Analysis of IDBI Bank's Merger with United Western Bank

The assignment content discusses the merger of United Western Bank (UWB) with Industrial Development Bank of India (IDBI). The acquisition was inexpensive, but it came with hidden costs. UWB had bad loans and a large workforce that IDBI had to absorb, leading to an increase in wages and salaries. The merger also brought benefits, such as diversification into the agricultural sector and expansion of deposits and assets. Additionally, the economy witnessed a growth of 9.2% in GDP, and IDBI's Gross Domestic Investment increased by 25.2%. The Reserve Bank of India imposed a penalty on UWB for irregular transactions with the Makharia Group of companies, leading to the announcement of the merger.

Table of Contents
Introduction......................................................................................................Page No.2
Justification of choice for selection of the company..............................................Page No.3
Profitability before and after merger................................................................Page No.4-13
Rationale & Theories relating to the merger....................................................Page No.4-13
Announcements.................................................................................................Page No.14
Conclusion & Recommendations......................................................................Page No.15
References........................................................................................................Page No.16-17
Merger & Acquisition Page 1

Introduction
One plus one is more than two. This is the benefit of merger and acquisition. A company in
order to expand needs resources. One company itself has limitations regarding raising
additional resources, the resources which it can raise through equity or debt, is limited and in
order to expand into different countries of the world it takes huge time and resources to
expand and diversify. In order to expand in a short span of time, the company can enter into
an amalgamation with the companies already existing in different markets of the world. This
will benefit the company as it will not be required to deploy time and resources. It can buy
the stake in a company, and such existing company becomes a subsidiary of the holding
company.
In many cases, the existing company may suffer a downfall with regards to continuous
losses or fall in market share. Under such circumstances, the market price of the share keeps
on declining. In order to save such company from being wound up, another existing
company carrying on the same business or other business takes up such company and does
the restructuring part. It is a very tedious and time-consuming process to form a company
and get it listed on the stock exchange
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Justification of choice for selection of the company
There occurred so many amalgamations in the history of mankind. But specifically I choose
the amalgamation of two banks located in the continent Asia. These two banks were located
in the country India. India is the largest democratic country in the world second highest
population in the world. The two banks that amalgamated are United Western Bank and
Industrial Development Bank of India (INDUSTRIAL DEVELOPMENT BANK OF
INDIA). The basic reason for selection is that the information regarding the project is easily
available over the internet. Further, the bank, that amalgamated with INDUSTRIAL
DEVELOPMENT BANK OF INDIA, was the largest private sector bank in the country.
This amalgamation was done due to so much internal mismanagement done within the bank.
This amalgamation diverted the attention of the Government to make the rules and
regulation stricter. I got to learn the importance of rules and regulations that should be
strictly followed. Banks work for the benefit of the general public and not for the personal
benefit of any relative of the employees working in the bank. The banks need to strengthen
the internal controls regarding passing the loan and limiting the purpose for which the loan
should be utilized by the receiver of the loan
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Profitability Before and After Merger
&
Rationale & Theories Relating to Merger
(Financial Analysis in ‘000s)
(All the data has been taken from the annual report of IDBI bank available at the website of
the bank)
Merger & Acquisition Page 4

