Effects of bank mergers and acquisitions on comercial banks evidence from malaysia and lessons for vietnam,graduation thesis

BANKING ACADEMY Foreign Language Faculty GRADUATION THESIS EFFECTS OF BANK MERGERS AND ACQUISITIONS ON COMMERCIAL BANKS: EVIDENCE FROM MALAYSIA AND LESSONS FOR VIETNAM Student name :

BANKING ACADEMY Foreign Language Faculty

GRADUATION THESIS

EFFECTS OF BANK MERGERS AND ACQUISITIONS ON COMMERCIAL BANKS: EVIDENCE FROM MALAYSIA AND

LESSONS FOR VIETNAM

Student name : Dao Ngoc Minh

Class : ATCA-K11

Lecturers : PhD Do Thi Kim Hao

MA Bui Le Minh

June, 6th 2012

ACKNOWLEDGEMENTS

All my praises and gratitude to my supervisors, the Dean of Faculty of Banking, PhD

Do Thi Kim Hao from Banking Academy and MA Bui Le Minh from Hanoi University This study would not have been possible without their constructive comments, suggestion, kindness and encouragements

I also would like to express my appreciation to my lecturers from Faculty of Foreign Languages of Banking Academy for their guidance and support throughout the completion of this research

In addition, my deepest thanks to my parents and my friends for their continuous source

of inspiration and encouragement Thanks for giving a great support throughout the duration of my studies and unceasing prayers for my success

Thankyou

ABSTRACT

Merger and acquisition (M&A) in banks will be boosted in the next five years as part of efforts to overhaul the entire banking system and speed up the formation of one to two regional class commercial banks in Vietnam In order to give the reader a brief view of the necessity of banking consolidation, I have studied the experiences and organizational structure of other countries which have strong and efficient banking systems, particularly of neighboring countries in the ASEAN region To some extent, Malaysia’s banking system has been at the forefront in ASEAN This study investigates the extent of merger and acquisition activity affect Malaysian banks’ performance after the consolidation of banking sector in year 2000 which was expedited by the Asian Financial crisis By utilizing secondary data collected from several previous researches

as well as the financial ratio analysis, it can be concluded that the merger program in Malaysia was relatively successful So as a matter of fact, the thesis seeks to build up a safe and efficient banking system in Vietnam by learning from Malaysia’s model and experience

TABLE OF CONTENTS

ACKOWLEDGEMENTS i

ABSTRACT ii

TABLE OF CONTENTS iii

LIST OF TABLES & FIGURES v

LIST OF ABBREVIATIONS vi

CHAPTER 1: INTRODUCTION 1

1.1 Current Problem Statement 1

1.2 Objective and research questions 2

1.2.1 Objective 2

1.2.2 Research questions 3

1.3 Scope and limitations 3

1.4 Research methodology 3

CHAPTER 2: THEORETICAL FRAMEWORK 5

2.1 Mergers and Acquisitions definition 5

2.2 Factors contributing to the occurrence of Mergers and Acquisitions 6

2.3 Effects of Mergers and Acquisitions on commercial banks 6

2.3.1 Advantages 7

2.3.2 Disdvantages 8

2.4 Summary of theoretical framework 11

CHAPTER 3: EFFECTS OF BANK MERGERS AND ACQUISITIONS ON MALAYSIAN BANKING SYSTEM 13

3.1 Overview of Malaysian banking system 13

3.1.1 Financial Crisis in Malaysia 1997-1998 13

3.1.2 Mergers and Acquisitions in Malaysia 15

3.2 Effects of bank Mergers and Acquisitions on Malaysian banking system 16

3.2.1 Profitability ratio 17

3.2.2 Cost efficiency ratio 18

3.2.3 Liquidity ratio 20

3.2.4 Share performance ratio 22

3.2.5 Leverage ratio 24

3.3 Summary 26

3.4 Reasons for the success of merger program in Malaysian banking system 27

CHAPTER 4: CONCLUSION & LESSONS FOR VIETNAMESE BANKING SYSTEM 31

4.1 Overview of Vietnamese banking system 31

4.2 Conclusion and lessons for Vietnamese banking system … 36

REFERRENCE vii

APPENDIX ix

LIST OF TABLES & FIGURES

List of tables

List of figures

LIST OF ABBREVIATIONS

M&A Merger and Acquisition

CHAPTER 1

INTRODUCTION

1.1 Current problem statement

The global economic crisis during the period of 2008 and 2009 left negative impacts on many different economies and Vietnam is not an exception Although the country still keeps its medium economic growth, there are several difficulties and challenges it has

