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In a move that caught everyone by surprised, BNM announced the accelerated merger programme (AMP) in which all the Domestic Commercial Banks, Finance companies and the merchant banks are to be merged into 6 Banking groups. The 6 anchor institution groups are Mayban, BBMB/BOC, Public Bank Bhd, Southern Bank Perwira Affin and Multi Purpose Bank. Eyebrows are raised over the choice of the last three institutions as anchor banks.

FEBFI is of the view that the merger is the right way forward, but we are extremely concern over the manner in which it is done, especially that the mergers must be committed by end of September 1999.

We must first state that contrary to the practice of most Central Banks when implementing a major policy, there appears to be no policy paper produced by BNM to justify the merger plans. What we have is a few press statements in July and August by the Governor. It is disappointing that the views of relevant quarters were not even sought, much less discussed and debated before announcing the AMP.

We submit this memorandum to BNM, The Minister of Finance, Minister of Human Resources, The Prime Minister, Association of Banks, Association of Finance Companies and BNM's professional advisers, including Smith Solomon Barney.

We seek to convince the relevant authorities that there is a need to review the merger plans in so far as to enable all parties to expresses the views and that the interest of all parties are taken into account, especially the Malaysian public. The AMP needs to be carefully debated

As mentioned, the BNM did not produce formal policy paper to clearly identify the rational behind the AMP. We can only examine the reasons as contained in the press release dated 10 August 1999 entitled Tax incentives for Consolidation of Domestic Banking institutions which is as far as possible quoted in toto.

We seek to address the following issues

A. COST SAVINGS & EFFICIENCY GAINS
B. GLOBALISATION
C. IS MALAYSIA OVER BANKED
D. ROLE OF SMALL BANKS
E. STABILITY OF THE FINANCIAL SYSTEM -BIG BANKS/SMALL BANKS 
F. REDUCTION IN COMPETITION 
G. HUMAN RESOURCES 
H. CONCLUSIONS & RECOMMENDATIONS

We hope that BNM will take in account our views and recommendations

ANDREW LO KIAN NYAN
GENERAL SECRETARY
12 September 1999

A     COST SAVINGS AND EFFICIENCY GAINS

1     The Governor of Bank Negara Malaysia, Tan Sri Dato' Seri Ali Abul Hassan bin Sulaiman today (10 August 1999) referred to his earlier statement on the merger programme for domestic banking institutions announced on July 29, 1999 and emphasised that the merger exercise will not, in any way, weaken the financial strength of the merged entities. In fact, the creation of the six domestic financial groups will ensure that the domestic banking institutions will be able to withstand pressures and challenges arising from globalisation and from an increasingly competitive global environment. This move towards consolidation is in line with the Government's policy not to bail out weak companies but to rationalise businesses towards higher productivity. Business consolidation through merger is indeed a common practice globally to achieve economies of scale and higher productivity. 

18    The merger is also expected to bring about greater efficiency to banking operations. The same extent of banking services can be provided to the whole country at lower costs due to savings on manpower, information system and reduction in branch network.

1. Evidence that bank mergers result in efficiency gains is mixed and there is no clear link between bank mergers and improved efficiency.

2. In a study of 9 US bank mergers, only 4 showed clear evidence of improvement in cost efficiency, despite significant cost cutting Research had also showed that banks which had undertaken mergers cut cost more slowly than banks which had not been involved in mergers. This is blamed on the management of the merger process getting in the way of cutting costs 

3. Cost-savings resulting from bank mergers are often confused with efficiency gains. Clear efficiency gains should be demonstrated in any proposed merger.

4. Bigger does not necessarily mean better for customers. There is some evidence that bigger banks mean bigger fees and also customer service seems to drop away. In Australia there is now a huge outcry that bank mergers means worse service. The public outcry is so alarming that the Australian Bankers Association has to pay off a popular radio talk show host AUD1.2 million to try to ward off criticisms. 