Financial analysis of ratios is a very important and a useful tool that helps us to measure the
performance and financial position of a bank. They serve many purposes, one of it for
comparison among the existing competitors. These ratios are classified according to the
information they provide
Profitability Ratio
Net Profit Ratio
It is the most popular financial ratio that shows a relationship between net profit earned by
an entity during the year & after-tax net sales. Formula for the same is
Net Profits after Tax / Net Income *100
When we deduct all operating expense from the gross profit, we get net profit. The main
objective of this ratio is to evaluate the profitability performance of the company. The
relationship is expressed in a percentage form. A high ratio is a measure of efficient
performance by the management. It is a ratio that measures how much part or portion of
every dollar a company keeps in earnings. It is very useful while we compare two companies
in similar industries. Higher percentage of this ratio indicates that the company has a better
control over its cost as compared to competitors. Shareholders have a close watch over this
ratio. Changes in this ratio are endlessly scrutinized Let us analyze the net profits of
INDUSTRIAL DEVELOPMENT BANK OF INDIA before and after merger
Particulars 2005-06 2006-07
Net Profit Rs. 5,608,874.00 Rs. 6,303,094.00
Income Rs. 66,611,677.00 Rs. 73,726,026.00
Profit % 8.42% 8.55%
The profit percentage has increased by 0.13%. We saw a rise of Rs.7,114,349.00 in the
income. This happened due to rise in the number of branches. The bank got more than 200
branches located in rural and semi-rural areas without investing in the infrastructure. But
there were certain hidden costs regarding the merger. UNITED WESTERN BANK had
many bad loans in its basket that affected the quality of existing assets. The cost of
maintaining the same rose to 100crores. This was the additional cost that INDUSTRIAL
DEVELOPMENT BANK OF INDIA had to incur. This was the reason we see the profit
percentage was not increasing even though the income increased drastically
Merger & Acquisition Page 5

Efficiency Ratio
The word efficiency means optimal utilization of resources. This ratio is used to analyze
how a company uses its assets & liabilities internally. The most widely used ratios are
Accounts receivable ratio, Fixed Assets turnover ratio, stock turnover ratio, sales to
networking capital ratio& sales to inventory ratios.
The ratios are calculated by INDUSTRIAL DEVELOPMENT BANK OF INDIA are as
follows
Fixed assets turnover ratio: The Company uses fixed assets to produce goods & services.
The company should have a regular check on the utilization of fixed assets. The basic
purpose of fixed assets is to fixed assets like land, building, machinery, etc. is to produce
goods & services that earn income to the company. This ratio measures the capability of the
company to generate sales by utilizing the fixed assets. The fixed assets used should be net
of depreciation. This ratio is more often used in manufacturing industries where any fixed
asset is purchased to increase the production. This ratio shows how efficiently the
investment in fixed assets is utilized. The ratio of INDUSTRIAL DEVELOPMENT BANK
OF INDIA is calculated as follows
Merger & Acquisition Page 6

Sales to Net Working Capital Ratio
Working capital is the difference between Current Assets & Current Liabilities. A company
has to maintain a minimum amount of cash to maintain a level of sales. This ratio measures
how the working capital is utilized or depleted when a particular level of sales is achieved. It
establishes how efficiently the company is utilizing it current assets & current liabilities
Particulars 2005-06 2006-07
Income Rs. 66,611,677.00 Rs. 73,726,026.00
Working Capital Rs. 55,214,960.00 Rs. 55,611,571.00
Sales to working capital 82.89% 75.43%
Here sales represent Income because for a bank income is from the receipt of interest. We
see that the percentage of bank after merger has fallen down. This means that the only
75.43% of working capital is utilized to achieve such sale. This is a good indication. This
was due to the existing infrastructure of UNITED WESTERN BANK. The bank entered into
a joint venture business for life insurance business International N. V. (Fortis), and Federal
Bank Ltd. There was a rise in 229 branches, 14 counters, 78 Automated Teller Machines,
etc. This bought the presence of the bank in the state of Maharashtra. The bank has 970
delivery outlets i.e. 432 branches, 18 extension counters and 520 Automated Teller
Machines
Merger & Acquisition Page 7

