Impact of Mergers and Acquisitions on Banks

Nepal’s banking landscape has undergone a substantial transformation due to the wave of mergers and acquisitions (M&As) spurred by regulatory mandates to increase minimum capital requirements. While these consolidations have undoubtedly brought about certain benefits, their overall effectiveness is a complex issue with both positive and negative implications. On the positive side, M&As have significantly enhanced the capital adequacy of the banking sector, bolstering its resilience against economic shocks. By amalgamating operations, banks have achieved economies of scale, leading to improved efficiency and cost reduction. This, in turn, has enabled them to invest more in technology, human capital, and product development, thereby strengthening their competitive edge. Moreover, the expanded branch networks resulting from mergers have increased access to financial services for a larger population.

However, challenges and criticisms also abound. Integrating disparate organisational cultures, systems, and processes can be a formidable task, often leading to disruptions in service delivery and customer dissatisfaction. Job losses are an inevitable consequence of M&As, which can negatively impact employee morale and public perception. Furthermore, a reduction in the number of banks due to consolidation can lead to decreased competition, potentially resulting in higher interest rates and reduced choice for consumers.

While there is evidence to suggest that some merged banks have exhibited improved financial performance and market share, the overall impact on competition and interest rates remains inconclusive. Some studies indicate increased market concentration, while others argue that efficiency gains outweigh competitive concerns. Additionally, the long-term effects of M&As on financial inclusion and credit accessibility require further investigation.

In conclusion, M&As have been a significant catalyst for change in Nepal’s banking sector. While they have undoubtedly strengthened the industry in certain aspects, their overall effectiveness depends on various factors and the specific circumstances of each merger. To maximise the benefits and mitigate the risks, careful planning, execution, and post-merger integration are essential. Moreover, ongoing monitoring and evaluation are necessary to assess the long-term impact of these consolidations on the banking sector and the broader economy.

To get a deeper understanding of the decisions to encourage mergers and acquisitions, in this edition of Business 360, we spoke to prominent bankers Ashok Sherchan, CEO of Prabhu Bank and Ratna Raj Bajracharya, Former CEO of Global IME Bank.

Could there have been alternative strategies to mergers and acquisitions to address the challenges faced by banks in recent times?

Ashok Sherchan: Another strategy to mergers and acquisitions for capital enhancement is the injection of new capital through existing or new shareholders. The chances of that working are not as good, which led to the central bank deciding to prioritise mergers and acquisitions. The options available for capital enhancement are these, M&As, injections of new capital, and if available converting reserves into capital. Which is why many banks, because of the size of the markets and keeping in accordance with the Rastra Bank, proceeded with mergers and acquisitions.

Ratna Raj Bajracharya: This depends on the basic objective considered for a merger. When enhancing the business, volume is the prime concern, and there are little alternative strategies available. Mergers ensure the fastest means to attain higher volumes of business with expanded reach at once and market share. However, if the concern is enhancing capital to sustain and expand current business volume, alternative strategies could have been explored.

Mergers entail banks taking on both the good and the bad of each other. How has that affected the functioning of your bank?

Ashok Sherchan: M&As have both benefits and harm, this is a worldwide truth. In the past we have merged with around ten big and small institutions. At times, these decisions were primarily positive, some cases were negative. Our previous merger left us with some negative effects. This happened because of the quality of the assets. While it is taking up precious time and resources, we have been trying to manage the consequences.

Other than that, there are also cultural consequences. With M&As, there can be clashes in the two different work cultures. No two work environments are the same. There could be differences in the quality of the staff. The processes and functioning are guaranteed to differ. The same is true for the customer bases. Whoever is leading takes up the responsibility of integrating everyone into a coherent system. This always takes up time and focus. So, the benefits of M&As is not always immediate and sometimes has to be seen as a long-term investment.

Ratna Raj Bajracharya: Banks and financial institutions (BFIs) have been operating in the same market and have a sound understanding of competitor status, particularly regarding assets quality and management practices. These are further authenticated through DDA exercises. In many cases, the ‘bad’ side is relegated through the swap ratio itself. Despite being prepared, there may surface some issues that were not thought of or anticipated. However, the merged organisation has to move on with all these being addressed equitably. A blame game benefits no one.

How do mergers impact customer service levels, waiting times, and branch accessibility?

Ashok Sherchan: More often than not, the customer base that has been acquired, are the ones who benefit due to the leading organisations having lower interest rates, larger market share, more branch locations, and faster processing times. But in some cases, if the bank that is leading has higher interest rates and costs it would end up costing the customers so much more. There are two very clear sides to this. In some cases, the customers benefit while the banks suffer, in other cases it is the opposite. The ultimate goal of M&As is for the size of the bank to increase and for it to be a less risky endeavour that is stress free which will eventually go on to benefit both the customers and the banks.

Ratna Raj Bajracharya: When two competing BFIs merge, it would not be appropriate to consider that the customer service level would deteriorate presumably due to mixing of staff from both the organisations. Since both the merging institutions are primarily providing the same type of services, it would be fair to understand that all staff have equally been trained and appropriately placed by erstwhile organisations as well. A concern as to providing “accommodation” in terms of work culture might need articulation. In the post-merger period, this should be the primary job of top management, supported by clear strategies and immediate implementation in which getting support of all managerial level executives would become the prerequisite. This can very well be served by proper communication and balanced behaviour.

