Holding Company...& more

Here are some reasons i can think of for banks like ICICI and SBI pitching for a holding company set up -

• RBI is planning to allow international banks like China's largest bank, ICBC, to enter the indian markets by 2009 (with full foreign capital holding - in retail banking operations). In order to protect the Indian banking system from competitive banking products (like high deposits rates & cheaper loans in the future), they want bigger banks like SBI and ICICI to have a strong capital structure. This is also followed by completion of adherance to BASEL II norms by March 2008.
  
  In this light, banks are working on a better capital structure. Now, as discussed in class, currently there exists a conflict of interest between a parent bank and its subsidiaries - which sell products generating fee based income. Using bank's channel for the same, it might so happen that bank's increasing trend towards fee based income might hurt the capital-based expectations of the bank.

• ICICI Bank wishes to form a holding company, namely ICICI Financial Services, in order to free its own capital and increase its capital in the subsidiaries. As of now, a bank is allowed to hold only 20% of capital in a subsidiary. Once the holding company is formed under ICICI Bank, the parent bank can invest in the holding company (with no current limit) and then, this holding company can in turn invest in the subsidiaries (with no current limit). This way, ICICI Bank can increase its stake in the subsidiaries. Also, in its books, it can show the investment in the holding company as an 'investment'.

• A very important factor that ICICI Bank mentions in the DHRP of it's FPO in June is that it wishes to form the holding company to facilitate its price discovery. According to the valuation technique "Sum of it's parts", a company's valuation would be based on the valuation of its individual lines of business and entities. Since the subsidiaries are a part of the parent bank, the bank would be valued as a sum of the valuations of the subsidiaries. Now, consider the lines of business ICICI Bank is in - Life Insurance, General Insurance, Mutual Funds etc. Insurance companies have generally a lower EPS than banks as their EPS is based on their capital locked up by IRDA norms. ICICI Bank thinks that its true business value is not being reflected in its share price as some of the subsidiaries are lowering its inherent value! Once the holding company is formed, ICICI Bank's real profitability can be easily 'discovered'.

• SBI's consolidation as mentioned in the article i have posted earlier, is more to do with making the bank stronger, in order to make it ready for ICBC's entry into India. SBI Chairman from time to time, has made sweeping statements that the bank may face some threat from chinese banks in the future. These banks are 6 times bigger than SBI and might capture the market with higher volumes. The merger of the 7 subsidiaries with SBI would help the bank have a stronger balance sheet in terms of capital and revenue, plus, the bank would be able to provide uniform services across the nation (in all regions where its branches are not present currently - but has a tie up with the associate banks) under the Core Banking Solution framework! It is currently merging all those banks (SHS) where it has 100% holding and has branch network enhancement scenario. Second would be those banks, where it has major stake (SBH...). It wishes to complete this process by 2009.
  
  This would help SBI to foray into international financial markets to buy foreign banks to increase its global presence. Currently, SBI has presence in 60 countries only, whereas ICBC is a wider global pressure. By expanding into international markets, it would be able to make a wider global mark. Also, a stronger capital structure and wider branch network closer home would help SBI comply with the international capital structure standards of other countries.
  
  We never know - it might so happen tomorrow that after the ICICI Bank's Holding Company issue is solved & implemented (whichever way it is done - ICICI Bank - Holding Company - Subsidiaries or Holding Company - ICICI Bank & Subsidiaries), SBI might follow the same model. Currently the bank also has innumerable subsidiaries which provide varied services to different target segments. They can be all brought under the same umbrella. Probably, ICICI Bank's step right now might a roadmap for SBI later.

(These are my views and can be wrong...!! )

SANAT SATYAN

State Bank consolidation - Yes & Why?

Bank consolidation not inevitable — Multi-tiered model still relevant

(T B Kapali, Business Line, 30th August, 2007)

Bank consolidation is again in the news. The boards of State Bank of India (SBI) and State Bank of Saurashtra (SBS) are reported to have approved the merger of the latter with the former.

Predictably, and almost axiomatically, the merger has been welcomed and an SBI official has been reported saying that “there is a lot of business synergy and the merger would enhance the capital and balance sheet of SBI”. The SBI official has also observed that the consolidation would benefit all stakeholders — shareholders, employees and customers.

At just around 3 per cent of State Bank of India’s balance sheet size of Rs 5,70,000 crore, State Bank of Saurashtra’s present balance sheet will make little material impact on the overall operational parameters, financials and profitability of the parent bank. Indeed, it is possible that the business levels of a couple of branches of the SBI match that of the entire State Bank of Saurashtra. It is difficult to understand how the merger would enhance the capital and balance sheet of SBI, given those numbers.