to cope with One of those is the consolidation of banking sector Banks as financial intermediaries play a significant role in economic growth, provide funds for investments, and keep the cost of capital low The failure of a bank will not only bring financial difficulties to its depositors and owners, but will certainly be harmful to

public confidence in the banking system

During the last few decades, structure of banking sector has turned from a controlled system into liberalized one The efficiency of banks, which reflects the ability of banks

in transforming its resources to output by making its best allocation, is essential for the growth of an economy The competition among banks at domestic and global level has increased and it has compelled the banking industry to improve their efficiency and productivity Moreover, the government and policy makers have considered carefully various policies and measures out of which consolidation of banks emerged as one of the most preferable strategy There are diverse ways to consolidate the banking industry and the most commonly adopted by local Vietnamese banks is mergers and acquisitions (M&A) However, skepticism also arises due to the suspicion on post- merger performance and the risk of too big too fails Size may itself become a

constraint, and dis-economies of scale may set in Lower competition may also lead to

a relatively more relaxed management, thereby leading to productivity losses Therefore, another issue related to M&A is the concern on whether the merger of bank has strengthened the financial condition and effectiveness management to increase bank’s efficiency

Meanwhile, Malaysia’s banking system is at the forefront in the ASEAN region and also plays the leading role in the regional banking industry Majority consolidation activity in Malaysian banking industry was executed in mid of year 2000 when it was proposed and imposed by the Bank Negara Malaysia (BNM) Troubles in the banking system are specific to a country and so are the solutions However, the learning experience and systemic structure of a well-managed, safe and efficient banking system such as that of Malaysia will assist banking merger in Vietnam by giving some valuable lessons to be learned

1.2 Objective and research question

1.2.1 Objective

The main objectives of this study is to measure the state of efficiency of Malaysian banks pre- and post merger and to investigate whether the M&A activity in the past time has enabled banks to take advantage of economies of scale and enjoy greater financial performance and improve bank’s efficiency By the lessons to be learned from Malaysian commercial banks, the thesis hopefully can give some recommendations to Vietnamese government during the restructuring of banking industry

1.2.2 Research questions

The thesis should be able to answer three of the following questions:

acquisitions between local banks?

1.3 Scope and limitations

The research solely focuses on identifying whether merger program in Malaysian banking system was successful or not through the collected data of financial ratio pre- and post-merger of nine Malaysian commercial banks Also, the study points out the reasons for the success of merger program in Malaysia by reviewing the past era researches related to the topic so that it could hopefully give some highlights that SBV should pay attention to when implementing M&A in Vietnam However, the research does not give a comparison of the performance between the two banking systems, since there are some differences between the two (Vietnam and Malaysia) e.g economic and political conditions, development history, and legal framework

1.4 Research methodology

The study uses the secondary data collected from several previous researches and from the respective banks’ annual reports and DataStream for the selected periods Then comparison and analysis of ratios are used to compare the performance of Malaysian local banks during the pre-merger period (1999-2001) and post-merger period (2002-

2010) Majority consolidation activity in Malaysian banking industry was executed in mid of year 2000 when it was proposed and imposed by the Bank Negara Malaysia (BNM) Therefore, the performance from 1999 to 2001 will be treated as pre- merger performance in order to compare with post-merger performance Year 1998 was not included in the selection period in assessing the pre-merger performance due to the Asian Financial Crisis in 1997 Thus, the period 2002 to 2010 was chosen as the post-merger period to measure the overall performance for merged banks and to identify whether the merger activity worked out in increasing the merged banks’ efficiency and profitability Moreover, financial statement analysis was chosen since accounting measurement is easy to understand and generally accepted in reflecting the financial performance of banks By comparing the financial ratio, the thesis will be not only reporting how does a bank perform, it also deliver supplementary information such as which bank has better performance than others

