PSBs eye M&A market but face talent, pay and regulatory hurdles ahead

The RBI has opened the M&A financing market to PSBs, but banks now face challenges around compensation structures, governance oversight, specialist hiring and regulatory constraints

In October, the Reserve Bank of India finally opened up the lucrative mergers-and-acquisitions market to public sector banks (PSBs), fulfilling a long-standing demand from state-owned banks. While PSBs have welcomed the move, they could run into some contentious issues before entering the M&A market.

 

What talent and compensation gaps could PSBs face?

 

For starters, PSBs will need to take a closer look at their talent and compensation structures, and possibly even governance Boards, once operational guidelines are issued. For example, bonuses in the merchant banking divisions can sometimes run into crores. While this is still much lower than global standards, it will force banks to rethink who they pick to lead and drive this vertical. More critically, they will have to carefully decide on Board-level hiring given the oversight needed for the M&A division.

 

A key challenge will be where to host such a division: given salary caps at public sector banks, the question of where to house such a high-compensation division — within the bank or in a subsidiary — will certainly be a weighty one. As it is, differential salary structures have already drawn the attention of oversight committees.

 

The PJ Nayak Committee Report to Review Governance of Boards of Banks in India (2014) had noted, with regard to major compensation differentials at senior levels at state-run banks, that “It is unsustainable for such differentials to continue without a major adverse impact on the recruitment and retention of talented managers”.

 

Rohan Lakhaiyar, partner (financial services–risk) at Grant Thornton Bharat, is categorical that state-run banks will face a much bigger remuneration shock because their pay structure is the most rigid, and the new business requires talent that is paid like investment bankers rather than credit officers.

 

“It may be that in the short-term (first couple of years), these banks may constitute specialised teams from inside their corporate banking divisions and rely on structured and project finance officers, supplementing the talent bandwidth with selective lateral hiring within existing senior bands, without major compensation overhaul,” he says.

 

But to remain relevant and compete meaningfully with private players, in the medium- to long-term, the government (Department of Financial Services) “may need to approve a separate career band for M&A finance for state-run banks (in particular) to attract and retain the specialised talent needed for executing such transactions,” says Lakhaiyar.

 

“Today, law firms are being seen as one of the big paymasters for those with this kind of expertise. Banks could possibly get around this difficulty by hiring suitable persons as consultants, but this will create significant dissonance within the organisation given the steep variance in payouts,” says Raghu Palat, managing director, Cortlandt Rand Consultancy.

 

“If need be, we can evaluate the scope for collaboration to augment the capacity for M&A advisory. It is potentially a good business to be in,” says Debadatta Chand, managing director and chief executive officer (CEO), Bank of Baroda (of which BoB Capital is a subsidiary). He points to past examples of such tie-ups: in the 90s, there were a number of Indian entities, albeit in the private sector, that had tied up with major foreign i-banking specialist firms. Among these were I-Sec–JP Morgan (I-Sec is a subsidiary of ICICI Bank), Kotak Mahindra Capital–Goldman Sachs (before Kotak Mahindra became a bank), DSP–Merrill Lynch, and JM Financial–Morgan Stanley.

 

What regulatory obstacles do PSBs face?

 

Even if banks were to sort out their staffing requirements and models, they would still have to overcome a bigger problem: regulatory changes to key Acts, notably the Companies Act (2013) and the Banking Regulation Act, 1949 (BR Act, 1949), that would be essential to facilitate PSBs’ entry into the M&A sector.

 

Section 67 of the Companies Act, for example, restricts public companies from providing financial assistance for the acquisition of their shares or shares of its holding company.

 

“This means a private limited target company could be deemed as a public company as directions stipulate that the acquirer has to be a listed entity, thus bringing any financial assistance by the target under strict regulatory scrutiny,” says Divyanshu Pandey of CB Pandey & Associates.

 

In a typical acquisition financing, the assets of the target company are used as collateral. According to experts, this makes it crucial for the Ministry of Corporate Affairs to introduce safeguards — such as solvency tests, corporate benefit assessments and shareholder approvals — to protect creditors and shareholders of the target company instead of a blanket restriction.

 

Then there’s Section 19 of the BR Act, 1949, which limits banks from holding more than 30 per cent of a company’s shares as a pledgee or owner. This directly conflicts with the RBI draft on M&A financing by PSBs that propose shares of the target company as primary security.

 

“Separately, while the proposed changes to external commercial borrowings norms will expand funding options for M&A activity, it will also intensify competition for domestic banks in this market,” adds Pandey.

 

Governance and advisory skills could affect PSBs’ M&A ambitions

 

All of these call for the hiring of personnel of a certain pedigree: those who understand regulations, the changes needed and their impact on emerging business models.

 

“In the initial phase, you may not necessarily need advisory talent because you will basically be funding. But as you move up the value chain and get to the knowledge part, then you will need specialists,” says Samir Ojha, partner (investment banking advisory), EY India. “I look at the funding as the interest-income part and the advisory as the fee side.”

 

“The point is we are just getting started on this journey. While issues regarding talent and Board oversight remain, it is not that all banks will enter this area,” says Mandeep Moitra, chief executive officer (CEO), M-Suite Leadership Consulting LLP, and former head of HR at HDFC Bank.

 

In fact, Board oversight and governance will also be a key factor in the restructuring that will likely follow a bank’s entry into the M&A game. As Reserve Bank of India Deputy Governor Swaminathan J noted earlier this month, most organisations often respond to governance questions by redrawing organisation charts, tweaking reporting lines and updating committee charters. While such fixes do help, they work only up to a point.

 

“Business models, technology, and vendor chains change faster than boxes on a slide. As firms expand, digitise, outsource and integrate, two patterns keep showing up: overlaps — two teams or two regulators asking for the same thing; and gaps — a new product, partner or dataset sitting outside or at the perimeter of any policy,” he said.

 

According to Sampath Kumar, partner (governance and compliance) at Trilegal, the new business line of acquisition financing should fall within the larger domain of banking and financial markets, many of which banks are already exposed to and are experienced with related risk management.

 

However, exposure to the capital markets has its own inbuilt risks. “Boards need to ensure that the policy framework, related credit and risk assessments, monitoring and reporting mechanisms are in place specifically designed for such capital market exposures to ensure governance and compliances,” he says.

 

Banks that are planning to enter the M&A sector might therefore have to undertake a risk governance review specifically for the business, part of which could be upskilling Board directors on business and risk exposures, and inducting individuals with specialised knowledge and domain experience who can advise or provide insights crucial for Board-level deliberations.

 

Will PSBs struggle to attract M&A talent?

 

As for navigation-talent on bank boards, Moitra rules out any problems. “I don’t think bigger state-run banks will have problems attracting those with M&A expertise despite the lower payout. The attraction of being on the Board of a major bank is in itself a factor also,” he says.

 

However, Ankit Bansal, founder and CEO at Sapphire Human Capital, feels this is not very material in the first place. “As for independent directors on bank boards who understand the subject, I feel there is no concern on this front. Boards have people who are aware of M&As and related issues.”

 

That said, what he does see unfolding is that given the investment banking talent pool is limited, “it will drive up demand leading to talent wars among the banks”.