5. 'Experience has shown…that while some mergers may achieve significant cost-savings they are not guaranteed and many mergers do not achieve them. It should also be noted that mergers are not the only means of achieving such savings. Others include outsourcing and joint ventures.' (Wallis Inquiry)

6. Efficiencies resulting from bank mergers and cost-savings resulting from mergers are two different concepts. As pointed out by the Wallis Inquiry, efficiency effects of a merger are typically measured by an expense ratio. Cost-savings are measured only by reference to savings in gross expenses. In terms of benefits to the community it is efficiency gains which have the greatest implications for the real long-term performance of the industry .

7. In mergers, cost-savings are relatively easy to achieve e.g. folding together two IT systems. Efficiency gains are more difficult and require extensive managerial skills. Difficulties include management of different customer-bases, blending differing cultures and the managerial quality of the new institution.

8. 'For example, while an in-market merger is bound to result in cost-savings when neighbouring branches are closed down, this does not necessarily indicate improved efficiency in the long-run. The point is, unless cost-savings arise from improved institutional efficiency, the public may not benefit from the merger and any improvement to the bottom line is likely to be short lived' 

9. Most empirical evidence is from the US. Most of the US evidence is inconclusive. A paper on bank merger performance published by the Board of Governors of the US Federal Reserve concluded that after reviewing 39 studies on post-merger performance:
'…the findings point to a lack of improvement in efficiency or profitability as a result of bank mergers.' 
'…efficiency indicators such as cost-to-asset and cost-to-revenue ratios remain steady or actually deteriorate.'

10. A 1992 study devoted to mega-mergers published in the Federal Reserve Bank's Antitrust Bulletin concluded that:
'…mega-mergers were not very successful on average in improving cost efficiency in banking.'

11. The evidence is also mixed on whether bigger banks actually bring benefits for customers. In terms of customer service, smaller banks typically rank ahead of bigger banks, e.g. the continual top customer service rating of Taranaki Savings Bank. A survey of US banks released in August 1997 shows that bigger banks charge significantly higher fees than their smaller rivals. 

12. We have a very good example in Malaysia where, a Big international bank is charging RM50 for a "marked cheque' while a small local bank is charging only RM5- ten times more expensive. A Telegraphic Transfer to Singapore cost only RM10.00 compared with RM25 for the big bank.

13. There is also no clear advantage when it comes to cost to income ratio between big and small banks.

14. In Australia the Australian Consumers' Association have claimed, 

'Bigger should mean better and cheaper. But after merging most of these banks have decided to take the money and run. They're charging whatever they can get away with and it's meant higher fees.'

'There is a very distinct price difference between smaller banks and bigger banks and that distinction has created an alternative in the US which also is distinct and no longer exists here. And that is the majors versus the other players which offer a different kind of competitive pressure, not just based on service, relationships, accessibility, a whole range of factors' .

15. It can be seen, therefore, that mergers does not necessary bring about improvement in efficiency. Those who asserted that there would be should demonstrate them, before they are allowed to merge.

B     GLOBALISATION

2     In this time and age of globalisation, banks must merge to survive the onslaught of greater competition. The need to merge is even more imperative in the face of increasing pressures under WTO for countries to open up their financial markets to further entry of foreign banks. All countries are now moving towards consolidating their banking system and Malaysia cannot be the exception. In fact, Malaysia cannot be seen to fall backward in the consolidation of the banking industry. 

16.    At the same time, the merger allows for smaller financial institutions to participate in a much larger banking group. To the extent all the six banking groups are listed, anybody can buy bank shares from the market. The racial issue should not arise at all. In the previous merger exercises involving Kwong Yik Bank, Sime Bank and even Bumiputra Bank, no issue was raised that it was racial. The same should apply now. What is important is to ensure banking institutions will remain in the hands of Malaysians, now and in the future. 

1. Not all banks in Malaysia need to compete globally. There is a role for small banks to operate, as seen in many countries, including US, UK & Australia & CANADA. In countries dominated by big players the government as allowed small banks to operate, and provide a choice to customers.

