Banking Industry Mergers…
Mergers are strategic tools and techniques that are used to increase productive efficacy of an institute, by means of combining one with the other - Banking Industry Mergers… introduction. It is known as a high level strategic move because it takes into account long term goals of the organization, which is of course to grow and make money.
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Perceptual Thought and Traditional View
Mergers are often confused with hostile take over, but there is a huge difference between the two. Hostile take over is the one in which a firm by hook or by crook, generally by crook, takes over a counterpart, and attempts to achieve the advantages of merger despite taking the ‘hostile’ route. The anticipated outcomes are the same as of a merger; however, the real outcome differs drastically. Based on the mindset of both being the same, the impact of take-over are associated as the disadvantages of a merger. Economic theories state that supplementary efficient gains should be the consequence and impact of the merger on the degree of local market competition.
Trends of Merger and the Banking Industry
Consolidation has radically distorted the configuration of Banking Industry. Since the mid-1980s, the number of banks has dropped, and larger banks straddling ever wider geographic areas have become more widespread. On an average, there have been more than two bank mergers almost business day for the past three years. Prior to the 90s, a number of bank mergers were participated by banks with less than $1 billion in assets; of late, quite large sized-banks have also been involved in mergers with other banks and with non-bank financial firms.
Current mammoth mergers in the banking sector have reopened queries pertaining to the continuous association in the direction of consolidation in the U.S. banking sector. Mergers such as those of Chase Manhattan with J. P. Morgan (to form J. P. Morgan Chase), Firstar with U.S. Bancorp (taking the U.S. Bancorp name), and Fleet Financial with Bank Boston (generating Fleet Boston Financial as the survivor) have renewed interest in an area of merger and acquisition (M&A) activity. The consolidation has reduced the number of banks in-accession of 40% since 1984.
It is quite important to analyze the facts that actually provoke the merger or acquisition activity. The foremost responsible factor stands out to be Globalization, Technological Advancements, and Regulatory Retreat (that stimulate and motivate banks to merge. Following can be considered as a rather comprehensive list of constituents for the same:
a) Anticipation of revenue growth in the resultant merged entity.
b) Operational efficiency
c) Economies of scale
d) Diversified scope (products and geography) of income
e) Asset quality stabilization
f) Optimal resource allocation, particularly capital
g) Higher value and worth of common stocks
h) Lower cost of financing, as the resultant is a much more stable product.
Barclays and ABN AMRO
The application of mergers can be traced to any number of banks of any size. The most recent example of the same is the Barclays and ABN AMRO merger, one of them serving the Dutch and the other serving the English sectors. A number of strategic advantages shall be obtained from this merger deal for both the banks. This paper discusses the outcome of mergers in the UK taking along the case of Barclays and ABN AMRO.
Analyzing the Deal: Barclays and ABN AMRO
The most important aspect of a merger is analyzing the profitability of the resultant entity. The most common outcomes of a bank merger are the associated cost reductions (mainly through economies of scale and scope) and superior efficiency of operations (attained through the added resources). However, these generally apply when one of the banks in the deal is an under-dog, or may be in a scenario where one of the banks is local and the other is foreign. The deal under consideration, however, stands an absolute exception. It is, therefore, important to analyze the outcome for a deep and thorough understanding of what exactly mergers are about.
There are the good points attached to the deal i.e. the benefits that would be reaped as a final outcome; these are discussed as below:
Both the banks served different markets. Elaborating on this, both banks have different origins and are considered quite strong at their home grounds. With this merger, therefore, the giants of the banking industry would enjoy expanded customer base and facilitations that each can provide to its customers. For example, if one of the banks provided a set of services X to the customers while the other provided Y, the services would also be merged to provide the combine customer base a service set of X+Y.
Value Added Services to Customers
This phenomenon is derived from the fact that now there would be more and more product and service development in the residual organization. In addition, the cross border trade would also become easier; alongside the geographical expansion that always remain a distinct edge of a merger.
Expanded Value of Residual
The stock prices already denote an expansion in the value/net-worth of the residual. This merger is possibly the biggest deal in this sector in history. Barclays now has become the 5th biggest bank in the world. The net worth of Barclays-ABN would approximately have a market value of around £90 billion, with more than 0.23 million staff and over 40 million customers in more than 70 countries.