The list of banks selected for this study are as follows: Affin Bank, Alliance Bank, AmBank , CIMB Bank, EON Bank , Hong Leong Bank, Maybank, Public Bank RHB Bank After the Southern bank was acquired by CIMB bank on March 2006, there were only nine local banks in Malaysia banking industry The independent variables that need to collected including the pre-tax income, total asset, total equity, total expenses, total revenue, dividend expenses, earning per share, total loan, total deposit, common equity, and non- interest expenses

CHAPTER 2

THEORETICAL FRAMEWORK

2.1 Mergers and Acquisitions definition

According to Oxford Dictionary the expression, “Merger means combining two

commercial companies into one.” A merger takes place when two or more banks disappear in order to give their place to a new bank or when a bank or a company more generally, buys out another one – or more than one – and absorbs it into one unified operational structure, usually maintaining the original corporate identity of the buying out bank It is, therefore, the unification of two or more banks into one new bank In essence, the merger is expressed by the following two steps:

Meanwhile, Acquisitions have to do with the transfer of the whole or part of the

ownership of a company (company being bought) to another (company that buys out), which pays the agreed on price The transfer usually takes place with the payment of cash or with buying and exchanging shares, through the Stock Exchange In many cases, even the acquisition of a minority interest of a bank is possible to secure for the buying bank real control, if with the transfer is in a position to affect critical choices of the management and the strategy of the bank being bought or if the rest of the shares of the particular bank are held by many different owners

According to Straub (2007) the phrase M&A refers to the aspect of corporate strategy,

corporate finance, and management dealing with the buying, selling, and the combination of another company that can aid, finance, or help a growing company in a given industry to grow rapidly without having to create another business entity I.e when a company engages in M&A activity and decides to acquire a target company it

is making an investment The general principle is that the acquiring company should go ahead with the acquisition if by doing so it creates a net contribution to shareholders wealth (Brealey et al., 2007)

2.2 Factors contributing to the occurrence of Mergers and Acquisitions

M&As tended to occur when the overall bank health was deteriorated and where the market was less concentrated especially in the post-crisis period The banking system may prone to several internal weaknesses due to its weak and vulnerable structure, i.e excessive loan concentration, weak management system as well as inadequate information Weak management seemed to stem from the government’s decision to have banks operate on self-regulatory basis No specific oversight mechanism existed, and thus misuses of authority by the politically well connected few went unchecked The result of these misuses comes in the form of excessive credit concentration or bad lending decisions In addition, without adequate information on the quality of banks and general disturb, the public had lost much of its confidence and capital flow became uncontrolled As the situation worsened, so did the degree of bank violations, with liquidity and capital adequacy ratios (CARs) becoming dangerously low

2.3 Effects of Mergers and Acquisitions on commercial banks

2.3.1 Advantages

The general perception is that M&A is applied to generate added value to a business by reducing costs and/or increasing profits, but other benefits are also highly relevant when discussing M&A within the financial sector The advantages of bank mergers are many but generally they can be listed as the following four:

Improving efficiency

The primary motive for consolidation would be maximizing the value of shares owned

by existing shareholders Banks can maximize value either by increasing their efficiency or by increasing their market power in setting prices Cost efficiency will be improved if an efficient bank spreads its superior managerial skills to an inefficient bank by acquiring the latter Profitability will be enhanced by superior risk management The efficiency improvement hypothesis suggests that an efficient bank

tends to acquire or purchase the business of an inefficient bank

Strengthening market power

Market power can be strengthened if two or more banks operating in the same market are consolidated and consequently the market becomes more concentrated Existing evidences from the U.S bank M&As suggest that in-market M&As, i.e., M&As of banks operating in the same market, may increase market power in setting prices

Taking advantage of a too-big-to-fail policy

The government policy directly or indirectly affects banks’ M&A decisions In particular, if regulatory authorities are expected to pursue a too-big-to-fail policy, weak banks have a strong incentive to be consolidated with each other, because bank managers may want to keep their positions Bank shareholders can also gain from the value of deposit insurance by surviving through mergers The government can promote bank consolidations among weak banks in some ways First, the government can