2. One must however to be careful in being drawn in nationalistic arguments. In Australia, there is the same argument that Australian institutions need critical mass to avoid being taken over by overseas groups . This is related to the argument that mergers are necessary to create national champions, an argument that has been noted as somewhat tenous 

3. Even if all domestic banks are merged into one big bank it is still tiny compared to the financial giants. The total assets of local banks, amounting to RM352 Billion for Commercial banks RM123B for F Co and RM39B for merchant banks are negligible when compared with assets of the world biggest banks.

4. Therefore, merger as a defence against foreign takeover is not supported by strong evidence. On the contrary it will be easier for foreign banks to take over one big merged bank than 6 to seven smaller banks. We are doing house cleaning for the foreigners before they move in.

5. Instead of merging into one bank, the various banks can be consolidated within a banking group with each able to operate independently with its own markets (similar to Kwong Yik and Maybank) this will generate internal competition, migration of best practices and, provide the stability. It will reduced branch closures and allow the group to reach out to and larger market and cross segment.

6. This has worked out successfully in Netherlands (Rabo Bank) and the credit unions in Canada. 

We note that this appears to be the direction envisage by BNM 

C     IS MALAYSIA OVER BANKED?

5     With 71 banking institutions prevailing in the country today, there are 2,712 branches located all over the country. There is clear view that Malaysia is over-banked and some resources are wasted due to duplication of branches in the same locality.

6     While the number of banking institutions in Malaysia remains large, other countries have succeeded in consolidating their domestic banks into a few large and competitive banking groups. For instance, the United Kingdom has 4 major banking groups, Australia has 4 major banking groups and Singapore has 5. In the case of Singapore, the Government intends to reduce the number to even 2.

1. From the above figures Malaysia have only 1.36 Bank Branch per 10,000 people, while Australian have 3.8, New Zealand 3.6 Canada 3.3, UK 2.7 & USA 1.96. We have about the same as Singapore. It must be noted that Singapore with a 100 % urban population with a first class transport system has about the same number of bank branch per 10,000 people when compared to Malaysia with a large portion of its population in the rural areas. We submit therefore that Malaysia is not over banked.

2. The argument that Malaysia is overbanked, often used to justify the merger process, also does not hold water given that historic profitability data indicates that the current banking system is well matched to the country's credit allocation needs.

3. The overall historic profitability of Malaysia's banks as measured by the return on average assets is spot-on regional averages. Interest margins at Malaysian banks have also been broadly in line with regional averages In addition, boosting the profitability levels of Malaysian banks was the fact that the industry's operating costs were only about 70% of regional averages.

7     The experience of these countries has proved that consolidation in the financial sector is both viable and desirable. The IMF too has forced countries under their programmes (Indonesia, Thailand and S. Korea) to reduce the number of banking institutions by effectively closing them down.

8     Malaysia does not believe that the IMF prescription of closing down the problem banks is the way to go, as the social costs involved in terms of dislocation of resources are high. A more reasonable approach adopted by us is guided merger, with the Central Bank playing a proactive role in solving the issues involved and the principle of fairness will be strictly applied to all parties in the merger. 

4. Branch closures due to mergers and branch closures due to banks closing down have the same negative impact and social cost to employees in terms of job security and to the pubic in terms of accessibility to banking services, are no different.

5. Contrary to the received wisdom bank branches are not dead. A branch network is a key element in a successful distribution strategy. Branches provide a valuable platform for the distribution of bank products and services. Customers like branches.

6. In an effort to cut costs banks run the risks of closing too many branches and so cutting out the revenue opportunities provided by these branches.

7. In New Zealand the issue of branch closures periodically receives significant publicity, especially when the 'last' bank in the community closes. In some people's view a bank branch does more than provide a financial service to a community; it provides a status and stability to that community - hence the hurt when the bank closes.

8. In Australia this issue receives far more prominence than in New Zealand and significant community opposition has been mounted in various communities (mainly rural), around retaining branches. Arguably it was this sort of opposition that frightened the Australian government from taking up the full recommendations of the Wallis Inquiry.