Knowledge-sharing and Management
The unique patents, knowledge management, experiences, organizational best practices, etc. may all lead to firms having different management and technological capabilities. Applying the same concept to this case, the merger may lead to diffusion-of-know-how amongst the participant organizations. In case of one of the organizations having a higher and dominant level of know-how, it tends to overshadow any other pertinent practice in an organization and tends to develop its routes. Such diffusion is called the one-way diffusion. In another form, the two-way diffusion, the participants of the merger stand almost equivalent for the technological and administrative abilities therefore, both benefit from the fixture. The later is the concept that would be applicable in this scenario. R&D is probably the prime most examples where process or product improvement is deliberate for new product development and knowledge sharing. In a nutshell, when banks merge, their knowledge management systems also mingle with each other and as interaction increases, best practices are shared all over, and so is the priceless knowledge and experience. This is a highly value and worthy advantage which enhances efficiency of a merger-deal.
Increase in Resources
Another distinct feature of a merger is the fact that the size of the bank grows tremendously. For example of an MNC bank acquires a local bank that has reach in the sub-urban area, then definitely the bank would be able to increase its reach, which would have been difficult otherwise. This, in essence, is due to the increased in resources that a bank gets through a merger. Human and technological resources are also increased due to a merger, and a merger over an acquisition is successful because it is more of a win-win position. In the later scenario, the human resource of the acquired bank is easily de-motivated destroying the advantage of increased resources. These merits increase exponentially when the concerned parties may both actually be huge figures themselves as in this case. Therefore, this would be more advantageous for both the involved banks. The resources would increase so drastically in this case, that Barclays moves from 15th to the 5th top bank in the world.
Erecting of Barriers to Entry
By expanding the reach towards the masses, a bank creates barriers to entry for competition and strengthens its position in the market, as is done in this case. This generally erects the barriers to entry, and once there is a dominant position, the bank can experiment further to enhances its operational efficiency.
A bank increases is competency level through achieving huge scale operational base. With increased network (the reach towards people) it can enhance its competitive position among the competition. This again leads to motivation that would among the employees to put in their best to have their name on the top, in turn making the bank efficient.
Excess Capacity Building
Building of excess capacity is a definite outcome of a merger deal and so is applicable here. A piece of theoretical wisdom is that oligopoly markets (markets with a small number of firms) with economies of scale and no barriers to the establishment of new outlets can be characterized by too many outlets. Consider retail banks, which have historically competed through branch location as well as on other dimensions of service and price. Open entry means that, if a bank can find profit in establishing another branch, it will do so. So will its rivals. Thus, banks compete through branching until their profits reach competitive levels. Meanwhile, to pay their fixed costs, all banks impose service charges that exceed the marginal cost of providing the service. For a rival bank, the loss of a customer means the loss of demand and the corresponding markup on the service, a profit externality imposed by the bank establishing the branch. This tendency to compete vigorously through branching, forces banks to develop efficiencies in their scale of operations. However, it is noticeable that the development of excess capacity would take place in an off-shore manner as each of the banks has limited reach in the other’s origin.
The Demerits and Unsuccessful Desired Outcomes
This section is a bit unique, not purely the same as the title, rather given possibly the best title. It analyzes the benefits that are reaped from merger deals but won’t stand valid in this case, the loopholes rather that could have been filled if a local bank was involved. However, it is by no means intended to negate the deal or to negate the strategic view point at its back:
Economies of Scale and Scope
Economies of scale are achieved when a firm has its average cost reduced primarily due to increased output levels. Economies of scope provide a generic view for multi-product firm. Financial institutions have products that are spread over transaction services such as deposits, loans, funds management, etc. In today’s competitive banking sector, economies of scale and scope are a mandatory requirement to survive. The answer to this issue is the diversification of product and geographical portfolio which is attained by means of a merger. When merged with another institution, a bank increases the length of its reach to the masses. There might be a factor of redundancy; however, the benefit to the cost is quite high. At this point in time, it is very important to have known that are the economies affecting actually long run or short run in essence. However, the agreement of merger under-consideration doesn’t seem to be quite a fit when it comes to cost cutting because there is hardly a geographical overlap, and this has restrain the scope of cost cutting.
Employee downsizing is one of the most horrific consequence of a merger or an agreement of similar sort. There have been rumors that ABN would like a huge cost cutting, in excess of 30 billion, and employee downsizing has been the major activity that has contributed to this cost cut in the past.
Undesirable Outcomes of the Merger
Alongside everything else, there are the undesirable outcomes of a merger that actually should be considered as a priority because these are the key to success or failure of such an agreement. Desired outcomes can be obtained through certain manipulations, but generally, undesired outcomes remain out of control for the concerned parties.
Unwanted Results for Parties Involved
Mainly due to the downsizing impact, there may be loss of employee moral that the banks need to take care of. In addition, there might also be the free-rider concept after the mergence along with leaning-back-employees i.e. once the downsizing is over. This hampers the productivity of any organization. Therefore, it is equally important to maintain a constant check on employees in this respect.