“arrange” consolidations, persuading (or sometimes forcing) relatively healthy banks to acquire unhealthy banks Second, the government can give weak banks incentives to be consolidated with each other by establishing a scheme for recapitalizing consolidated banks If the government’s anticipated too-big-to-fail policy and local market stabilization policy affect the decision of M&A, unhealthy banks or banks recapitalized

by the government tend to be consolidated with each other

Managerial Empire Building

When corporate governance structures are weak, managers may be willing to acquire other banks for the purpose of empire-building They may gain personal financial and non-financial gains from consolidated institutions Managerial hubris may also drive bank mergers Weak governance structures allow managers to spend on activities with scope for generating managerial private benefits, such as advertisement or entertainment expenditures In addition, if managerial empire building motive drives M&As, then a consolidated bank cannot realize efficiency gains, and is not willing to downsize or restructure the business Managers of consolidated banks may increase advertise expenditures for their private benefits

2.3.2 Disadvantages

In spite of many advantages in connection with M&A, disadvantages also exist In fact, the main problems when applying M&A are:

Lack of Management Skills

Managerial problems can occur when entering M&A This partly includes the decision

of who is going to take the front lead of the activity, as well as picking the person possessing the required skills Delays of such decisions can lead to delays in cost-cutting efforts as well as decreases in cost-cutting opportunities such as a lack of elimination of excess staff The choice of inappropriate managers to do M&A activity can turn certain advantages into disadvantages Market growth is one of the mentioned advantages of M&A, but this can quickly be turned into a disadvantage if the wrong person is chosen to run the M&A activity when the lack of awareness of competencies and capabilities can lead to management hubris This kind of management can influence M&A activity in a way that instead of adding value to the company, M&A may destroy it Furthermore studies show that some management fail to register that some advantages could have been achieved without applying M&A, as well as a lack

of ability to register losses in revenue caused by cost savings These mistakes can therefore result in inaccurate estimations of the added value gained from M&A

Lack of Focus on Intangible Assets

Implementation of the different activities after M&A can be difficult and cause problems to managers who are not capable of accomplishing a professional integration

of the merging banks This includes the different working processes; accounting methods and corporate cultures An important thing to consider in the process of M&A

as well is the human resources, which will represent the combined company The core value of many businesses depends on a harmonized working force including both managers and other employees Thus, many banks do not exploit their opportunities and potential value fully due to a lack of focus on intangible assets, including human capital, business culture, and corporate governance Instead, banks are characterized by over-prioritizing system integration, and by overemphasizing financial and system due diligence leading to the mentioned lack of focus on intangible assets

Difficulties within Post-merger Integration

The reasons leading to merger failure can be connected to one or more of five major causes: poor strategic rationale, mismatch of cultures, difficulties in communication and leading the organization, poor integration planning and execution, and/or paying too much for the target bank

Size versus Complexity

Another subject related to M&A failure is the size and complexity of a bank The banking sector has been very affected by the global financial crisis resulting in disasters including bailouts of large financial institutions during 2008 and 2009 These happenings have emphasized the importance of the risks connected to the increased size of banks, which rise concerns about implications for macroeconomic and financial market The competition is very limited within the banking sector compared to other sectors, since a few banks possess a greater part of the market share Another disadvantage of becoming too big is the costs connected M&A can lead to economies

of scale and scope and increased efficiency, but it is also important to consider the costs associated with a bank becoming too large and too complex It is more difficult to

manage a large corporation than to run a small one Cost discipline, teamwork, and common culture is more difficult to change if it includes many employees and departments The degree of complexity is therefore worth to consider when estimating potential cost efficiency Additionally, management also has to consider and include the risk of customers leaving the bank due to fee increases and changes in services offered by the acquiring bank

2.4 Summary of theoretical framework

Generally, there are several motivations for M&A to name but four: improving efficiency, strengthening market power, taking advantage of a too-big-to-fail policy, managerial empire building