9. While the debate still goes on about the future of branch network most Australian and NZ; banks are now committing to their branch network as part of their growth strategy:

'The erroneous conclusions we have seen recently about costs and efficiencies (from closing branches) lead to similarly heroic assumptions about our need to slash staff and branches'. (Don Argus, CEO, NAB)

'The branch network has a huge role in the future as well as today'. (Don Mercer, CEO, ANZ)

10. Any merger will inevitably result in a net reduction of branches. Our concern is that, in the drive to quickly realise the costs of the purchase, a bank will close down too many branches in order to show quick cost-saving returns. These returns may have little to do with the longer-run institutional efficiencies that any merger should be capable of showing.

11. Branch overlap had surprising little positive impact on increase efficiency due to mergers. Merged banks with the greatest branch overlapped showed the least positive gains.

D     ROLE OF SMALL BANKS

9     Without the merger, the small non-Bumiputera financial institutions are likely to disappear as a result of globalisation and increased competition. There is actually no more place for family-run banks to survive in the long run. It should be emphasised again that no small banking institutions can survive once the financial market is opened up. There is no place for family type of management in a modern economy, especially in financial institutions.

1. The evidence is also mixed on whether bigger banks actually bring benefits for customers. In terms of customer service, smaller banks typically rank ahead of bigger banks, e.g. the continual top customer service rating of Taranaki Savings Bank. A survey of US banks released in August 1997 shows that bigger banks charge significantly higher fees than their smaller rivals .

2. The Australian Consumers' Association have claimed:

'Bigger should mean better and cheaper. But after merging most of these banks have decided to take the money and run. They're charging whatever they can get away with and it's meant higher fees.'

'There is a very distinct price difference between smaller banks and bigger banks and that distinction has created an alternative in the US which also is distinct and no longer exists here. And that is the majors versus the other players which offer a different kind of competitive pressure, not just based on service, relationships, accessibility, a whole range of factors' (supra)

3. Malaysia has a sizeable rural population and different levels of development in different regions, especially those in the east cost of Pen Malaysia and in Sabah and Sarawak. There is still a need to have small banks that understand the local conditions and able to serve the particular need of small business and depositors.

4. 'Malaysia, with its wide variety of industries with unique funding needs spread over a large geographic area, would be better served by a mixture of small and large banks allocating credit in a more efficient manner. It is difficult to see how centrally determined credit and operational policies can efficiently allocate credit throughout such a disparate economy'' .

5. Already we have seen big foreign bank closing down branches in small rural towns and move than to high-density urban areas. If this goes on, very soon the rural rears will not have any bank branches. This has happened in Australia where there are only 4 big banks, plus the international banks that are reluctant to invest in an extensive rural branch network.

6. In UK and US small banks are flourishing and are offering a very important alternative to the bigger international bank. Not all Malaysian Banks need to compete globally. Bank of Granite, a small US bank with 12 branches and US550M in assets is a case in point. . 

7. Evidence in US also points to the fact that small banks have a higher proportion of their assets in loans to small businesses than larger banks. 

8. In Malaysia the small and well-managed banks and finance company are performing a very useful role and service to the small bushiness and rural communities. Removing them will encourage money lending to be driven underground and the increase in loan sharks

9. By having just 6 big banks, the small businesses and borrowers would be squeezed out of credit facilities. Already, some big foreign banks in Malaysia have policies of going up-market in their customer's base such as credit cards holders, depositors and borrowers. Some banks are offering minimal interest rates to small deposits as well as not extending credit facilities or credit cards merchant arrangements if their business volume is below a substantial level

10. Small business should not be confused with the Small & Medium Scale Industries (SMI). SMI are much larger industrial undertakings than the small traders, contractors, retail outlets, small holders and farmers which provided crucial services and employment to hundred of thousands of Malaysians.

E    STABILITY OF THE FINANCIAL SYSTEM -BIG BANKS/SMALL BANKS

12     It should be noted that despite the progress achieved thus far in bank restructuring, the non-performing loans (NPL) still remain large. For instance, on the gross basis, the NPL of the banking system amounts to RM72 billion on 3-month basis and RM53 billion on 6-month basis. The portion for finance companies is RM20 billion and RM14 billion respectively. Without comprehensive merger, it is possible these NPL could threaten the stability of the banking system in the future, with the smaller financial institutions dragging down the bigger ones. 