Short Term Solvency Ratios
These ratios help to evaluate the ability of a company to clear its debts & other obligations.
It analyzes whether a company can meet its short term obligations & current liabilities as &
when demanded from the creditors; the lower the ratio, the more the chances that the
company will default. This ratio is used majorly in insurance companies.
This help to know that the company will remain solvent, or there are certain indications that
show that the company may become insolvent in the near future. It measures only cash flows
& not income. The majorly used short term solvency ratio is Current ratio that is explained
& calculated as follows
Current Ratio
It is a ratio that helps to evaluate a company's liquid position which includes analysis
regarding the entity's ability to pay short-term obligation as and when they arise. The
formula for this ratio is Current Assets divided by Current Liabilities. Current Assets are
those which can be converted into cash within 12months or within the normal operating
cycle whereas Current liabilities are the obligations of a business that have to be paid within
12months. An idle Current Ratio is 2:1 which means Current Liabilities are half of Current
Assets.
This ratio is constantly monitored by the creditors and short term money lenders. On the
basis of this ratio, they decide to grant credit to the company or not. In case if granted than
for how long it should be granted. Creditors will prefer granting credit to those companies
that have Current Ratio more than the other as they will feel safe. The formula for this ratio
is Current Assets divided by Current Liabilities. The different forms of this ratio are
Liquidity Ratio, Cash asset ratio or cash ratio. When the current liabilities are more than the
current assets then the company may face problem in clearing its short-term liabilities &
obligations. (Accounting explained, 2014)
When the ratio is less than one then there are chances that the company may face a financial
crisis in the near future, but that does not mean that company will become bankrupt.
Particulars 2005-06 2006-07
Current Assets Rs. 1,010,609,573.00 Rs. 877,538,791.00
Current Liabilities Rs. 955,394,613.00 Rs. 821,927,220.00
Current Ratio 1.06 1.07
Normally the current ratio should be more than 1.5. But in case of banks it should be more
than 1. So there is no effect of the merger on the current ratio.
Merger & Acquisition Page 8

Long term liquidity ratio
Such ratio analyzes the presence of debt & equity in the capital structure. The company that
has debt in its capital structure is has something called leverage in its capital structure.
Leverage means risk. Risk of non-payment of interest or principal amount as & when they
become due.
The company gets the benefit of tax while paying interest. There are chances where the
control gets diluted in the hands of debt holders in case if the presence of equity is less than
the presence of debt in the capital structure. In the case, if the company does not have debt in
its capital structure, it is said to be an un levered firm. One of the commonly used ratios is
calculated as follows
Gearing Ratio:
This ratio makes the comparison of two items of Balance Sheet. First is owner's equity & the
second is borrowed fund. This ratio helps in measuring financial leverage. Leverage means
risk. It is the risk of nonability of a company to pay interest or principal installment on or
before a due date. These shows a mixture of owned & borrowed fund & shows the presence
of financial leverage in the capital structure of the company, more this ratio more the risk in
the capital structure of the company. This ratio shows the proportion of debt to the equity.
The formula for Gearing Ratio is
Interest Bearing Debt
(Share Capital + Retained Earnings)
The Long Term Debt includes all long term & short term debts including the Bank
overdrafts
Particulars 2005-06 2006-07
Interest Bearing Debt Rs. 424,043,756.00 Rs. 475,302,057.00
Net Worth Rs. 82,994,612.00 Rs. 63,711,831.00
Gearing Ratio 5.11 times 7.46 times
Here we see that the ratio has increased to 7.46 times after the merger. UWB had so many
Non-Performing Assets in its Balance Sheet so after merger it has affected the Gearing Ratio
making it more complex
Merger & Acquisition Page 9

Market-based Ratio
Such ratios help the investors how to value a company. All the market ratios have one thing
in common which is that they measure two things, one is the earning capacity of the
company & the other is the market price of the company in the stock exchange in which it is
listed. The most widely used ratio is P/E ratio which is explained as follows
Price To earnings ratio
This ratio analyzes the value of an investment on a particular date. It is a stick that ascertains
the true worth of an investment. Investors use this ratio for measuring the value of
investments, the general public at who invest in the shares of the company uses it wisely,
more the price to earnings ratio, optimum the performance of the company. The formula for
calculating this ratio is Market price per share divide by Earnings per share. One can easily
calculate the numerator as it available on different websites of the stock exchange. The
market price of shares is available to a stock market and is easily assessable. But the thong,
that is difficult to exactly calculated, is the denominator i.e. Earnings per share. Because the
value or the amount used here varies and have different forms. When the ownership of the
company gets diluted then it is difficult to analyze the actual EPS paid to the shareholder
who is not diluted.
This ratio calculates the number of times of earnings a company is paying for its stock. For
example, if the P/E ratio is 12, then it means that the company is paying 12 years' worth of
its earnings. This ratio is dynamic and keeps on changing every second till the market price
of the shares keeps changing.
This ratio is helpful when we compare two firms. In isolation basis, this ratio has no use.
The companies, which are compared, should be in the same industry. It is referred as
multiple, as it shows how much investors are willing to pay per dollar. This ratio is more
dependent on the mixture of debt & equity in the capital structure. Because the debt in
capital employed affects both earnings and share prices in many ways. Higher the debt,
lower the earnings per share. (Anderson, K.; Brooks, 2006)
Particulars 2005-06 2006-07
Market Price/Share Rs. 75.65 Rs. 75.45
Earning/Share Rs. 7.74 Rs. 8.70
Price Earnings Ratio 9.77 8.67
Merger & Acquisition Page 10

