Bank Mergers Cost Efficiency Gains among Commercial Banks in India

Article excerpt

Abstract

This paper empirically examines the impact of mergers on the cost efficiency of Indian commercial banks over the period 1990-2008. The analysis consists of two stages. Firstly, non-parametric Data Envelopment Analysis approach is used to examine the cost, technical and allocative efficiency for the banks that have been merged during post liberalization period. Secondly, the changes in the efficiency of Indian banking sector during the pre merger and post merger period is obtained by using a series of parametric and non-parametric tests. The findings of this paper suggest that to some extent merger programme has been successful in Indian banking sector. The Government and Policy makers should not promote merger between strong and distressed banks as a way to promote the interest of the depositors of distreseed banks, as it will have adverse effect upon the asset quality of the stronger banks.

JEL Classification: G21, G34, H21

Keywords: Mergers, Indian Banks, Cost efficiency, DEA

I. INTRODUCTION

The financial system plays a crucial role in mobilizing funds and savings and the use of these funds and savings into more productive use. Banking sector as a major part of the financial system plays an effective role in accelerating the path of economic growth. A sound and efficient financial system has been considered as a pre-requisite for the growth of any economy. This sector plays a very crucial role in promoting the payment and settlement system of an economy. Banks also play an important role in discharging social responsibilities such as poverty eradication, balanced regional development, employment generation etc. The main cause behind the outcome of industrial revolution in Europe during 18th and 19th century was the growth of commercial banking. The banking sector in India as well as in the world continues to be one of the primary engines of growth.

Economies of the world have experienced a revolutionary change in the environment of banking sector. One of the radical changes that have taken place in the banking industry at global level is the increased competition among banks. Increased competition has compelled the banking industry to improve their efficiency and productivity. The banking industry has also to face competition from the non-banking companies such as insurance, investment banks, and saving banks that also encouraged the banks to improve their efficiency and productivity.

The strategic priority in the banking industry has changed over the last two decades. Presently, more emphasis has been put on efficiency, soundness, value creation, and productivity rather than on growth. To achieve all these goals, the government and regulatory authorities have adopted various policies and measures, out of which consolidation of the banks emerged as one of the most preferable strategy. There are several ways to consolidate the banking sector; the most commonly adopted by the banks is mergers. Merger and acquisition of the banking sector was one of the outcomes of the deregulation, liberalization, and technological progress. Merger of two weaker banks or merger of one healthy bank with one weak bank can be treated as the faster and less costly way to improve profitability than spurring internal growth (Franz, H. Khan).

One of the main motives behind the mergers and acquisitions in the banking industry is to achieve economies of scale. Scale economies arise when banks increase their scale of production and size by merging with other banks.

With this consideration in mind, the present paper attempted to study the effect of mergers on efficiency of Indian banks that have participated in the merger activity during 1990-200. The remainder of this paper is organized as follows: section 2 provides brief overview of the Indian banking sector. Next section deals with the review of empirical studies related with the impact of mergers on efficiency. …