Stakeholder benefits

Boost from larger consolidation

Larger implications

Niche models

(Read more about the above points from

http://www.thehindubusinessline.com/2007/08/30/stories/2007083050160800.htm)

Now, let's see what SBI has to say about this?

Why did SBI pick up State Bank of Saurashtra to kick off consolidation?

(D Murali, Business Line, 30th August, 2007)

For a very long time, SBI associates have remained in the shadow of the giant parent while many comparative banks overtook the associates and became much bigger. Although small and dependent on the parent bank for resources, including managerial talent, many of these associate banks set enviable standards in terms of operating performance and efficiency, according to Mr Robin Roy, Associate Director, PricewaterhouseCoopers.
In an e-mail interview to Business Line shortly after SBI kicked off the consolidation process by announcing its decision to merge State Bank of Saurashtra (SBS) with itself, Mr Roy dwelt on issues such as why SBI picked SBS for the merger and how it will iompact valuations, among others.

Excerpts:

First, why the merger?

The Finance Minister has been advocating consolidation among Indian banks to enable them to participate in overseas acquisition activities of Indian companies. Relative to global banks, the small size of their balance sheets has always constrained these banks. So, if the largest commercial bank in the country is looking at consolidation moves, it is perhaps only logical.

What recent measures have facilitated consolidation?

As a step towards further autonomy of the SBI subsidiaries and to bring them at par with other public sector banks, the Government has lowered the minimum shareholding of SBI in its subsidiaries to 51 per cent and allowed them to issue preference shares. Thus, the way was clear for the “group of 7” subsidiary banks of SBI to approach the capital market for raising resources to fund business growth and also proactively meet the Basel-II norms on capital adequacy.

Will the merger impact the valuations?

Yes. The valuation ratios for the subsidiaries are much better than the parent bank itself. Therefore, post-merger, SBI is likely to get a better valuation.

How has the SBI been preparing itself for consolidation?

As often stated in public, SBI has been preparing for a virtual merger of all its associate banks for quite some time. Some of the steps taken in this direction include:

Adopting a similar technology platform across associates and the parent bank to make the “virtual merger” a reality.

Adopting similar business policies and risk management approaches.

Consolidating and unifying the ATM network within the SBI group (viz. SBM debit card holders can use SBI ATMs).

Move towards integrating the treasuries of all the associates in Mumbai.

But why SBS?

Of the seven associates, SBS was the first to be picked because of a few strategic reasons:

It is the smallest of all associate banks.

It operates mostly in a smaller geographic region (Saurashtra) whereby it can complement SBI’s limited presence there.

Historically, the associate banks have had mutually exclusive fund transfer arrangements vis-À-vis SBI network to obviate duplication of channels. Post merger the combined resources will be filling in residual gaps in the existing operations.

It is owned entirely by SBI. Since there is no other shareholder, SBI could move quickly ahead with the merger.

A description of the post-merger scenario.

In addition to spreading its reach to the Saurashtra region, adding a workforce of 7,000 employees, the merger will increase the size of SBI’s balance sheet by Rs 19,000 crore. In the domestic context, the merger of SBS gives the bank an additional Rs 15,871 crore of deposits and Rs 11,162 crore of advances. Against this, ICICI Bank added over Rs 65,000 crore of deposits and Rs 49,000 crore of advances in 2006-07. Following the SBI-SBS merger, the new entity will have combined assets exceeding Rs 5,85,365 crore, reserves of over Rs 31,500 crore and a combined net worth in excess of Rs 33,422 crore. In comparison, ICICI Bank now has total assets of Rs 3,44,658 crore, reserves of Rs 23,414 crore and net worth of Rs 24,313 crore.

On the immediate priorities.

It should be noted here that the merger is not formally over. The Government and the RBI have to grant approval first. Once approvals are obtained, redundancies in terms of operating branches and optimal deployment of staff have to be looked into.

What further action can we expect on the SBI consolidation front?

If the SBS merger experiment succeeds, there is speculation that SBI will move ahead quickly with merging the other six associates by 2009. The other unlisted associates in order of increasing size (State Bank Hyderabad and State Bank of Patiala) are expected to be the next merger targets. The listed ones could follow next.

Will this fuel M&A activity in the industry?

Yes, according to one school of thought, which believes that the anticipated series of SBI mergers might trigger more mergers and acquisitions amongst the remaining players.

This will be fuelled by two reasons, it is argued:
After the opening of the banking sector to foreign players in 2009, pressures on national players will increase further. The two major national players – ICICI and SBI – will be even further ahead in the number game, post-mergers.