Looking At Competition Law To Manage The Mergers Of Banks Finance Essay - Free Essay Example

Sample details Pages: 8 Words: 2525 Downloads: 4 Date added: 2017/06/26 Category Finance Essay Type Narrative essay Did you like this example? Introduction The tussle between Reserve Bank of India and the Competition Commission of India is long drawn. At different occasions, RBI has sought to exclude the jurisdiction of CCI from mergers and acquisitions (MAs) of banks. In a report to the Ministry of Finance, RBI stated that bank MAs should be excluded from application of the Competition Act, 2002, following their unique nature, and expedient circumstances, especially in cases of forced mergers. Don’t waste time! Our writers will create an original "Looking At Competition Law To Manage The Mergers Of Banks Finance Essay" essay for you Create order The main argument of RBI had been that CCI is a general body regulating competition across markets and sectors, and thus, may not have the requisite technical expertise to adjudge in bank MAs. Any decision made for or on behalf of a bank may have a direct impact on the depositors and on the economy as a whole. A merger is a combination of two or more corporate entities, wherein one or more such corporate entities lose their corporate existence as they merge with the surviving entity. Competition law primarily focuses on horizontal mergers; as such cases have high potential of adversely affecting completion in the market. In exceptional circumstances, vertical mergers are also enquired into; where a dominant entity merges with another entity from another related market to further strengthen its dominant position. RBI has suggested that in cases of both, horizontal and vertical mergers, the final determination in sectoral regulators in banking, and insurance, for cases of MAs sho uld rest with RBI, as it is best equipped to understand the issues involved. Further, bank MAs were also excluded under the erstwhile Monopoly and Restrictive Trade Practices Act (MRTPC) which was replaced by the Competition Act, 2002. This has led to emergence of a debate between CCI and RBI, which shall be resolved at the earliest. Hypothesis: The author believes that such a proposition would defeat the entire purpose of the Competition Act, 2002. Authority of both, RBI and CCI shall be harmoniously read and RBI should not have the sole authority to determine bank MAs. This paper aims to answer the following research questions: Why shall bank MA shall be treated differentially in comparison with other corporate MAs? What is the need of performing competition analysis in cases of bank MAs? Is there a conflict between the regulatory authority afforded to the RBI and the CCI? Can these authorities harmoniously perform their functions? Reasons for differential treatment of banking sector There are various reasons for affording a differential level of protection and regulation to bank MAs, when compared to regular corporate MAs. Failure of an individual bank may not in itself be principally different from a corporate breakdown. However, its high potential of precipitating into a general systemic failure is one of the main reasons for treating banks differently. There is a heavy inter-linkage between several banks. Inter-bank lending and the payment systems have grown considerably in the past few years. Banks lend and borrow amongst them, in large amounts to moderate daily liquidity fluctuations. Also, large value payments are made by banks as a result of their own and their clients activities. Thus, in both these ways, banks are heavily linked to each other. The risk of such physical exposure is further amplified by the information asymmetries about financial position of one bank with another. In such a case, failure of one bank may precipitate to other banks, gener ating a systemic risk of interbank contagion. Another reason for providing a differential treatment is the asset-liability mismatch of banks. Most of the assets of the banks are in the form of loans, which are not liquid, as they are subject to contracts and have limited resale value. Further, the liabilities of a bank are in form of deposits by people, which is liquid and easily demandable as the depositors can withdraw their deposits on demand. This is further complemented by a maturity mismatch between assets and liabilities. This exposes the bank to a possibility of runs. The only safeguard available is for the banks to have deposit insurance. Also, the functional aspect of banking sector points towards its uniqueness. It is not easy for users to distinguish banks on the basis of quality of financial services they provide. As a result, there exists a problem of free-rider. Banks with a higher risk profile will free ride on the reputation and trust enjoyed by the banking in dustry as a whole. In addition, this indistinguishability of banks may result in a domino effect, where failure of one bank may beguile consumers to withdraw their deposits from other banks. In such a situation, liquidation of deposits would lead to a general run on bank reserves. This self-fulfilling nature of bank business and their operations, which are based on trust and confidence, strengthens the rationale of RBI for affording banks with special protection by regulators. Need For Competition Analysis In Bank MAs There are primarily two anti-competitive effects of a merger. First, unilateral