By Roshni Jayakar

It could be a marriage of giants. The normally-secretive corridors of the Union Finance Ministry are reverberating with the news of a possible merger of the Industrial Credit & Investment Corporation of India (ICICI, 1996-97 income: Rs 4,510 crore) and the Industrial Development Bank of India (IDBI, 1996-97 income: Rs 5,963.80 crore). While the Government of India, which directly holds a 72.14 per cent stake in IDBI, and indirectly, through financial institutions (FIs), banks, and mutual funds, holds 37.60 per cent, in ICICI--is yet to take a firm decision, BT learns that a feasibility exercise is under way.

Says a senior bureaucrat in the finance ministry: "Although the proposal is lying with us, a decision will be taken only after the new government assumes power." However, another senior bureaucrat in the banking division dismisses the news, saying: "There never was, nor will there ever be, a proposal like that." Nevertheless, he hints that a merger between the two--set up to finance industrial projects in 1955 and 1964, respectively--could take place if IDBI was corporatised, with the government holding a minority stake, after which it would be allowed to take a decision on the subject.

Several indicators of the merger--and for options such as a merger of a fi and a bank, or of two nationalised banks--are already there:

The IDBI Act, 1964, is being repealed in a bid to corporatise the institution. The Bill may be tabled in Parliament in the first session after Elections 98 and Union Budget 1998-99. If passed, it will imply that IDBI's operations will be governed by the Companies Act, 1956. Once IDBI--like ICICI--becomes a corporate with the repealing of the IDBI Act, it will provide more flexibility and freedom to the institution to capitalise on its skills.

ICICI CEO K.V. Kamath, 47, is seriously exploring merger options with the aim of becoming a universal banking group. And he already has two mergers--with the Rs 541-crore Shipping Credit & Investment Corporation of India (SCICI) in early 1997, and the Rs 196.21-crore ITC Classic in December, 1997--under his belt. Both the mergers have enabled ICICI to become bigger and better.

Senior government officials have consistently hinted that India should have mega-banks and mega-institutions. For instance, while laying the foundation stone of the Union Bank of India's (1996-97 income: Rs 2,501 crore) Hostel Block in Bangalore on December 21, 1997, Union Finance Minister P. Chidambaram, 52, said India needed to set up "internationally-sized banks" since there was a need for banks and FIs to become "competitive and world-class."

In the past few years, the concept of consolidation in the banking sector is gaining popularity. Moreover, the manifesto of the Congress (I) states that "mergers and consolidation in the banking industry will be encouraged." Besides, it acknowledges that the banks "have to be given more autonomy to introduce new technology, provide new services and offer new products, recruit laterally, and restructure themselves."

Many experts, like M. Narasimham, 70, who heads the new committee on financial sector reforms, have also maintained that India should start thinking in terms of creating two or three banks with international character. In fact, Narasimham is of the opinion that mergers between strong institutions is the only route for achieving this objective. BT learns that the finance ministry constituted the Narasimham Committee primarily to suggest options on mergers between two FIs, or a fi with a bank, or two banks.

The proposed merger between IDBI and ICICI will definitely result in a mega-institution. For, it will make the combined entity the second-largest Indian company in terms of income, after the Rs 6,409.43-crore TELCO; the most profitable; and the fourth-most valuable--in terms of market capitalisation--after the Rs 7,244.64-crore Hindustan Lever, TELCO, and the Rs 8,730-crore Reliance Industries.

Of course, despite an asset base of Rs 84,173.49 crore ($20.23 billion), the entity will still be puny compared to the Rs 1,10,000-crore asset-base State Bank of India (SBI), and its global competitors such as the Bank of Tokyo-Mitsubishi (asset base: $648 billion) of Japan, SBC-UBS ($592 billion) of Switzerland, Deutsche Bank ($570 billion) of Germany, Credit Agricole ($477 billion) of France, and Sumitomo Bank ($460 billion) of Japan. But then, size is not the only incentive to create the largest fi in the country. Competition from both within and outside, and financial synergies between the two institutions are the other two major factors that justify the merger. BT conducts a swot of the merged entity, and explores how these factors may force other banks and FIs to join hands in the near future.