Unwanted Societal Results
Previously, it was stated that mergers increase the competency and competitiveness of an organization; however, it also tends to reduce the industry competition through directly influencing the number of players in the market. The sign of concern is the fact that service providers reduce in an economy, giving monopolistic power to an organization, due to its size advantage, to out-run others in the race. With increased market share, the firm may become a dominant player in the market.
Due to this imperfection, market forces need to play an extensive role so as to fill as a selection drive. If the competition existing in the industry is quite intensive, managers having the most accurate intuitions might be the only ones getting their organizations to succeed, survive, and expand. It is due to this broad vision that the managers are able to produce cost-effective varieties that would satisfy the customer needs and wants.
This might even increase the inflation across the product or service category, which is later in this case. From an economic perspective, there are two outcomes, on a broader scale implied by the increased prices:
Distributional Consideration: Transfer of wealth from consumers to producers
Deadweight loss: Allocative in-efficiency lead by the increased prices over the marginal cost.
Pertinent authorities and the government have the primary goal set to assure the elimination of distributional effect of price increment. At the same time, economist focus more on the allocative in-efficiency portion; this is another consequent of a merger.
The theories pertinent to oligopoly re-instate that the number of firms stands inversely proportional to the prices, i.e. increase in the former witnesses’ reduction in the late and vice-versa.
It is understandable that a merger is definite to increase joint market power as in the addition of the existing market share of the parties involved in a merger, and over and above, new customers might be attracted due to the expanded network. The firms, therefore, must compete prior to the mergers giving no account to the impact of price or quality decisions on the profits of their competitors. In the post-merger scenario, there would be vast scale joint-profits, with account for the prominent disadvantageous effect of increased quantities and reduced prices, while cutting down on the pie-of-the-market of the competitor’s products.
Also the fact that a merger in such a scenario may lead to collusive behavior that may actually by a major alteration in the nature of conduct. This in essence leads to premium pricing led by explicit collusion. Due to the reduced number of firms, because of mergers, implicit alliance agreements become easier to sustain. The primary example of this is the ease of detecting a cheating within the cartel. The movement or alteration of conduct has the tendency to increase the combine market strength of organizations in an industry.
There may be several other social impacts of a merger; some are listed as below:
Consumer Surplus: Protection of consumer interests and rights is probably the prime objective of a merger analyses. In such a scenario, competitive analyses and price impact are the core important facts for merger analyses.
Total Surplus: However, only the interest of consumer shouldn’t be considered; also to giver certain incentives to the producer. Total surplus is the aggregation or summation of producer and the customer surplus. However, the weights assigned to each may vary.
Other Objectives: Other objectives of a merger can be several and numerous, some of them are:
Viability of small firms
Global competitive scenario
The employment concern has been a major cause of thought for the governments all across because generally mergers are associated with lay-off of a vast number of employees. Most probably, the policy that has been developed to conserve previous production structure is generally found as not the best manner to take case of the employment aim in the long run.
Efficient Reallocation of Productive, Financial and Managerial resources within the Economy
Allocative efficiency deals with allocating the resources in an appropriate and optimal manner to achieve the means of efficiency. The only constraint for this matter is the availability of resources; let it be in any form i.e. capital, human resource, etc. Mergers result in enhancement of resources of all forms. Thus the constraint is removed to certain extent. Due to increased availability of resources in terms of productivity, finances, and managerial experiences, it becomes easier to reallocate resources much more efficiently. It is not being argued that earlier the resources were not allocated appropriately; however, the increased level of resources requires a definite reallocation to assure and ensure that resources are utilized in the most optimal manner. Such reallocation of resources leads to enhanced productivity and as a positive desired consequence, the economy also grows. Thus, it can be said that mergers bring about economic prosperity in the nation.
While taking on the important decision about mergers, it is important to analyze the impact of the same on all the stakeholders, particularly the following:
Other stakeholders also hold prime importance but the importance associated with these is the maximum. These are probably the ones that are most directly impacted by any strategic decision, let alone mergers. Therefore, it becomes critical and crucial to take these set of stakeholders in confidence and assure them the best expected outcome and present them with all the findings.
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Bliss, R.T. and R.J. Rosen, (2001) “CEO Compensation and Bank Mergers.” Journal of Financial Economics, 61, 107-138.
DeYoung, R., I. Hasan, and B. Kirchhoff, (1998) “The Impact of Out-of-State Entry on the Cost Efficiency of Local Banks,” Journal of Economics and Business, 50, 191-203.
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