Banking Merger by Decree- FEER article
 

This article appeared in Far Eastern Economic Review:

BANKING Merger by Decree
 
Malaysia is ordering its many banks to merge into six big ones. The rationale is sound, but critics say the plan is flawed.

                            By S. Jayasankaran in Kuala Lumpur
                           Issue cover-dated September 9, 1999

Segamat is a typical small town in the south of Malaysia. It has turreted, Moorish-style government offices, high-ceilinged Chinese coffee shops, and banks. Lots of banks. Crowding the town centre are the local branches of no fewer than 21 institutions.

Segamat's surfeit of banks reflects a national excess: Malaysia has 58 financial institutions, with a total of 2,712 branches. That's way too many for a population of 22 million, according to Bank Negara, the country's central bank. Its ideal figure is just six banking groups. Now, to the dismay of many bankers, it's translating the ideal into reality.

The central bank has ordered the 58 to merge into six "superbanks" next year. The aim: to make Malaysian banks big enough and efficient enough to withstand the expected onslaught of foreign competitors in 2003--the year financial markets are due to be liberalized under a World Trade
Organization pact. "No small banking institution can survive once the financial market is opened up," central-bank Governor Ali Abul Hassan Sulaiman said in August. The central bank reports to Finance Minister Daim Zainuddin, who has said that the mergers are unavoidable.

Malaysia's 21 commercial banks, 12 merchant banks and 25 finance companies are  under government instructions to sign preliminary merger agreements by the end of September. The mergers themselves are tentatively set for April. Few quibble with the concept of consolidating
an industry with excess capacity, but the speed and scale of the mergers, and the manner of their official orchestration, alarms many in and outside the banking community.

A major worry is that the government seems to have weighed political ties in choosing some of the leader banks. The six groups will each be led by an "anchor bank," three of which are state-owned (see chart on page 12). Critics fret that some of the superbanks will be susceptible to government pressure, thus weakening the financial system rather than strengthening it. And then there's the question, yet to be decided, of who will manage the superbanks. Will the subordination of some banks to others sideline some of Malaysia's more capable and innovative
bankers?

Foreign holders of Malaysian bank stocks are meanwhile concerned that the mergers will be consummated at the expense of minority shareholders.  "A lot of my clients are unhappy," says Yeoh Keat Seng, head of Merrill Lynch in Kuala Lumpur. "The biggest concern is the choice of the six core banks, the basis of valuing the companies acquired and the seeming rush to complete the acquisition process." Manu Bhaskaran, managing director of SG Securities in Singapore, says the forced amalgamation of independent, profitable banks also raises the broader issue of "the freedom of a businessman to decide his own destiny in a capitalist economy."

Despite disquiet, however, no banker dares to citicize the central bank publicly because of its sweeping powers. "Bank Negara can make life very unpleasant for any banker in this town," says a European banker in Kuala Lumpur. Most bankers who spoke to the    REVIEW asked not to be quoted by name; many declined to talk at all. Finance Minister Daim and central-bank officials also declined to respond to faxed questions.

In itself, the rationale for the mergers is sound--too many banks means a fragmented and inefficient use of resources; having just six banking groups will allow operations, branches and services to be streamlined. And Malaysia will merely be following a global trend--banks in America, Germany, France and Japan have moved towards union in the past two years. Indeed, in the early 1990s, Bank Negara began nudging banks to merge voluntarily, rewarding those that increased their capital base with permission to offer more services. But in Governor Ali's words, the effort was a "dismal" failure: Some of the expanded banks lent aggressively in pursuit of higher returns for their shareholders--then got into big trouble when the Asian crisis struck and the loans turned bad.

Since mid-1998, the government has spent 60 billion ringgit ($15.8 billion) taking bad  loans off banks' books and recapitalizing tottering institutions. It has clearly had enough. "In future, banks will no longer be bailed out," Finance Minister Daim said recently. "We cannot afford to save banks every 10 years or so. That's why the mergers are unavoidable."

