Bank Negara explains rationale for bank merger

The following is the full text of the Bank Negara statement released on August 10, 1999

BANK Negara governor Tan Sri Ali Abul Hassan Sulaiman yesterday referred to his earlier statement on the merger programme for domestic banking institutions announced on July 29, 1999 and emphasised that the merger exercise will not, in any way, weaken the financial strength of the merged entities.

In fact, the creation of the six domestic financial groups will ensure that the domestic banking institutions will be able to withstand pressures and challenges arising from globalisation and from an increasingly competitive global environment.

This move towards consolidation is in line with the Government's policy not to bail out weak companies but to rationalise 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 globalisation, banks must merge to survive the onslaught of greater competition.

The need to merge is even more imperative in the face of increasing pressure under World Trade Organisation (WTO) for countries to open up their financial markets to further entry of foreign banks.

All countries are now moving towards consolidating their banking system and Malaysia cannot be the exception.

In fact, Malaysia cannot be seen to fall backward in the consolidation of the banking industry.

The process of getting the banks to merge in Malaysia started in earnest in mid-1980s as a result of economic recession.

The policy, however, has always been to allow market forces to dictate the merger pace.

The result has been dismal as shown in the slow reduction in the number of banking institutions in Table 1.

In the past, the Government has consistently called on banking institutions to merge.

Unfortunately, the call went unheeded as the shareholders of banking institutions were more interested in protecting their interest above that of national consideration.

In the mean time, the banking crisis in the mid-1980s propelled a number of weak commercial banks and finance companies into insolvency and financial distress.

These institutions were badly hit by the 1985-1986 recession as they were saddled with huge levels of NPLs, the aftermath of over-lending to the property sector and imprudent exposure to share-based lending during the earlier boom years.

In addition, the finance company industry, in particular, was highly fragmented, comprising 47 finance companies.

Given the severity of the losses and to maintain integrity of public savings and the stability of the financial system, Bank Negara Malaysia had to implement a rescue scheme.

The rescue scheme involved Bank Negara Malaysia acquiring shares in some of the ailing commercial banks and the absorption of the assets and liabilities of the insolvent finance companies by stronger finance companies.

As a result of the rescue scheme, the number of finance companies was reduced from 47 to 40.

The merger of one commercial bank and the consolidation of the finance company industry were thus driven by the rescue scheme in order to restore stability in the banking sector.

The design and the implementation of the rescue scheme had been a very costly experience to the nation as a whole.

With 71 banking institutions prevailing in the country today, there are 2,712 branches located all over the country.

There is clear view that Malaysia is over-banked and some resources are wasted due to duplication of branches in the same locality.

While the number of banking institutions in Malaysia remains large, other countries have succeeded in consolidating their domestic banks into a few large and competitive banking groups.

For instance, the United Kingdom has four major banking groups, Australia has four major banking groups and Singapore has five.

In the case of Singapore, the Government intends to reduce the number to even two.

The experience of these countries has proved that consolidation in the financial sector is both viable and desirable.

The IMF too has forced countries under their programmes (Indonesia, Thailand and South Korea) to reduce the number of banking institutions by effectively closing them down.

Malaysia does not believe that the IMF prescription of closing down the problem banks is the way to go, as the social costs involved in terms of dislocation of resources are high.

A more reasonable approach adopted by us is guided merger, with the central bank playing a proactive role in solving the issues involved and the principle of fairness will be strictly applied to all parties in the merger.

Without the merger, the small non-bumiputra financial institutions are likely to disappear as a result of globalisation and increased competition.

There is actually no more place for family run banks to survive in the long run.

It should be emphasised again that no small banking institutions can survive once the financial market is opened up.

The is no place for family type of management in a modern economy, especially in financial institutions.

The recent article in the Asian Wall Street Journal while appreciating the benefits of the merger in the long run, gave a racial slant to our merger to discredit our efforts as they have always done in the past.

Of course, the opposition leaders are quick to jump on the issue. We believe once the dust settles, everybody will see the benefits of the merger for the interest of the country in the long run.

It is also ironic that some analysts appear to question the motives of the merger, when they themselves were accusing Malaysia for not moving fast enough on the merger programme before.

When good progress in bank restructuring through Danamodal, Danaharta and CDRC was evident early this year, most analysts changed their views of Malaysia for the better.

However, the nagging issues raised was the lack of progress on bank merger.

Now that Malaysia moves ahead with the merger, a few seem to doubt our intention.

In fact, the need for rapid and major merger programme has also been one of the advice given by our professional advisers, including Smith Solomon Barney.

It should be noted that despite the progress achieved thus far in bank restructuring, the non-performing loans (NPL) still remain large. For instance, on the gross basis, the NPL of the banking system-amounts to RM72bil on 3-month basis and RM53bil on 6-month basis.

