Effect of Bank Mergers on Cost of Capital: Evidence from India

Abstract

This chapter examines the effect of the recent bank merger in India on the cost of raising debt and equity for the sample of merger-affected firms. Our multiple linear regression model with industry fixed effects suggests that the bank mergers in India are related to a higher overall cost of capital for the borrowers of merger banks. The higher cost of capital is driven by the higher cost of equity for the firms. This finding contrasts with the results in the developed economies where bank mergers essentially affect the interest rates of loans. The merger is associated with a higher cost of equity for the borrowers, and this can be attributed to the shareholder’s perceived increase in the risk of these firms. Our results are also robust to using panel data models with firm fixed effects. The firms in emerging market economies like India predominantly rely on bank loans as the source of capital, and bank mergers can be associated with loan portfolio rationalization in the post-merger period that can adversely affect the credit availability of the borrowers. The empirical evidence indicates that bank mergers do not affect the capital structure of the firms post-merger, indicating the absence of substitution of equity for debt following the merger. We find that bank mergers can have a negative spillover effect on the cost of equity capital for the borrowers in the short run. The findings suggest that the welfare effect of bank mergers in emerging markets with less than fully developed financial markets can be more complicated and alter investor’s expectations.