It is an undeniable truth that banks can gain many advantages through M&A, but most banks will experience complications during the process The main problems leading to disappointments and failures are the lack of management skills, lack of focus on intangible assets, and difficulties within post-merger integration

In fact, there are numerous measures to minimize the disadvantages that are likely to happen during merger process:

merger so as to improve the profitability and efficiency of the proposed banking groups;

rationalization of branches and employees;

merged entity;

 Ensuring that each banking group has sufficient size In this regard, upon completion of the merger program, each banking group was to have a minimum shareholder’s fund

Although having some particular drawbacks, it cannot be denied that to some extent, the positive effects of M&A exceed its negative side This statement can be proved by different research articles that I have done literature review of Burki & Ahmad (2008) talked about the impact of changes in governance of banks on the performance of commercial banks in Pakistan’s banking sector from 1991 to 2005 The findings of this paper suggest that, in general, financial reforms improve banking sector performance Choi & Harmatuck (2006) discussed the post operating performance of constructive mergers of United States of America This study examines the operating performances after the merger during the past two decades (1980-2002) After merger the cash flow returns were not improved significantly Secondly, the operating performance was slightly improved due to increased in the size of the firm Altunbas & Ibanez (2004) have observed the impact of strategic similarities between bidders and targets on post-merger financial performance This article shows that on average, bank mergers in European Union resulted in improved return on capital Fixler & Zieschang (1993) illustrate the determinants of cost efficiencies of banks mergers For this purpose the methodology is used to estimate pre and post merger cost efficiencies of 348 mergers From this article it is proved that the cost efficiency improves in the most of the banks mergers but the gains were smaller

After the thorough review, it has been noticed that M&As of the banks in many countries of the world increases or improves the cost efficiency and also improves little profit efficiency which is beneficial for the society and economy

CHAPTER 3

EFFECTS OF BANK MERGERS AND ACQUISITIONS ON MALAYSIAN

BANKING SYSTEM

3.1 Overview of Malaysian banking system

In Malaysia, the plan to consolidate and rationalize the banking sector was initiated as early as mid 80’s when the industry was badly hit by the 1985-1986 economic recession The period saw a number of weak commercial banks and finance companies succumb into insolvency and financial distress In addition, the Malaysian banking system has historically been characterized by its large number of small institutions Unfortunately, the call went unheeded as the shareholders of banking institutions were more interested in protecting their interest above that of national consideration Although the Malaysian central bank, Bank Negara Malaysia (BNM) has always encouraged banks to merge in order to achieve economies of scale and higher level of efficiency, only a few mergers among the banking institutions have taken place The urgency to consolidate the banking sector was apparent during the Asian financial crisis that struck the region in 1997-1998

3.1.1 Financial Crisis in Malaysia 1997-1998

During the early 1990’s, Malaysia was a popular investment destination, and this was reflected in Kuala Lumpur Stock Exchange (KLSE) activity which was regularly the most active stock exchange in the world Expectations at the time were that the growth

rate would continue, propelling Malaysia to developed status by 2020

However, in July 1997, the Malaysia ringgit was affected by speculators The overnight rate jumped from under 8% to over 40% Besides Malaysia, Thailand, Korea, Indonesia and the Philippines were also badly hit The toll of the crisis was enormous

as it persisted and spread to the real sector On average, in October 1998, these five economies shrank about 7.7%, with millions of people sustaining livelihood losses (Yellen, 2007) By the end of 1997, ratings in Malaysia had fallen many notches from investment rate to junk; the KLSE had lost more than 50% from above 1200 to fewer than 600, and the ringgit had lost 50% of its value falling from above RM2.50 to under RM3.80 to the dollar

