Even as mergers in the private banking space has caught the fancy of the market, the Banking Regulation Act, restricts private sector banks from holding more than 4.9 percent in another bank.

In a discussion on consolidation in banking sector with CNBC-TV18, industry expert AK Purwar said consolidation is key for the industry. "Banks at the helm must flex their muscles and they must acquire their poorer cousins who are not so well managed," Purwar said. Such mergers result in better management of smaller banks, he said.

Ashvin Parekh of Ashvin Parekh Advisory Services agrees with Purwar. He suggests banks to look at friendly acquisitions.

Other acquisition targets could be banks that have significant stress with limited additional capitalisation or an inability to raise capital.

Purwar believes in feasibility of such friendly mergers and says market forces play an important role in deciding the valuation of a bank. At a right price, investment for mergers and acquisitions (M&As) is possible.

Parekh points out it is always favourable if a bank agrees for consolidation before RBI takes things in its hands.

Below is the verbatim transcript of AK Purwar and Ashvin Parekh’s interview to Latha Venkatesh and Anuj Singhal on CNBC-TV18.

Latha: Private sector bank consolidation, in fact one of the names mentioned yesterday, purely rumour, we are not confirming anything or even hinting at anything that the Piramal Group will take over Federal, these names keep coming up, there is no sanctity about the names, is that easy?

Purwar: No, it is not easy at all. Private sector banks, the Reserve Bank of India (RBI) regulations, the way in which these are in place and you very rightly pointed out, private sector player can purchase only a limited amount, less than 5 percent. If they purchase 5 percent, what kind of effective control they will be able to exercise on the bank is an obvious question mark. Having said that, consolidation in private sector, particularly some of the private sector banks which are very efficiently managed, very well managed, they have the cash, they have the management bandwidth.

They must flex their muscles and they must acquire some of their poor cousins so to say in private sector who are not so well managed. It will lead to some sort of consolidation, growing of size, it will lead to the poor banks, the smaller banks which have been acquired getting better managed and also the branch network, all kinds of those advantages.

Latha: Can you just walk us through the legal process. Let us assume say Federal wants to take over Lakshmi Vilas, just any names, I am not giving anything in terms of what the market is talking, what is the process? Should it be an open offer because there is no identifiable big promoter in most of these small banks?

Parekh: The question of an open offer in case of listed entity is certainly governed by the Sebi regulations. However, I would say, let us look at the subject and I segment the private sector banking, particularly now we are not talking of old private sector any longer because the so called consolidation question, or the play seems to be coming up open in both these categories of private sector banks. However, I would say a friendly acquisition, that is certainly possible, that is a route which is very open. All these entities come under Indian companies act, so, if three fourth of the shareholders agree to let us say a proposed merger, then the merger can be executed, can be completed and then the RBIs approval of course. RBI will certainly look at the public interest and the interest of the deposit holders and they will look at the scheme of such a merger and thereafter approve.

Within the old private sector, so called old private sector banks, you will realise that there have been some banks who been able to draw good seniors, good managing directors, CEO managing directors, these people have been ex-foreign bankers, they have really been able to lead their banks very well. So, taking from what AK Purwar said, these banks can certainly target and look at acquiring some of the smaller ones.

The second category would be those where let us say the banks are troubled or there hasn’t been any additional capitalisation, these banks are not in a position to grow because they do not have that kind of an ability to raise more capital or they have just been keeping the shareholding because some shareholders want control on those banks; that is the second category. Now, there, there are two parts. One is if they come and voluntarily agree to merge then of course that is the best situation. Failing which, if the regulator believes, and that brings me to the next point and we had seen a lot of this about a decade ago, you had these moratoriums or RBI led or the regulator and government led mergers.

These are not seen very often these days but RBI still has the powers. Both the banking regulation act and the RBI gave the regulator that empowerment if they find that there is a troubled bank either on account of let us say issues with the shareholders or with the directors or if they find that there is a genuine reason in the public interest, that that banks should be merged with any other bank, then the regulator could certainly do that.

Anuj: Just to carry forward the first point that Ashvin Parekh made, because a lot of these banks don’t have identifiable promoters but they have institutions who hold stake. Is friendly merger possible, that is something that we have seen in the past as well?

Purwar: Definitely, friendly merger is possible. Look at it this way that market forces are quite important these days and if a bank is a poorly managed bank, naturally it will reflect on its price, it reflects on the market capitalisation, it reflects on the management and those key promoters there, key situational promoters and key private promoters there would be interested in sort of sometimes if they get at a reasonably attractive price, they will be interested in selling it off and getting it up and in the process if they hold shares in the merged entity, but they might create much better value than what kind of valuation they are commanding today. So, these kind of friendly mergers should be market driven, number one, and are very much possible in the present framework, present legal regulatory framework.

Latha: How do you the negotiation forward in this case, it looks like only in DCB’s case there is a seen person, in the others there is really no identifiable promoter.

Parekh: That is very interesting. The whole definition of a promoter in case of some of these old private sector banks does demand a certain amount of attention. In some of the cases, you do have not one shareholder who has got anything more than 2 percent, they work together. What they normally do is, if let us say seven or eight of them come together, collectively and they have anything that would make a special resolution difficult let us say, then to that extent, they can sort of stop any kind of let us say discussion around this and we have seen this in the past.

We have seen that there are some in the list that you just mentioned where collectively the shareholders, the promoters, work together and then they make it difficult for any kind of an effort on the part of the other shareholders. So, that we have seen in the past. Definition of a promoter and declaring someone who is not more than a given benchmark percentage holder, is very critical over here but then of course as long as they continue, as long as they function, as long as the RBI does not see them as troubled banks requiring any intervention, then of course they continue their existence.