The New Era of Banking Consolidation

the HRM
In what can be termed as the ‘start of a merger spree’ in the Nepali banking sector in 2023, Kumari Bank and NCC Bank began unified business on January 1. After this, the second week of January saw two mergers and one acquisition becoming successful in the Nepali banking sector; the Global IME Bank and Bank of Kathmandu merged and commenced their unified business on January 9 and Prabhu Bank acquired Century Commercial Bank to start an integrated transaction on January 10. The same week saw Nepal Investment Bank and Mega Bank completing their merger and commencing business as Nepal Investment Mega Bank on January 11.

Similarly, Laxmi Bank and Sunrise Bank have also signed a memorandum of understanding (MoU) for a merger on January 9. In the meantime, the Himalayan Bank’s acquisition of Civil Bank will is expected to be completed over the next few weeks.

With the start of 2023, the Nepali banking sector is invigorated with mergers and acquisitions (M&As). Even as the banking sector is grappling with a prolonged liquidity crunch and shortage of loanable funds, the consolidation drive is redefining the banking industry.

Nearly a decade ago, the Nepal Rastra Bank (NRB) started seeking ‘big mergers’ of banks to create big financial entities that are able to bear larger risks, withstand domestic and international economic shocks, and provide modern banking services to the population and aid in the economic development of the country in meaningful ways. It’s been a couple of years since the central bank forced banks and financial institutions (BFIs) to go for consolidation, but the much-talked-about ‘big mergers’ is finally taking place in the Nepali banking sector.

Even as the banking sector was reeling under an acute shortage of liquidity with the country facing severe economic headwinds, there was a series of understandings between banks in 2022 to go for mergers and acquisitions. With the start of 2023, the majority of those MoUs are now being taken to a logical conclusion.

The fact that the total number of commercial banks that had reached 32 in 2012 has come down to 22 by this January clearly shows that NRB has been successful in achieving its aim to reduce the number of banks in the country. In the last one year, M&As between 10 commercial banks have concluded and the entities have started their unified business as five banks.

Himalayan Bank and Civil Bank have already called their annual general meeting to endorse the merger MoU. Once they merged, the number will come down to 21. And, if the proposed merger between Laxmi Bank and Sunrise Bank materialized, the total number of commercial banks in the country will drop to 20.

With the central bank prodding four other commercial banks for the merger, the total number of commercial banks will likely come down to 18 in the near future.

And, if that happens, it would be something near what the NRB in its 2022 study has envisioned. In April last year, the central bank published a report titled ‘Optimal Number of Banks and Financial Institutions in Nepal’ which stated that the current number of BFIs in Nepal is ‘more than optimal’.

The report which was based on an opinion survey carried out by NRB shows that the majority of the top management of BFIs believe the current number of BFIs in Nepal is more than necessary.

One-half of the respondents of the survey opined that the appropriate number of commercial banks in Nepal is 11 to 15. Another one-fifth of the respondents

preferred 5 to 10 commercial banks, 15 percent were in favor of 16 to 20 banks and the rest were in favor of the existence of 20 to 25 commercial banks.

“Of those respondents who feel that the current number of commercial banks is more than optimal, about 57.1 percent of the respondents from the BFIs and 50.9 percent of the experts opined that the optimal number of commercial banks in Nepal should be in the range of 11 to 15,” reads the report.

With NRB adopting a liberal policy in licensing in the early 1990s, the total number of BFIs (A, B, C & D class financial institutions) in Nepal reached as high as 220 in 2012. However, as the number increased, it also brought a series of anomalies in the banking system, forcing the central bank to rethink its licensing policy.

When Dr. Chiranjibi Nepal became the governor in 2015, NRB pushed the BFIs to either go for mergers voluntarily or the central bank will force BFIs to merge. In the monetary policy of the fiscal year 2015/16, the central bank raised the minimum paid-up capital of all types of BFIs by four folds that sent shockwaves in the financial sector of the country. NRB also sought concrete proposals on M&As from the BFIs. While most of the BFIs submitted such proposals, very few mergers among the commercial banks took place in the later years with the most notable being the merger between Global IME Bank and Janata Bank in 2019.

The current NRB Governor Maha Prasad Adhikari, after assuming office continued the merger push. What makes the current M&A drive distinguishable is, the majority of those are taking place between commercial banks.

“The merger in the banking system is materializing in real terms now. Some of the strategic steps taken by the central bank of late have also pushed the commercial banks to go for the merger. We have cautioned banks and financial institutions that mergers are no longer a compulsion but a business need,” said NRB Governor Adhikari.

For years, promoters of banks resisted the consolidation push despite the central bank’s official and unofficial instructions. One such example was the Himalayan Bank in which a group of promoters time and again stalled the merger efforts. The proposed ‘mega merger’ between Himalayan Bank and Nepal Investment Bank failed to materialize last year due to the deep dissatisfaction of some promoters of Himalayan Bank.

However, with NRB hardening its stance on mergers and the stark economic realities the country was forced to face after the start of the Covid-19 pandemic, the reluctance of bank promoters and bankers has eased as they seem to have realized the need to have bigger and better banks that are able to cope the challenges posed by adverse economic situations.

According to NRB officials, there are two major reasons behind the willingness of commercial banks to go for mergers. The first is, the central bank’s position that incentives announced to promote merger, is not for forever.