There are certain benefits of merger and acquisition. These are as follows
1. Economies of scale: There are different types of economies to scale. These are
Technical economies, financial, organizational, etc. INDUSTRIAL
DEVELOPMENT BANK OF INDIA wanted to expand its business but due to RBI
norms it could not expand. But after the merger with the bank with UNITED
WESTERN BANK, the bank expanded into the agricultural sector, as UNITED
WESTERN BANK already had its branches in rural and semi-urban areas. There
was diversification wherein the SME's and agri-business also came into the portfolio
of the bank. The amalgamation strengthened the efforts of INDUSTRIAL
DEVELOPMENT BANK OF INDIA Bank to pursue its business strategy in a more
healthy manner
2. UNITED WESTERN BANK was a competitor of INDUSTRIAL DEVELOPMENT
BANK OF INDIA bank. When both the banks joined hands together the competition
eroded and the bank was able to tackle competition with other private banks such as
ICICI
3. More investment in R&D: Bank was able to invest in new research and development
programs
4. Protection to a bank from closing down: When any existing company closes down, it
poses harm to the economy. There were 3200 employees working at UNITED
WESTERN BANK. In the case, if the bank has been closed down, all these
employees would become jobless creating unemployment in the economy. Opening
up a bank is not everyone's cup of tea. It requires huge capital investment approx 100
cores. Further, the legal fees for operating as a bank is also huge. Getting the
company listed on a stock exchange requires following all the rules and regulation of
the stock exchange. These are appointment of the audit committee, having certain
number of independent directors, etc. so it is better to buy such existing company
instead of creating another company
5. Diversification: The bank diversified its credit profile. The bank got an entry into the
agricultural sector as more than half of the branches of UNITED WESTERN BANK
were located in semi-urban areas and rural areas. The deposits expanded by 20%; the
asset base increased by 10%. The UNITED WESTERN BANK had ready
infrastructure that provided the bank to mobilize to low-cost platform. Bank got the
benefit for mix of deposits. The bank transformed from the financial institution into a
commercial bank. The net interest margin was very low for the bank as compared to
three of the industry margin.
The theory, which has been relevant for the downfall of the bank, is inefficient management
theory. The reason, the bank had a downfall, was due to inefficiency in the operation of the
management. United Western Bank Limited (UNITED WESTERN BANK) was the largest
Merger & Acquisition Page 11

