DealMakers AFRICA Q1 2020
The Rationale for Consolidation in Banking
by Gauri Gupta
The era of consolidation in the local banking sector is here, with more than eight M&A deals announced in Kenya over the last 15 months. It is an exciting time that will undoubtedly provide a solid foundation for the growth in this sector.
A leaner, more efficient market provides a number of advantages, ranging from sound supervision by the regulator to attractive products and services for the customers.
The ultimate objective of any merger is to enhance the value of either the acquiring entity or the merged entity, and this has become even more relevant against the backdrop of the increased globalisation that has followed an economic liberalisation, increased regulation in the financial services sector, a technological revolution and unprecedented changes in financial markets across the world.
The instability, uncertainty and fast-changing business environment have altered the ways and means in which banks conduct their business – there is thus a need for continuous restructuring, and re-engineering business models, requiring development of new and innovative products and services, increased investments in technology to keep pace with, or to move on to better, more robust and efficient technological platforms, and the adoption of new distribution channels.
Consolidation in the banking industry, while being guided by the factors mentioned above is, however, largely synergy-driven to achieve an increase in the profitability and performance of the combined entity where 2+2 = 5. This becomes possible not only by saving on operating costs realised by economies of scale, and increased revenues from cross-selling, but also by the complementary strengths of the merging institutions, an increased customer base and geographical spread, and reduced competition.
The overarching theme, however, remains the desire to make the merged entity more efficient, not just in terms of the efficiency ratio (measured by the bank’s overheads or operating costs as a percentage of total revenue), but also in terms of banking operations. Banks are increasingly required to have in place an elaborate infrastructure to ensure adequate and appropriate frameworks for internal control, risk management, compliance, governance and management of the information technology and information security platforms. Upon consolidation, the merged entity is able to more effectively and efficiently consolidate and administer these operational infrastructures. Even from a credit risk perspective, a larger bank has a lower aggregated risk profile since a large number of similar risk-level complementary loans decrease overall institutional risk.
Occasionally, acquiring the talent pool and skilled human resources of another small bank could be one of the motivating factors in undertaking a merger.
From the Central Bank’s viewpoint, consolidation is encouraged, given that it enhances the safety and soundness of banking institutions and improves the allocation of credit.
It is, therefore, no surprise that there has been a notable increase in bank mergers, not only in Kenya but across the globe, over the last three decades.
In the US alone, consolidation in the banking industry resulted in the number of banking and savings organisations declining by 51% during the period 1984 to 2006. Europe, too, saw similarly hectic activity. During the period 2001-2005, the total number of EU credit institutions decreased by 12% while assets increased by 33%. In Latin America, similar trends were noted in Argentina, in Mexico following the banking crisis in 1995 and, to a lesser extent, in Chile and Colombia during the late 1990s. In Asia, Malaysia and Indonesia successfully and actively encouraged consolidation in the banking sector during the period 1996 to 2003. Similar trends were noted in Korea and Japan.
Closer to home, in Nigeria, the regulator-driven consolidation resulted in the number of banks reducing from 89 to 25 between 2004 and 2006, successfully unlocking the sector’s potential by creating bigger banks with better capabilities to drive down costs and, riding on the back of rapid economic growth, allowing them to penetrate a larger portion of the unbanked population.
A report prepared by McKinsey in mid-2010 claimed that there were 430 M&A deals involving financial institutions in Africa during the period 2004 to 2009. Of these, about 40% were cross-border, with the acquirer originating elsewhere in Africa or outside it. Banks in South Africa are especially busy gaining footholds outside their home market.
This tells us that, in the new world, consolidations will continue to be the weapons used to enhance the value of the banking sector as it races ahead to deliver value for customers.
Gupta is a Director at I&M Burbidge Capital in Kenya.