effects, which arise as the merged entity may enjoy considerably higher single firm market power than its components, prior to the merger. Second, co-ordinated effects, which occur when a merger enhances the capability of an entity to engage in anti-competitive behaviour. The risks of co-ordinated effects are especially significant in oligopolistic markets, such as the banking sector. Performing a competition analysis over the effects of a bank merger is not significantly different from the analysis performed for other sectors. Factors, such as creation and facilitation of dominant position remain the same. Dominant position is defined as position of strength , enjoyed by an entity, which enables it to: (i) operate independently of competitive forces prevailing in the relevant market; or (ii) affect its competitors or consumers or the relevant market in its favour A merger may have anti-comp etitive repercussions, by making it lucrative for a leading bank to exercise market power unilaterally, or by escalating the likelihood of collusive practices by the merged entity in the market. This analysis is further complicated in the banking sector by virtue of the fact that the relevant geographic market varies with the characteristics of the buyer of bank services. For example, proximity may be a criterion for small businesses, or introduction of internet banking resulting in enlarging the relevant market for depositors. Besides, high switching costs between banks reduces the significance of competition on the supply side and may be a very important element in the assessment of market power. In the banking sector, agreements among competitors are often necessary for the existence of efficient payment systems, unlike other sectors where no such agreements are made. For example, to maintain the interoperability of automated teller machines (ATMs) across various banks, banks have to enter into a cost sharing agreement. Banks also have to agree upon sharing of costs between acquirers and issuers, in cases of debit and credit card associations. Such agreements may per se seem to be anti-competitive. Moreover, provisions like the honour all cards or the no discrimination rules are prevalent in card markets, which have been categorized as anti-competitive by several anti-trust authorities globally. Application of competition law in the banking sector improvises the access to finance for investment at lower interest rates and lenient guarantee requirements, as banks become more customer friendly. In some states, larger banks might tend to allocate lower amount of assets towards lending in general, and towards loans to small business in particular. Thus, when large bank is formed by merging two banks, resultant decrease in funding to small businesses may be argued as being anti-competitive. Such deduction, however, cannot be sustained as any apparent re duction in loans to small business by the new bank can be easily waged by an increase in such lending by the other non merging banks. Existence of high switching costs, may tie the clients and businesses to a particular bank. Switching costs are costs that the customer has to incur while changing the service provider. There costs can be further divided into two categories: fixed transactional costs and informational switching costs. For example, cost incurred by a customer in searching for another bank, opportunity cost of time and money spent, cost of transferring of funds and closure of previous account would all count as transactional switching costs. Many of these costs are dependent upon the behaviour and policies of the banks, e.g. offering low deposit rates to attract customers. Also, charging customers for closure of bank account (closing charges) may also influence their decision. Such practices are to be evaluated in light of the competition law policies. Further, su ch fixed transactional costs are complemented by information switching costs. Most clear example is the loan market, where in the borrowers have to consider informational switching costs when considering a switch, as the current financier is better informed about the borrowers credit worthiness. Such switching costs may be exploited by rent seeking behaviour of banks. Markets with high switching costs might taken as a whole be less competitive, as presence of such costs would tend to soften competition. It could also deter new entrants in the market. Thus, it is very important to frequently analyse the practices of banks under competition laws, as there is ample scope of unfair and abusive trade practices. Mandate And Authority Of RBI And CCI Bank MAs are not new to the Indian banking sector. Seventy seven bank amalgamations have taken place in India since 1961, when the Banking Regulation Act, 1949 was introduced. Around fourty-six amalgamations took place before bank nationalisation in 1969, and the remaining thirty-one post nationalisation. There have been around six cases of mergers among private sector banks exclusively. Prior to 1999, the major driving force behind amalgamations was the weak financial position of the bank being merged. In the post 1999 period, mergers between healthy banks have taken place, primarily driven by commercial and business considerations. Report of the Committee on Banking Sector Reforms (the Second Narasimham Committee Report, 1998) argued for, inter alia encouraging mergers among big banks, both in the