COMPETITION. There is no doubt that Indian FIs will face increasing competition from both domestic and foreign players. As the pressures on the Indian government to open up the financial services sector increase, and foreign banks are allowed to open more branches and expand their operations in the country, institutions such as IDBI and ICICI will have to play the game by the new rules. Add to this the fact that global investment banks--which act as commercial banks, and can raise capital abroad at cheaper rates--are eyeing emerging markets like India. As Chidambaram said in Bangalore, it might be better for the Indian FIs and banks to compete globally rather than with each other.

Moreover, the differentiation in the line of operations between FIs, banks, investment banks, and other finance companies are blurring every day, thereby reflecting a move towards universal banking and intensifying competition. Banks have been allowed to finance term loans--so far a preserve of the FIs--upto Rs 500 crore, and the relaxation in the project financing norms for infrastructure lending by banks has enabled them to exceed the prudential exposure norm of 50 per cent by an additional 10 per cent.

According to a Merrill Lynch report on the Indian banking sector, "fi managements are realising that it would be impossible to improve asset quality unless they diversify away from funding projects in the manufacturing sector." Thus, the institutions are looking at infrastructure projects and short-term working capital lending--a forte of the banks--as a means of achieving risk-diversification. But, according to the report, "Regulations limit them (the banks) from deploying more than 10 per cent of the total funding in short-term lending, a level not sufficient to achieve any meaningful risk-diversification of portfolio." Banks like the SBI and the Bank of Baroda (1996-97 income: Rs 4,220 crore) have also set up full-fledged project finance divisions, which carry out techno-economic feasibility studies, appraise new projects, and prepare rehabilitation packages just like any fi does. Thus, with banks catering to the better-off corporate houses, FIs are finding it tough to tackle emerging competition.

In the new environment, what will matter most is financial power, and the ability to offer diverse and innovative products. At present, the Indian FIs falter in both these areas. Even if they concentrate on giving loans for infrastructure projects, there will be a need to develop excellent project-appraisal skills, and offer competitive lending rates. As banks and other finance companies offer similar products, both IDBI and ICICI will constantly have to reduce their cost of funds and work on thin margins.

GLOBAL SCALE. That's where size will matter. For two reasons: it will enable the institutions to play bigger roles in infrastructure projects, and raise resources at more competitive rates. These reasons also explain why the merger fever has caught on globally, and resulted in a series of unions, the most recent being the one between the Union Bank of Switzerland (1996-97 income: $18.90 billion) and the Switzerland Banking Corporation (1996-97 income: $15.71 billion.)

Consider the existing lending constraints on the FIs. In 1995-96, the FIs disbursed Rs 31,500 crore for industrial and infrastructure projects. Assuming that the total disbursements grow at a compounded annual rate of 15 per cent per annum, the figure will climb to Rs 2,44,000 crore over the next five years. But this will still fall short of the country's needs by Rs 1,26,000 crore. Another example: estimates made by ICICI indicate that the total funds required for the various telecom projects in India would be more than Rs 45,000 crore, of which the debt component will be Rs 25,000 crore. But to meet the demand for such funds, lenders must be large institutions.

At present, most of the Indian FIs and banks feel constrained while lending to infrastructure projects. For example, consider what's happening to the numerous power projects--which require funds totalling Rs 72,000 crore--being set up in India. To reduce risks, a fi normally lends no more than 15 per cent of its total outstanding loan portfolio to the power sector. Most experts say that with such low exposure limits, all these institutions will hit their ceiling by 2000 and not be able to finance power projects in the next century.

Says Girish Kumar, 32, analyst, Merrill Lynch: "Reforms in provident funds segment, and an increased availability of external capital would increase disintermediation in the top-end of the market, and add to the credit risk in regular project lending business." But a larger entity could take on larger exposures, and will be in a better position to absorb the increased risks in the form of bad loans.