I have not come across any changes in the level of customer service due to the merger. Rather, with the expanded branch network, the customers benefit largely due to increased accessibility. With respect to differences in “service fee” structures of merging institutions, some adjustments will be inevitable in order to make them “uniform”. In this respect, largely the lower-end fee structures are applied throughout. Regarding interest rates, the fixed deposit rate on existing deposits continues till their maturity. Saving accounts are adjusted/merged with similar nature and priced products. Some products from ether institutions may have to be continued due to specific features/rate. Lending rates may be subject to change due to change in the “base rate”. However, where the base rate goes up impacting the borrowers of another institution, some adjustment in the “premium rate” may be warranted.

These all are normal “adjustments” and need not be construed as complications arising from merger.

How have mergers impacted the banks’ capital adequacy ratio and overall financial stability?

Ashok Sherchan: A bank’s capital adequacy can indicate wealth and stability but it can also raise questions about whether the funds are being properly utilised and not just hoarded. If it is not used for business, it displays stagnation in the bank. If no loans are being given out, no revenue is being created. The ideal is to utilise the capital and be capable of generating a revenue off of it. However, that is also dependent on the situations at hand. The Covid 19 pandemic led to a significant portion of the population not being able to pay back their loans. The government’s policy impacts the capital adequacy ratio regularly as well. The external environment plays a huge role in a bank’s stability. External factors often see a bank’s assets being eroded. But this erosion recovers in the long term. Similarly, mergers and acquisitions may have a short-term impact on the financial stability but we make sure to resolve those issues in the long term.

Ratna Raj Bajracharya: Capital adequacy depends on the ‘available capital space’ brought in by the merging institution. Where both the institutions are running with a high level of tight capital position, the merger would provide no benefit in improving the capital adequacy. But it may still benefit the shareholders on account of available ‘distributable reserves’ either institution may be contributing to the capital structure. Likewise, the financial stability will surely be enhanced with an expanded capital base. The security position and sustainability improve with increased level of capital base (in absolute amount) notwithstanding the enhanced liabilities matching the capital adequacy ratio.

Have mergers led to an improvement in the banks’ return on assets (ROA) and return on equity (ROE)?

Ashok Sherchan: Some M&As have an immediate high-level return, whereas some display their benefits only in the long term. Sales could improve, asset policy could see some changes, the financial environment may improve, borrowers may start repaying their loans, all of this would lead to an improvement on the ROA and ROE. As dependent as it is on the bank’s internal functioning, it is doubly dependent on external factors. If the country’s situation improves, if the government makes good decisions and investments, then the banking sector improves as well.

Ratna Raj Bajracharya: In the initial period, improvements in profitability are less likely. The combined business profitability will average the ROA and ROE and hence dilute returns for the institution having higher ROA or ROE during the pre-merger period. However, the effect of merger will be reflected in increased business volume and profitability due to restructuring of business modules as well as better management of expenses by avoiding duplications and benefit of margin of scale.

Are you seeing desired increase in market share?

Ashok Sherchan: Market shares increase automatically after M&As. The institution being merged brings its own businesses and assets, which support the existing business. The size of the market share sees an immediate increase. The assets, number of customers, and size of the institution sees an immediate increase following a merger, among other things.

M&As are also followed by a diversification in the businesses and assets a bank is involved in. Following a merger a bank absorbs all the businesses in different segments that the other banks are involved in, creating a more diverse and stable portfolio for the bank.

Ratna Raj Bajracharya: Due to the combination of businesses of merging institutions, increase in market share comes along automatically. However, some of the credit files are bound to switch to another BFI due to promoters’ cross exposure. Some customers still may prefer leaving. Hence, maintenance of the acquired market shares and their growth, either in lending or deposits, would depend on the business strategies and market penetration. Merger would provide an increased platform in terms of reach and customer base. But, a change in management perception and brand building are the factors that would have an impact on enhancing the business,  including increasing the market share. The promotion of hitherto vibrant products/services (and brand value) of the merging institutions will provide scope for revenue diversification. With regard to cross selling and diversification, providing adequate orientation to the staff of either organisation would become crucial. Otherwise, they would die out in the absence of proper ownership among the employees.

Has it expanded the banks’ product and service offerings as anticipated?

Ashok Sherchan: The most important thing a customer receives from us would be the reduced interest rates we offer. The factor of our size increasing also gives customers the luxury of being a part of a more stable and richer group. It helps in many customers being able to get investments for various businesses that the bank may not have the expertise to deal with before the mergers. The customers of the bank being acquired also receive access to our well established digital and mobile banking services among others. To make sure that our customers keep getting better and better services we will make sure to innovate and improve our assets, stability and services. We also hope to contribute to our banking sector and society in any positive way we can.

Ratna Raj Bajracharya: Devising and launching new products is a regular feature of all BFIs. The merger would provide benefits in terms of having multiple products, including the boarding of the most successful flagship products of either institution. Post-merger period, continuation of such products would definitely be prioritised keeping the interest of various segments of customers in mind.

Lastly, mergers in itself are not a foolproof medicine for addressing business expectations. Banking is a service industry, heavily regulated and depending on public faith. Managing people always carries the highest value for proper service delivery, as well as business growth with due regulatory compliances. Mergers will benefit, making the organisation larger in one go. But sustaining the same with equal vigour of all will make it successful quicker.