public and private sectors and even with other financial institutions including Non-Banking Financial Corporations (NBFCs). Section 44.A of the Banking Regulation Act, 1949 lays down the procedure for voluntary amalgamation of banking companies. Resolutions, approved by two-third majority of each bank, in a general meeting, is submitted to RBI for it approval. Once approved, the scheme contained in the resolution becomes legally binding on the banking companies and their shareholders. RBI issued guidelines in May 2005, on the basis of the recommendations of the Working Group, for voluntary merger between banking companies. It laid down several requirements for performing such a merger, including inter alia, disclosures, determination of the swap ratio, the stages at which Boards will get involved in the merger process, etc. Although, mergers are generally determined on business considerations (such as the market share, synergies, acquisition of a business unit or segment, etc.), the policy objective of the RBI is to ensure that considerations akin to sound rationale for merger, the systemic benefits and the advantage accruing to the residual entity, etc. are appraised in detail. Financial health of both the amalgamating entities is kept under consideration by RBI, while sanctioning the scheme of amalgamation. This is done to ensure, inter alia, that after the amalgamation, the new entity will emerge as a stronger bank. General terms used in competition law, such as cartel, dominance, or agreements for abuse of dominance, etc. are not found in the Banking Regulations. This indicates that RBI is ill-equipped to deal with competition law issues using the Banking regulations. Thus, allowing RBI to check abuse of dominance and cartelisation is not a very lucrative option. RBI, however, has urged the Ministry of Finance that it shall exercise the sole jurisdiction over bank MAs and also, such instances shall be excluded from the purview of the Competition Authorities, as the RBI has the special knowledge and expertise required to regulate the banking sector. The RBI Guidelines specify prudential regulations with respect to bank mergers . Prudential regulations aim to safeguard the safety and soundness of individual financial institutions, with the intention of protecting the clients. These guidelines do not look into the areas dealt by CCI. The CCI simply checks whether a combination will likely result in dominance or facilitate cartelisation. It does not check the effect of the prudential regulations, over which it neither has the mandate nor the competence. Conversely, RBI, only checks the financial soundness of banks after mergers, and safety of public money at the hands of the new entity. It does not further assess the creation of a dominant position, or likely cartelisation, which is performed by CCI. A distinction is to be drawn between prudential regulation of banks by RBI and competition regulation of the whole economy, including the financial sector, by CCI. Prudential regulations are largely focused on laying and enforcing rules which limit risk-taking of banks, ensuring stability in financial sector and safety of depositors funds. Thus, regulation of MAs by the RBI would be determined by such benchmarks. However, competition regulation of MAs, in the banking sector, is a separate matter. It is aimed at ensuring competition between the banks, so that they serve customers by offering the best terms, lower interest rates on loans and higher interest rates on deposits and securities. MA regulations by CCI are therefore deliberated to ensure that such activities are not motivated by the desire to conspire and make disproportionate profits at the cost of customers or to squeeze other players out of the market through unfair trade practices. While CCI does not have either the expertise or the remit on prudential regulation, RBI does not have the expertise or remit to regulate anticompetitive behaviour. The prudential regulations and the competition regulations are mutually compatible to the extent that they both seek to prohibit unwarranted behaviour. As long as the authorities wor k towards checking undesired mergers, rather than forcing or mandating mergers, financial institutions, including banks will not face difficulty in abiding by both the RBI and CCI. With respect to certain mergers, prudential regulation and competition policy can be complementary. For example, a merger leading to a too big to fail bank, i.e. a bank which is so large that clients assume that the government would take necessary steps in order to preserve the solvency of the bank in a crisis. Such banks might be inclined to take, what regulators regard as excessive risks. Also, such banks may give rise to competitive distortions, as they may have a synthetic advantage in raising money, especially in markets where deposit insurance is derisory. Further, probability of a potential conflict between prudential and competition policy is low. For example, in cases of mergers designed to safeguard a failing bank. Such a merger would be promoted by prudential regulations, but may lead to competition problems. Such problems, however, may be avoided by choosing the right entity to merge with, or by structuring the merger to minimise its effects on competition in the market. Prior consultation between the parties and competent authorities may solve most of the conflicts. Conclusion