private sector bank during the 1990s in India. But post 1990 the bank was facing some
problems. All these problems were related to internal mismanagement that was asset-
liability mismanagement. The assets of the bank were utilized in an inappropriate manner.
There was a group known as Makharia Group; this group was the shareholder of the United
Western Bank Limited (UNITED WESTERN BANK). Certain transactions were entered by
the bank with this group. There was a conflict with the major shareholders of this bank. This
was due to poor governance. At the end, this issue became big and, as a result, the bank has
to be wound up and hence the bank collapsed. In order to save the depositor the Government
of India announced merger of this bank with Industrial Development Bank of India. Anand
Sinha, Executive Director, Reserve Bank of India said that it was the inefficient
management of the bank that led to the downfall of the bank. The prescribed net worth, that
has to be kept as per the guidelines by the Reserve Bank of India, was 300crore, but the net
worth of the bank fell below 300crore
During September 2006, the Government of India (GOI) made some regulations on
UNITED WESTERN BANK wherein it imposed a moratorium on the Satara based United
Western Bank Limited (UNITED WESTERN BANK). During that period, UNITED
WESTERN BANK was one of the largest private sector commercial banks in India.
Moratorium means prohibition or stopping any activity from occurring or blocking a
transaction. The moratorium order was passed by Government of India (GOI), and this was
in response to an application that was made by the Reserve Bank of India (RBI). This
application stated that financial conditions of UNITED WESTERN BANK are very poor,
and this is due to the internal inefficient management. This moratorium duration was for
three months from 14.00 hours on September 02, 2006 till December 01, 2006 or an earlier
date, in case of any alternative arrangement. During the period of the moratorium, UNITED
WESTERN BANK was given certain specific permission to make some specific payments
as mentioned in the order and depositors were allowed to withdraw only up to Rs.10,000 in
total from their savings/current account or any other deposit account through any of the
branches of the bank. Before this there was a period where the bank has reached such high
level that it was awarded "A" class bank category
During the month of May 1998, Reserve Bank of India has imposed a penalty of Rs.1
million on penalized for Rs. 1 million UNITED WESTERN BANK. This penalty was
imposed for making irregular transactions with the Makharia Group of companies (MGC).
The Makharia family was provided the loan. The purpose of this loan was to purchase the
shares of UNITED WESTERN BANK shares (in its 1995 rights issue) through its flagship
company - Emtex Industries (India) Limited (Emtex). UNITED WESTERN BANK has
provided an overdraft facility of Rs 68.8 million to Emtex. Also, a letter of credit (LC) was
sanctioned to Makharia Group of companies (MGC). As per the views of Reserve Bank of
India, the credit facility or the overdraft facility given to Emtex was for the sole purpose of
enabling the Makharia group of companies to subscribe to the rights issue of the bank. Apart
from this Reserve Bank of India was of the view that the Letter of Credit facility was
provided with the intention of preventing MGC's loan account with UNITED WESTERN
Merger & Acquisition Page 12

BANK from becoming non-performing assets (NPAs). UNITED WESTERN BANK paid
the penalty on June 16, 1998.
Many researchers and analysts felt that INDUSTRIAL DEVELOPMENT BANK OF INDIA
will be benefited from the amalgamation. INDUSTRIAL DEVELOPMENT BANK OF
INDIA offered Rs.28 per share. This amount was 31% more than the closing price of the
bank that was 21.45. The total amount aggregated to Rs.1.5 billion
The amalgamation of these two banks changed the rules of issuing valuation of shares. The
main advantage to the bank is synergy, when two or more companies combine and do some
task, the combined output is greater than the sum of individual companies. The bank
expanded its retail presence even though the size may not increase substantially. The bank
after the merger has 230 additional branches. This helped the bank in widening its deposit
The bank diversified its credit profile. The bank got an entry into an agricultural sector as
more than half of the branches of UNITED WESTERN BANK were located in semi urban
areas and rural areas. The deposits expanded by 20%; the asset base increased by 10%. The
UNITED WESTERN BANK had ready infrastructure that provided the bank to mobilize to
low-cost platform. Bank got the benefit for mix of deposits. The bank transformed from the
financial institution into a commercial bank. The net interest margin was very low for the
bank as compared to three of the industry margin.
The acquisition was inexpensive. The cost was only 150crore. The price, to book multiple
ratios, was 1.9 times. This was a little bit higher. It was due to the goodwill of UNITED
WESTERN BANK bank. The excess was the premium for the goodwill
But there were certain hidden costs regarding the merger. UNITED WESTERN BANK had
many bad loans in its basket that affected the quality of existing assets. The cost of
maintaining the same rose to 100crores. This was the additional cost that INDUSTRIAL
DEVELOPMENT BANK OF INDIA had to incur. UNITED WESTERN BANK had 3200
employees; this represents around 70% of INDUSTRIAL DEVELOPMENT BANK OF
INDIA’s staff. The amalgamation scheme contained a point that INDUSTRIAL
DEVELOPMENT BANK OF INDIA has to absorb all the workforce of UNITED
WESTERN BANK bank. This made the cost of wages and salaries to increase
Merger & Acquisition Page 13