The 1997 financial crisis exposed the fragilities of the Malaysian banking sector and economy The competitive landscape in Asia, rapid technological change, and changes

in the way intermediation is channeled evoked concern among countries The Malaysian government saw that the development of the banking system, particularly the domestic banking institutions, as vital in facilitating recovery and contributing to the long-term resilience of the economy This provided a strong rationale for the BNM

to speed up the consolidation process to create a cluster of strong and competitive local banks, and to restore stability to the banking arena The aim was to create a cluster of domestic banking institutions that could compete meaningfully with their foreign counterparts Moreover, many banks in Malaysia experienced erosion in their capital equity due to high non-performing loan (NPL) Additionally, with 71 banking institutions prevailing in the country, there were 2,712 branches located all over the country There was clear view that Malaysia was over-banked and some resources were wasted due to duplication of branches in the same locality Another reason was the increasing pressure from World Trade Organization (WTO) to open up local financial markets to foreign banks (Bank Negara, 1999) Following much lobbying from various quarters against this decision the government decided to increase the number of anchor banks In order to minimize the potential impact of systemic risks on the banking sector

as a whole, following the deepening of the financial crisis, the Government took stronger measurers to promote (force) merging of banking institutions

3.1.2 Mergers and Acquisitions in Malaysia

The merger programmed for domestic banking institutions was initiated in 1999 According to Bank Negara 6th Governor, Tan Sri Ali Abul Hassan Sulaiman , the merger program for domestic banking institutions announced on July 29, 1999 would not, in any way, weaken the financial strength of the merged entities In fact, the creation of the six domestic financial groups would ensure that the domestic banking institutions would be able to withstand pressures and challenges arising from globalization and from an increasingly competitive global environment This move towards consolidation was in line with the Government's policy of not to bail out weak companies but to rationalize businesses towards higher productivity Business consolidation through merger is indeed a common practice globally to achieve economies of scale and higher productivity In this time and age of globalization, banks must merge to survive the attack of greater competition The regulatory authority in Malaysia had repeatedly encouraged banks in Malaysia to merge with each other, but after years of moral persuasion with little success, the Malaysian government took the unprecedented measure of forcing banks to merge with each other in 1999 However, due to the strong protests, the central banks of Malaysia revised the scheme by allowing banks to choose their own partners and leaders (Bank Negara Malaysia,

October 1999)

In 2001, the focus of the domestic banking groups was to complete the business integration processes which formed the most critical aspect of the mergers BNM launched Financial Sector Master Plan (FSMP) in March 2001 which contained the board strategies for the development of the Malaysian financial sector for the next 10

years (2001 to 2010) The domestic banking sector was subsequently merged into 10 banking groups as shown in Appendix A

3.2 Effects of bank Mergers and Acquisitions on Malaysian banking system

After the Southern bank was acquired by CIMB bank on March 2006, there were only nine local banks in Malaysia banking industry The financial ratios will be used to

discuss the financial performance of nine local banks

Analysis of Ratio(s) used

Return on Equity (ROE)

Efficiency: Total Expenses to Total Revenues (TE/TR)

Non- Interest Expenses to Total Assets (NIE/TA)

Total Loan to Total Asset (TL/TA)

Share performance: Earnings per share (EPS)

Dividends per share (DPS)

Total Debt to Total Capital &

Short Term Debt (TD/TC)

3.2.1 Profitability ratio

Table 3.1: Growth Rate in Profitability Ratio

Pre (%)

Post (%)

Pre (%)

Post (%)

Public Bank 1.20 1.56 ↑ 16.06 19.58 ↑

(Source: www.ijbmt.com) Overall, most of the banks show an increased ROA and ROE This result supports several studies about mergers in Malaysian banking system which concluded that bank merger could contribute to bank’s profitability There is slight decrease in the average ROA after merger activity in Alliance Bank, Eon Bank and Public Bank This is probably because these three banks acquired too much asset after merger with other financial institutions which then caused reducing in their efficiency in using the asset to generate more income Another possible reason for Public Bank’s decrease in ROA is due to their conservative business policy The remaining banks enjoy a growth in their ROA and ROE after the merger Seemingly, they have wisely managed and utilize their asset and equity in generating the income

Since liberalization has launched more foreign direction investment in Malaysia and thus, creates more business opportunities for commercial banks who act as financial intermediary The profit from non-lending activities such as cross border payment services and trade financing activities has contributed to total revenue which then drives a higher income to bank Overall, the result shows that bank’s efficiency in generating income with their capital equity was enhanced since banks have higher ROE after the merger It was a good implication since additional scale allows investment and encourages innovative business models to serve evolving market needs

3.2.2 Cost efficiency ratio