratio
79.921
77.757
0.697
0.008(s)
Total debt to Net worth: This ratio is expressed as a number. The corresponding ratio in a manufacturing company is termed as debt- equity ratio. Abbreviated as TD/NW or TD/RNW, this ratio denotes a bank's leveraging relative to its net worth. A higher ratio is a proof of bank's ability to leverage its net worth effectively.
Interest Income to AWF: Expressed as a percentage, this ratio shows bank's liability to leverage its average total resources in enhancing its main stream operational interest income.
Net Interest Income to AWF :
Operating expenses to AWF: The operating expenses to AWF ratio explain the overall operational efficiency of a bank. In fact, this ratio is one of the indicators of the profitability of a bank.
Capital adequacy Ratio (CAR) : This ratio relates a bank's core net worth to its risk weighted assets. This ratio is an internationally accepted risk- driven measure of a bank's degree of capitalization. This ratio indicates the risk exposure of the bank, the quality of assets and the capacity of the bank's capital to sustain the risk level. A higher ratio indicates that a bank is well capitalized vis-à-vis its perceived risks. It is an excellent indicator of a bank's long term solvency. The minimum CAR prescribed by the RBI is 9%.
Net Interest Income (NII) to Assets: The NII when expressed as a percentage of earning assets gives the NIM (Net interest margin) of the bank. This is an extremely important measure in evaluating a bank's ability to manage interest rate risk.
Operating expenses to total Expenses: Operating expenses equals non-interest expenses. It is also called overhead expense. This can be decomposed in to components like establishment expenditure etc which as a percentage of total overhead expense indicate where cost efficiencies are being realized or where a bank has a comparative disadvantage. No-interest expenses vary between banks and are a function of the composition of liabilities. (Timothy W. Koch & S. Scott Macdonald,2003)
Efficiency Ratio: Efficiency ratio measures a bank's ability to control non-interest expense relative to adjusted operating income. This is given by the formula
Efficiency Ratio = Non-interest expense/ (NII+Non-interest income)
Banks use this ratio to measure the success of efforts to control non-interest expense while supplementing earnings from increasing fees. The smaller the efficiency ratio, the more profitable is the bank, all other factors being equal. (Timothy W. Koch & S. Scott MacDonald, 2003)
Analysis of Operational Parameters:
Total Debt to Net Worth
91.682
112.272
-0.442
0.850
Interest Income to AWF
8.584
8.157
0.702
0.206
Net Interest Income to AWF
1.754
2.383
-0.898
0.924
Operating Expenses to AWF
3.695
3.387
1.842
0.005(s)
Capital Adequacy Ratio(CAR)
9.550
11.362
-0.955
0.272
Net Interest Income to Assets
1.754
2.383
-0.898
0.924
Operating expenses to total expenses
35.934
37.185
-0.545
0.049(s)
Efficiency(Cost to income) Ratio
79.921
77.757
0.697
0.008(s)
Of the eight operational parameters listed above, a significant difference has been observed only in respect of three average i.e i) Operating Expenses to AWF ii) Operating expenses to total expenses and iii) Efficiency ratio. It may be further observed that average operating expenses to AWF ratio has declined from 3.67% to 3.39% (t=1.842, p=0.005) in the post-merger situation. The other operating performance ratio that has registered a marginal improvement is the efficiency ratio which has declined from 79.92% to 77.76% (t=0.697, p=0.008) in the post-merger situation. However, the average operating expenses to total expenses ratio has slightly increased (from 35.93% to 37.18%) in post merger period (t=-0.545, p=0.049). There is no significant difference in respect of other parameters i.e average i) Total Debt to Net worth ii) Interest income to AWF iii)Net Interest income to AWF iv) Net interest income to assets and v) Capital adequacy ratio, at 5% level of significance. Similar trends are observed in the graphs shown above.
These results suggest that commercial bank mergers in India have, on balance, resulted in a slight decline in operating efficiency. The bank mergers have also not significantly impacted even the Interest and Net interest income to Average Working Funds ratios. Net -interest income (NII) = Interest income minus interest expense, highlights a few basic risks in banking. It maps into interest rate risk, liquidity risk and prepayment risk. (Joseph.s.sinkey Jr,2002).The efficiency ratio is quite popular and measures a bank's ability to control non-interest expense relative to adjusted operating income[Non-interest expense/(NII+ Non-interest income)].Conceptually, it indicates how much a bank pays in non-interest expense for one rupee of operating income. The smaller the efficiency ratio, the more profitable is the bank, all other factors being equal. (Timothy W. Koch & S. Scott MacDonald, 2003)
PROFITABILITY PARAMETERS
Profitability Parameter Analysis : Mean Pre Merger and Post Merger for acquiring banks
Pre Merger
(3 years avg.%)
Post Merger
(3 year avg. %)
t-statistic
(0.05 significance)
p-values
Interest Spread to AWF
1.754
2.383
-0.898
0.924
Operating Profit to AWF
2.303
1.265
0.916
0.780
Net Profit to AWF
1.040
0.010
0.464
0.021(s)
Net Profit to Avg Net Worth
14.633
15.798
-0.304
0.741
Operating Profit to average Net Worth
80.804
20.684
0.924
0.487
Asset Utilization
10.338
9.093
3.396
0.222
Equity Multiplier
18.243
20.497
-0.465
0.007(s)
NIM
1.754
2.383
-0.898
0.924
Burden ratio
0.714
1.432
-0.987
0.829
Interest Spread to AWF: The ratio of IS to AWF shows the efficiency of the bank in managing and matching interest expenditure and interest income effectively. Interest spread is critical to a bank's success as it exerts a strong influence on its bottom-line.
Operating Profit to AWF: Operating profit net profit before provisions and contingencies. This is an indicator of a bank's profitability at the operating level. This ratio is a measure of a bank's operating efficiency.
Net Profit to AWF: This ratio is a foolproof indicator of excellent utilization of resources and optimum leveraging of funds.
Net Profit to Average Net worth : This ratio is the equivalent of the return on net worth ratio used in other industries. It is a good indicator of profitability and return on shareholder's funds.
Operating Profit to Net worth: This ratio is corollary to the NP/ANW ratio and another indicator of the shareholder's returns.
Asset Utilisation
Equity Multiplier
NIM
Burden Ratio
PRODUCTIVITY PARAMETERS
Productivity Parameter Analysis: Mean Pre Merger and Post Merger for acquiring banks
Pre Merger
(3 years avg.)
Post Merger
(3 year avg.)
t-statistic
(0.05 significance)
p-values
Business Per employee
1.5527
2.8062
-2.2186
0.0389
Business per branch
38.5511
49.1764
-2.9057
0.0000
Operating Profit per branch
14.1467
0.9222
0.9859
0.0704
Operating profit per employee
0.1896
0.0487
0.9319
0.0135
assets per employee
3.4687
4.2745
-1.3826
0.0000
Loans per employee
0.0016
0.0056
-0.6608
0.7699
Net income per employee
0.0316
0.0324
-0.2254
0.0000
Business per Employee: This ratio indicates the degree of labour (employee) productivity of banks.
Business per Branch: This ratio indicates how well a bank's branches are being managed and reflects the degree of branch productivity of banks.
Operating Profit per Branch This ratio indicates how well a bank's branches are being managed and reflects the degree of branch productivity of banks.
Operating Profit per Employee: This ratio indicates the degree of labour (employee) productivity of banks
Assets per Employee
Loans per Employee
Net Income per Employee