The mergers will certainly result in bigger banks, but will size alone make them safer? After all, size did not save two big Malaysian banks from running up more than half of the 39 billion ringgit in bad loans absorbed by the government. The two are Sime Bank, now part of RHB Bank, and state-owned Bank Bumiputra, now in the throes of being joined with Bank of Commerce. Meanwhile, at least four smaller banks are also to be forcibly merged into the superbanks even though they're well managed and made profits during the crisis. All four are owned by ethnic-Chinese interests. "I'm not sure the government's reasoning holds water," says Toh Kin Woon, a politician with Gerakan, a mainly Chinese party within the ruling coalition. "Many of the smaller banks have been better managed and more competitive than the bigger banks."

The government's choice of which banks to put in which groups has sparked concern among Malaysian-Chinese, who comprise almost 30% of the population, that their economic interests are being subsumed in favour of the majority Malays. Two of the six superbanks will be Chinese- owned--representing roughly the same proportion of Chinese-owned bank equity as now--but that hasn't stopped Chinese bankers and politicians from lobbying the government to increase the number of anchor banks.

Many of the questions about the merger plan arise from the apparent haste and opacity with which it's being implemented. No-one knows why the central bank decided on six banking groups, or why certain banks were grouped with others, or how the anchor banks were chosen. In March,
Governor Ali said the government would like the country's 58 financial institutions eventually merged into 16 groups. He also said the central bank recognized that the Asian crisis had made mergers unattractive --loss-making banks could be bought at firesale prices. But four months later, on July 29, he unveiled the plan for six superbanks. The sudden change in tack has left analysts speculating about the government's motives. "There is a disquieting whiff of political agenda," says the head of a Western bank in Kuala Lumpur. "Choosing partners like this is like playing God."

Speculation is rife that the mergers may be victimizing bank owners allied to former Deputy Premier Anwar Ibrahim, who was convicted of abuse of power in April and is serving a six-year jail term. At least two  ethnic-Chinese tycoons perceived to be associates of Anwar will see their banks swallowed up by bumiputra institutions. The two are Quek Leng Chan, owner of Hong Leong Bank, and Tong Kooi Ong, controlling shareholder of PhileoAllied Bank.

The central bank has said the choice of anchor banks was based on their "financial resilience" during the crisis--presumed to mean that they didn't need government bailouts. PhileoAllied Bank posted net losses of 53 million ringgit for the year to January 31 (following a net loss of 71 million ringgit the year before), but it hasn't had infusions of taxpayers' money. Instead, it has submitted its own recapitalization proposal to the central bank. Moreover, bankers say PhileoAllied is ahead of its peers in tapping new banking technology.

Hong Leong Bank's case for selection as an anchor bank is even stronger, bankers say. Its shareholder  funds of over 1 billion ringgit make it a largish bank, and it has yet to make a loss. True, net earnings fell 78% to over 41 million ringgit for the year to June 30, 1998. But a surprisingly small 4.5% of the bank's loans were deemed nonperforming that year, compared with an industry average of 13%. And Hong Leong also hasn't turned to the government for aid.

Both Quek and Tong, however, obtained their banking licences during Anwar's tenure as finance minister. In early 1993, Tong bought a failed cooperative bank which he merged with a branch of Singapore's United Overseas Bank in the east Malaysian state of Sabah and folded into a listed company that became PhileoAllied. Later that year, Quek bought MUI Bank from another tycoon for 700 million ringgit and listed it. The renamed Hong Leong Bank was capitalized at over 4 billion ringgit.

The speed of the two bankers' acquisitions was attributed to their political connections, since they had leapfrogged over several other tycoons applying to own a bank. Malaysia's strict banking laws require prior permission from the central bank before a businessman can even begin negotiations with another bank owner. The central bank, in turn, reports directly to the finance minister. "These guys were close to Anwar and they could be paying the price for it," says a Western diplomat in Kuala Lumpur. Tong and Hong Leong declined to comment for this article.