The portion for finance companies is RM20bil and RM14bil respectively. Without comprehensive merger, it is possible these NPL could threaten the stability of the banking system in the future, with the smaller financial institutions dragging down the bigger ones.

The problems faced by smaller financial institutions have appeared to be relatively predictable.

Due to their inefficiency, they tend to offer higher interest rates and compete aggressively for deposits.

They tend to price their loans higher to pay for higher deposit rates and get high- risk borrowers because good borrowers go to bigger and stronger institutions with lower lending rates.

In the end, whenever economic problems set in, the small institutions get hit first. This was what happened to DTCs and finance companies in the past, and is threatening to bring down smaller banks now.

The only viable solution is for a merger which removes smaller financial institutions from the market.

In order to minimise the difficulties involved, particularly to those employed in the industry, an attractive separation scheme can be devised where the costs are borne by the merged entities.

The Government could assist by giving some tax incentives to smoothen the merger process. One big incentive is to give tax credit for losses incurred by financial institutions involved in the merger.

This way, the lead banks could absorb as much as possible the costs associated with the merger exercise, to be compensated with the tax incentive.

While the Government is seen to be sacrificing income, if tax incentive is given, the cost of bailing out banking institutions in the future will be even higher without the merger.

The recent bank restructuring exercise has cost the Government about RM60bil. In addition, the Government had to spend RM2bil to rescue Deposit Taking Cooperatives (DTCs) in the 1980s. It is difficult to envisage that the Government will continue to be rescuer of banking institutions in the future as the risks are likely to be higher and amount of funds involved, larger.

At the same time, the merger allows for smaller financial institutions to participate in a much larger banking group.

To the extent all the six banking groups are listed, anybody can buy bank shares from the market.

The racial issue should not arise at all. In the previous merger exercises involving Kwong Yik Bank, Sime Bank and even Bumiputra Bank, no issue was raised that it was racial. The same should apply now.

What is important is to ensure banking institutions will remain in the hands of Malaysians, now and in the future.

Given the sheer size of the merger exercise, there is bound to be operational issues which need to be resolved satisfactorily The most important is the valuation of shares of each financial institution so as to be fair to all shareholders.

We believe with the appropriate tax incentive given on losses incurred by the merging institutions, maximum value can be given to shareholders so as to make them happy.

The merger is also expected to bring about greater efficiency to banking operations.

The same extent of banking services can be provided to the whole country at lower costs due to savings on manpower, information system and reduction in branch network.

There has been concerns that the merger programme is politically driven and would dilute the non-bumiputra interest in the banking system.

However, this perception is unfounded as the exercise would not substantially affect the existing composition of bumiputra and non-bumiputra interest in the banking system.

In addition it must be emphasised that these anchor banks are listed companies whose shares can be purchased by any investors in the open market.

In fact, the decision to hasten this merger programme is inevitable given the present increasingly competitive and globalised business environment.

There is a pressing need now to push and accelerate the consolidation and merger process to prepare the domestic banking institutions to face the inevitable opening up of the banking sector to foreign participation.

However, Bank Negara is discussing with the merging banks to ensure retrenchment, if any, is minimised through redeployment.

With the growth expected in the economy the expanded banking services may be able to retain a sizeable portion of the staff after rationalisation together with new job opportunities arising from the development of the domestic bond market.

Even in the cases of retrenchment, appropriate compensation will be given to those affected.

The Government is committed to ensure that the consolidation programme is implemented within the stipulated timeframe and that the-merger programme would not affect the value of the-merged entity.

In this regard, the Government wishes to extend the following tax benefits for the merger programme:

(i) Exemption of stamp duty and real property gains tax that was announced in the 1999 Budget will be extended to 30th June 2000; and

(ii) Recognition of 50% of the accumulated losses of banking institutions that are to be acquired for the purposes of computing the tax payable by the merged entity through tax credit. The credit must be utilised within two years from the completion of the merger exercise.

These tax incentives would result in substantial revenue losses to the Government. However, given the importance of the merger exercise, the Government is willing to forego-such revenue in order to ensure that the cost of the merger can be minimised and the value of the merged entity can be enhanced.

Bank Negara will work on the mechanism of the incentives and the details will be announced soon.

Finally, the announcement on the merger exercise has always been welcomed in all parts of the world. We believe the initial favourable response to the merger exercise in Malaysia will return when the public is better aware of the benefits of bank merger.

Equally important is to handle the operational issues pertaining to the merger in a most satisfactory manner.

Bank Negara will undertake to do whatever it can to make this merger exercise a success.

Article extracted from The Star, Malaysia


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