Second, the meeting between NRB and the chairmen of the commercial banks in May 2022, in which the bank promoters were clearly told if the bank goes into trouble tomorrow, NRB will not come to rescue them. The central bank leadership, in that meeting, told them (chairmen) that it is up to banks to take a call on a merger as the central bank is not in favor of forcefully pushing banks for the merger.

According to NRB senior official who was present in the meeting, a clear message was given that if any BFI comes to the central bank in the future seeking support in case it finds itself in a difficult position, NRB will not try to save that institution. The central bank will work only in the interest of the depositors, not for the promoters. “ I think this straight-talking did have some impact, pushing the promoters to start works on mergers,” said an NRB official under the condition of anonymity.

The Need of the Hour
The M&As have come at a time when Nepal’s economy is shrouded by dark clouds of uncertainty that have indeed affected the banking sector. Over the past 2-3 years, banks have found themselves surrounded by a number of challenges that have come in the form of a severe liquidity crisis and sharp hikes in interest rates. In the last fiscal year, the total deposits in the banking system grew by just 9 percent, while the growth of the private sector lending was at 13.3 percent.

Lately, a huge gap in financial resources has been seen with low deposit levels and higher demand for loans. Some 15 months ago, the lending rate was 8.43 percent which is now 12.6 percent.

“During the Covid-19 pandemic, liquidity in the financial system was in excess but the borrowing demand was low. So massive flow of loans at low margins occurred when the Covid lockdowns were lifted in 2020 and 2021. The central bank also introduced refinancing for businesses affected by the pandemic. There was relaxation on loan repayments with restructuring and rescheduling of loans. It created excessive liquidity in the market,” said Anil Kumar Upadhyay, former CEO of Agricultural Development Bank.

The money went to import-based consumption and sectors such as real estate and the stock market. But a large chunk of that money did not return to the banking channel creating a shortage of investment-grade liquidity in the system. This has increased the non-performing loans (NPL) in the system.

Post-Covid, it was increasingly difficult for small commercial banks to be able to go it alone for very long. Falling net profit, and increased cost of business forced the new commercial banks to find suitable partners. Interestingly, the existence of a new generation of commercial banks that received the licenses in the last 15 years has ended in the current merger bandwagon.

NRB officials held high hopes that the current consolidation will strengthen the overall stability of the financial system. “It bodes well for the country’s economy,” said Governor Adhikari adding that financial intermediation costs are decreasing as banks become bigger and stronger as a result of M&As.

Bankers and promoters say banks’ ability to bear risks has increased post-mergers. “I believe the Global IME-BoK merger will ease the difficulty of having to participate in many banks to raise investment in big projects,” said Chandra Prasad Dhakal, Chairman of Global IME Bank while addressing a function to mark the commencement of Global-BoK integrated business operation.

Sunil KC, CEO of NMB Bank agrees with Dhakal. “As banks’ size gets bigger, it will increase their risk appetite when it comes to funding large-scale projects,” said KC.

Bank promoters also express their hope that mergers will be instrumental to bring big changes in the banking sector. “The bigger the banks are, the safer will be the money of the depositors. So, mergers should not be stopped,” said Prithivi Bahadur Pande addressing a function to mark the start of the unified business of Nepal Investment Bank and Mega Bank. The banks commenced their joint transactions as Nepal Investment Mega Bank on January 11. Pande expects that the number of commercial banks in Nepal will come down to eight after the mergers under the second phase of the consolidation plan.

Experts are also hopeful that the M&A drive will yield positive results and say that banking consolidation has become necessary in today’s context. According to Bhuvan Kumar Dahal, former CEO of Sanima Bank, the cost of doing business in the country will be reduced with the lower number of banks. “In Nepal, the number of BFIs is also high population-wise. After the post-1990 economic liberalization, NRB eased BFI licensing with a view to increasing access to finance across the country. But after 2010, the central bank realized that having too many BFIs will create problems and that bigger and better banks will provide quality financial services to the people of the country,” he said.

Dahal disagrees that there will be a monopoly in the financial services industry with the reduced number of banks. “If there were only two or four banks, it would have been a matter of monopoly. But if there are 18-20 banks, there will be competition and customers will receive better services,” he said, adding, “On top of everything, a good level of corporate governance is maintained if banks become stronger.” He says that unhealthy competition among banks to attract deposits, violating the rules of the regulator and increasing loan premiums are some distortions that have been seen in the Nepali banking sector over the last couple of years. “With the M&As reducing the number of banks, we can expect better governance in the sector,” he mentioned.

Areas of Concerns
Amid the current merger bandwagon, experts have also pointed out risks that are associated with the consolidation drive. While M&As have been aimed at creating a synergy effect in banking, there are also concerns that things can go wrong with banks getting bigger. The banks can become ‘too big to fail’ if the regulatory regime is lax and corporate governance is not focused on. NRB Governor Adhikari is of the view that it is up to the banks how they are going to maintain good practices in banking. “Banks now should remain self-regulated as they have become larger after the mergers,” he said.

There are also concerns that the synergy effect will not be generated if complications arise in managing employees in a merged entity as people from two or more different organizations are likely to find it difficult to adjust to a new work environment. This has been seen in many ‘A’ and ‘B’ class financial institutions in the past as staff coming from different organizations failed to adjust to the new entity affecting the operational efficiency of the banks. “The merging banks need to carefully work in this respect as it is obvious for people from two organizations and cultures will find it difficult to work together,” said Dahal.

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