Announcements
The bank entered into joint venture business for life insurance business International N. V.
(Fortis), and Federal Bank Ltd. There was a rise in 229 branches, 14 counters, 78 Automated
Teller Machines, etc. This bought the presence of the bank in the state of Maharashtra. The
bank has 970 delivery outlets i.e. 432 branches, 18 extension counters and 520 Automated
Teller Machines
The economy witnessed a growth of 9.2% during the year in GDP. The bank increased its
Gross Domestic Investment by 25.2%
During the month of May 1998, Reserve Bank of India has imposed a penalty of Rs.1
million on penalized for Rs. 1 million UNITED WESTERN BANK. This penalty was
imposed for making irregular transactions with the Makharia Group of companies (MGC).
The Makharia family was provided the loan. The purpose of this loan was to purchase the
shares of UNITED WESTERN BANK shares (in its 1995 rights issue) through its flagship
company - Emtex Industries (India) Limited (Emtex). UNITED WESTERN BANK has
provided an overdraft facility of Rs 68.8 million to Emtex. Also, a letter of credit (LC) was
sanctioned to Makharia Group of companies (MGC). As per the views of Reserve Bank of
India, the credit facility or the overdraft facility given to Emtex was for the sole purpose of
enabling the Makharia group of companies to subscribe to the rights issue of the bank. Apart
from this Reserve Bank of India was of the view that the Letter of Credit facility was
provided with the intention of preventing MGC's loan account with UNITED WESTERN
BANK from becoming non-performing assets (NPAs). UNITED WESTERN BANK paid
the penalty on June 16, 1998.
The theory of inefficient management led to the downfall of UNITED WESTERN BANK.
Such transaction mentioned above continued to occur. Thus Reserve bank of India had to
announce the merger of UNITED WESTERN BANK with INDUSTRIAL
DEVELOPMENT BANK OF INDIA. Such merger took place during October 2006
Merger & Acquisition Page 14

Conclusion
There are positive and negative aspects of everything in the world. Merger has so many
benefits as we discussed above. Some are forced mergers especially announced by the
Government of the country, and the other is voluntary mergers. In order to save a company
from usually falling the Government of India interferes. The reason behind is the fear of
downfall of the economy. As we have heard the effect of Lehman Brothers Bank on the
economy of United States of America, it is a highly developed country. But in case if UWB
was closed down, it might have resulted to a great loss to the Indian economy. This loss
might have a depressive impact and might lead the country to face a recession. So in order to
save the economy, the Reserve Bank of India came into the picture and announced the
merger with IDBI. The bank diversified its credit profile. The bank got an entry into the
agricultural sector as more than half of the branches of UNITED WESTERN BANK were
located in semi urban areas and rural areas. The deposits expanded by 20%; the asset base
increased by 10%
Merger & Acquisition Page 15

References
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http://www.investopedia.com/terms/s/solvencyratio.asp
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available at http://www.accountingtools.com/sales-to-working-capital-ratio
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Financial memos, 2014 “Gearing Ratio Formula, calculation and analysis with examples”,
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January 2015 available
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2015 available at<http://papers.ssrn.com/sol3/papers.cfm?abstract_id=739664>
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http://www.investopedia.com/terms/w/workingcapitalturnover.asp
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http://www.economicshelp.org/microessays/competition/benefits-mergers/
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Radhika Kamath, 2006, “IDBI-United Western Bank merger
Advantage, branch and rural roots”, viewed on 17 January 2015 available at
http://www.thehindubusinessline.com/todays-paper/tp-investmentworld/idbiunited-western-
bank-mergeradvantage-branch-and-rural-roots/article1760520.ece
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