Just as there are losers in the merger stakes, so are there winners. One of them is Multi-Purpose Bank, a small institution controlled by businessmen widely  viewed by analysts as being close to Finance Minister Daim. Designated an anchor bank, Multi-Purpose will swallow 11 other institutions, including PhileoAllied and RHB Bank, which is eight times its size. That will boost Multi-Purpose's assets to almost 100 billion ringgit from 7.7 billion ringgit in 1998, making it Malaysia's second-largest bank. Foreign bankers and banking analysts say Multi-Purpose's selection will reinforce  perceptions that, for all the corporate restructuring going on in Malaysia, the nexus between business and  politics is alive and well. Daim didn't respond to a faxed question about whether he may be leaving himself open to allegations of conflict of interest. He has denied government interference in any bank, saying it is merely "a perception."

But the lack of transparency in decision-making merely  fuels speculation about political overtones. Opposition  leader Lim Kit Siang, for example, asks whether the mergers will result in banks being concentrated in "the hands of a few closely linked to the powers-that-be." Then, he says, "all this talk of cronyism won't go away."

The fear is that the superbanks will be under pressure to lend money to national projects that may not be commercially driven. The head of a European bank in Kuala Lumpur thinks the merger plan negates the success of Danaharta and Danamodal, the government agencies dealing with bank debt and recapitalization.  "Now you have three to four huge banks that are subject to government interference," he frets. "You're undoing all the good work by the government agencies in bank reform and going back to the old ways. What kind of signal are you sending?"

In interviews, bankers and analysts brought up other potential problems stemming from the merger plan:

Property rights.
Singapore's Oversea-Chinese Banking Corp., for example, holds more than 20% in Pacific Bank, which is to be merged with Maybank, Malaysia's largest bank. "How can anyone force OCBC to sell?" asks a local economist. "It could veer dangerously close to expropriation."

Management.
Its sheer size means RHB Bank will own 73% of the merged entity led by Multi-Purpose Bank. Similarly, Arab-Malaysian Group will have over 54% of the group to be led by Perwira Affin Bank, which is owned by the Armed Forces Pension Fund. "It's absurd to ask the minnows to manage," says the European banker. "Both Arab-Malaysian and Rashid Hussain have generally good management, although    they've made some serious mistakes."

Job losses.
Bankers estimate the mergers could axe up to 20% of the banking industry's 70,000 jobs. That means 14,000 people could be laid off nationwide just as the economy is emerging from its worst recession in decades. "All my colleagues are scared," worries the manager of a leading finance company in Segamat. "They wouldn't mind getting transferred out, but everyone knows there will be job losses."

Real-estate prices.
The already depressed property market could take another hit: A third of the 2,700 bank branches could be closed; many of them are leased.

Not everyone is pessimistic about the mergers, though. "What's the alternative?" asks  Azim Mohamad Zabidi, chairman of National Savings Bank and a senior official in the ruling United Malays
National Organization. "The central bank has been trying for years. Some of these owners have got egos as large as their assets. So dictate, and be done with it." The National Savings Bank will see its commercial-banking unit merged into one of the superbanks, but Azim will remain head of the state-owned Post Office Savings Bank, which has been left out of the mergers.

Closures of indebted banks are out of the question because of what central-bank Governor Ali calls "high social costs" in terms of job losses and lost deposits. There also seems no likelihood that Malaysia will throw the field open to big-league foreign competitors before 2003. That might induce local banks to merge in order to compete, but it's an option that's anathema to Mahathir Mohamad, the intensely nationalistic prime minister.

Measured against the weak supervision of bank regulators elsewhere in Southeast Asia, moreover, Malaysia's central bank appears to be bursting with initiative. "I look at Western central banks and I think Bank Negara is heavy-handed," says a foreign banker in Singapore. "Then I look at Thai banks and I go 'Well, maybe they're being pro-active.'"

Despite the April deadline, how long the mega-merger will take to complete is anyone's guess. "For mergers to work, you need time and an enormous amount of goodwill," says the European banker. "It's a stupendous management challenge." It will involve disputes over fair valuations and difficulties in meshing different operational systems and corporate cultures. And, as international ratings agency Moody's Investors Service says in an August report: "Political considerations,
which are a paramount feature in Malaysia, will significantly complicate and delay the process."