Merger and Acquisitions (M&A) is a widely used business strategy for restructuring through consolidation among two or more organizations into a common objective or a complete takeover of one organization by another. The reason for this is usually to help achieve competitiveness, promote efficiency, reduce cost and/or increase profit. M&A, as a tool proves to be an efficient one to facilitate consolidation in the financial system. This has helped reshape the banking industry across the globe. Originated in the US, during the early 1980s, the M&A was amplified by the Asian Financial Crisis of 1997-98 and the Global Financial Crisis (GFC) of 2007-08. After these crises, the banking industry underwent a period in which banks focused on establishing a resilient financial system and enhancing risk management. As a result, regulation concentrating on the increasing capital base and the merger of the Banking and Financial Institutions (BFIs) was introduced across the world.
The establishment of Nepal Bank Limited (NBL) in 1937, commenced Nepal’s formal financial sector. However, till mid 1980s Nepal’s financial system remained underdeveloped and concentrated as only state-owned financial institutions were in operation, that were located largely in urban cities. With the adoption of the liberalization regime, the financial system in Nepal witnessed an increase in private sector participation. Policies related to expansion of financial access and availability of resources in rural areas were introduced resulting in significant growth in financial institutions in the 1990s and 2000s. Despite, BFIs’ rapid growth in Nepal, the banking system was labeled to have a low volume of turnover, high-interest rate sensitivity, wide interest rate spread, inefficient management and a lack of capacity to finance large-scale projects. In addition, the financial system had displayed regional disparity and was more urban centric, which led to an inadequate and centralized financial inclusion.
Overview of Merger and Acquisitions in Nepal
In 2012, the number of BFIs had reached up to 220, which included 32 commercial banks, 88 development banks, 77 finance companies and 23 Micro Finance Institutions (MFIs). In comparison to the size of Nepal’s economy, the number of BFIs was high. This led to an unhealthy competition among the BFIs for deposit collection, loan disbursement and a growing share of bad loans causing issues of underperformance of BFIs. Thus, Nepal Rastra Bank (NRB) introduced Merger Bylaws Policy in 2011 to enhance the capacity of banks for healthy competition among foreign counterparts which were anticipated to enter the market. NRB also introduced various regulatory provisions such as acquisition bylaw in 2013, which later integrated into merger and acquisition bylaw of 2016. The monetary policy of 2015/2016 increased the minimum paid capital by four times for the financial institutions. In 2015, commercial bank paid up capital was NPR 4 billion, which has increased to NPR 18 billion in 2021.
NRB has made continuous efforts to encourage mergers of BFIs through annual monetary policies. There are incentives provided in terms of relaxation in regulatory ratio. Policy such as relaxation in maintaining cash reserve ratio (CRR) and credit to capital and deposit (CCD) ratio were introduced to incentivize a merger. This would allow BFIs to have access to additional liquidity, allowing them to increase their lending as well as help them with business expansion. Relaxation in sectoral lending targets would also help banks to focus their lending on the lucrative sector rather than having to meet the regulatory requirement of NRB.
NRB’s continuous attempt has led to noteworthy progress in reducing the number of BFIs through a merger which has created stability and credibility. The number of BFIs engaged in merger as of mid-March, 2022 has reached 239, out of which 177 BFIs’ license have been revoked. Currently, there are 27 commercial banks, 17 development banks, 17 finance companies and 66 microfinance institutions. The merger has improved the financial position of weak institutions when merged with a strong institution.
Reasons for a Merger
The banking industry is one of the most regulated industries in Nepal. With the decreased number of BFIs, it will allow NRB to carry out its supervisory role smoothly. The decline in the number of BFIs through mergers can reduce unhealthy competition. Furthermore, there is a limited supply of fresh deposit available in the market, causing a liquidity crunch, pushing BFIs to compete to attract deposits by offering higher interest rates, which gives rise to an unhealthy competition among each other. Higher competition can reduce lending standard and lower profitability of banks. Such poor lending standards can impact the stability of the banking system.
Many BFIs with a small capital base are unable to invest in large infrastructure projects. Through mergers when banks combine, their capital bases increase, further increasing their ability to lend for projects that require a large investment. A higher number of BFIs also means higher operating costs, which reduce profitability of the BFI as each BFI possesses a number of fixed assets such as buildings, and infrastructure. However, with mergers, these costs can be reduced through layoffs, reduced number of location and equipment, technological advancement etc.
Challenges of Merger
Despite merger being the ideal solution to problems faced by the banking sector, it has its own set of challenges. The main challenge of merger would be finding the right partner to merge with. The right partner would help achieve long-term goals and the terms of the merger would align the two parties, leading to an easier formation of a newly merged BFI. Decision to set a swap ratio for the purchase of share during a merger of BFI between the parties, also pose as a challenge. Additionally, mergers have an impact on employees, customers, and various stakeholders who are associated with the two said parties. Employee management is a crucial process after a merger as human resourcesare the major component of any organization and their work systems and policies may experience fundamental changes. Disputes can arise during an adjustment period between the employees and management regarding job role, job security, remuneration, compensation etc.
Conclusion
For the past many years, mergers of banks and financial institutions have been beneficial. Mergers have resulted in the growth of credit and deposits along with higher earning power and strengthening of risk management capacity. The consolidation of poor performing banks with strong performing bank have created competitive and standard financial institutions. For further growth of the sector, there is a need for discussion among the regulatory bodies and BFIs to create plans and policies accordingly. Banks and regulators must exhibit some degree of flexibility to promote growth and stability. Furthermore, to encourage banks to pursue merger and acquisition activities, the government should take a supporting role and provide effective incentives.
Pragati Karki is a recent BBA graduate of the School of Business of the University of Kathmandu (KUSOM) with a major in finance. Her interests include financial analysis, risk assessment and accounting. Currently, she is working as beed fellow at beed management.