For instance, the number of sick companies in the portfolio of the FIs as on March 31, 1997, stood at 425, and the total loan outstandings in respect of these companies was Rs 2,495 crore. While IDBI has written off Rs 2,504 crore as bad loans over the past two years, the figure for ICICI is Rs 176.62 crore. However, the size argument has a downside. For, a larger wholesale bank--twice the size of one IDBI, or one ICICI--would be exposed to larger systemic risks and regulatory attention.

But the institutions' ability to raise large volumes of funds in a cost-effective manner is critical. Especially since credit costs, as a percentage of returns, are in the range of 25 to 35 per cent in the case of banks, 55 per cent in the case of FIs, and 15 per cent in the case of financial companies.

It is also important to note that both IDBI and ICICI have been forced in recent times to seek alternative fund sources at market-related rates even as low cost funds--which had ensured that their spreads at between 5 to 6 per cent for banks, and 3 per cent in the case of the FIs--have dried up. The concern about the retail fund base of FIs should become relevant again in 1998-99, when the liquidity conditions are likely to tighten. However, while tapping the retail market without the advantages of a huge branch network, FIs are hard-pressed to mobilise resources.

Meanwhile, ICICI has formed a wholly-owned subsidiary non-banking finance company, the ICICI-Credit Corporation (I-CREDIT, 1996-97 income: Rs 166.41 crore), to create a network to enter areas like financing of automobiles and consumer durables, vendor leasing, and factoring services. However, the FIs are restrained by the Reserve Bank of India, and cannot offer a deposit rate that exceeds that of the SBI. So, ICICI's main source still remains the money raised from the wholesale bond market at a 14 per cent rate of interest.

FINANCIAL SYNERGIES. A merger of IDBI and ICICI at a swap ratio of 1:1 is likely to create an entity which has a capital base of Rs 1,135.40 crore. As this is reflected in the scrip price, it will enable the merged institution to issue shares through a rights issue at a higher premium. What the merger means is that a smaller, flexible, and innovative ICICI joins hands with a larger, resourceful, and profitable--in terms of net profits--IDBI.

There are other synergies too, since nearly 80 per cent of the loan portfolio is common to the two institutions. In this scenario, controlling future non-performing assets and working out rehabilitation packages for the ailing companies would be more effective after the merger. Today, for instance, a package put up by IDBI has to be approved by ICICI, which could take up to months. Such delays can be avoided if only one institution is involved. So, in terms of credit delivery, the combined entity will be faster and more efficient.

However, integrating two large FIs is not an easy task. For, each has its own historical baggage and culture, which is difficult to merge or wish away. A merger could mean re-looking at the way wholesale banking is done in the country. For example, ICICI has been able to foster an open culture, attract better talent, and become nimble enough to react to recent changes. It has also introduced the profit-centre concept, wherein all group leaders are responsible for both profits and recoveries. By contrast, IDBI has been slow to seize opportunities, and has remained a public sector enterprise with flashes of excellence.

Being a government-controlled institution, the chairman of IDBI, S.H. Khan, is a bureaucrat, unlike the CEO of ICICI. Also, only Khan--among IDBI's managers--is on the board of directors of IDBI, whereas in the case of ICICI, apart from the chairman and CEO, the deputy managing directors, and the executive directors are also represented on the board giving them a better say in decision-making.

In addition, the merged entity will have a staff strength of 3,980--ICICI's 1,280 and IDBI's 2,700--of which nearly 1,500 jobs will be redundant. And it is reasonable to assume that IDBI's trade union will oppose such moves. Even if the union is placated, the cost of an attractive Voluntary Retirement Scheme (VRS) can be a whopping Rs 65 crore, considering that the merger of SCICI with ICICI cost the latter Rs 5 crore for its VRS to 117 employees.

Even so, since the consolidation endgame is less about empire building and more about increasing revenues, lowering costs, and increasing shareholder value, the merger is a viable and an attractive option. According to Merrill Lynch's Girish Kumar: "India is getting closer to a stage where the prospect of FIs becoming commercial banks is a growing possibility over the next 12 to 24 months." And whatever the analysts or bureaucrats might say, the issue today is not whether IDBI and ICICI will merge, but when.

Write to us   Subscriptions