13     The problems faced by smaller financial institutions have appeared to be relatively predictable. Due to their inefficiency, they tend to offer higher interest rates and compete aggressively for deposits. They tend to price their loans higher to pay for higher deposit rates and get high- risk borrowers because good borrowers go to bigger and stronger institutions with lower lending rates. In the end, whenever economic problems set in, the small institutions get hit first. This was what happened to DTCs and finance companies in the past, and is threatening to bring down smaller banks now. The only viable solution is for a merger which removes smaller financial institutions from the market.

15     ……the cost of bailing out banking institutions in the future will be even higher without the merger. The recent bank restructuring exercise has cost the Government about RM60 billion In addition, the Government had to spend RM2 billion to rescue Deposit Taking Cooperatives (DTCs) in the 1980s. It is difficult to envisage that the Government will continue to be rescuer of banking institutions in the future as the risks are likely to be higher and amount of funds involved, larger.

1. Danamodal figures showed that the financial institutions require recapitalisation by Danamodal . are the big and medium size banks and finance companies. Out of a total of 6,2 Billion, 4.6 Billion went into the Arab Malaysian Banking Group, RHB and MBf Finance. Non of the small family owned bank require any capitalisation and their performance are far better than the big banks.

2. Further Malaysia's second biggest bank, Bank Bumiputera needs to be rescued twice while the biggest Finance Company MBf finance has to be placed under BNM control.

3. "Underlying the Malaysian Central Bank's initiative is the belief that larger banks are stronger. However, most of the system's smaller banks - whom this exercise is designed to eliminate - have come through this and previous downturns in the best shape. Contrary to expectations, many of Malaysia's smaller banks have emerged relatively unscathed from the regional crisis while many of the larger players were hit badly". 

4. One must appreciate that a big bank may be too big to fall and the cost to rescue it will be much higher. The LTCB failure in Japan is a case in point.

5. Large banks with major market share can become too big to fail, and the government may be forced to bail them out to avoid consequent economic disruptions and the cost to taxpayers will be significant. Such big banks might be even encouraged to take greater risk, knowing that the government would be likely to bail it out.

6. The consequences of a big bank failure are much greater. This is because the individual banks, being bigger, are more likely to have significant exposures to each other, so that the failure of one bank might render the other banks also insolvent (as a result of their inability to recover inter-bank advances. Where banks are small this will be less of a problem. The problem is compounded if there are only a few big banks in the country, as it would mean that all the banks will have more exposures to each other 

7. What prevents bank failures depend on management ability and the competent supervision by the authorities, and as seen in a lot of countries- the prevention of political interference in granting of loans. Size is hardly an indicator of stability of a bank. Even if the chances of a big bank failure are less, the consequence of a failure will be more damaging than a small bank

8. Management skills and competency and integrity transparency are more crucial factors in determining the stability of the banking system.

9. Therefore there is little empirical evidence to support the solution to remove all the small banks from the market.

F     REDUCTION IN COMPETITION

1. Mergers will result in a significant reduction in the number of effective competitors in the Financial sector in Malaysia especially to small business and depositors.

2. The area of greatest concern is small business lending. In New Zealand, where three are only 4 big banks, these banks are choosing not to compete in this area. 

3. It is not unreasonable to conclude that increase concentration of a few banks in Malaysia might allow bank to increase their profit margins and increase the cost of financial services for bank customers.

4. In Australia, the big 4 banks have continued to increase their fees for financial services. In commenting on this round of increases one analyst stated;

'In line with most banks' strategies they are targeting the customers they want - the others can go to hell. It recognises that growth for growth's sake is not the way to deliver profits' 

5. He further noted that the strategy was risky because judgements had to be made about unprofitable customers who might become profitable in future. These comments apply equally to New Zealand.

6. It is easy therefore to predict that fees in New Zealand will steadily increase. Firstly, to continue the move of unprofitable customers out of branches and secondly, to begin to recover the real costs of the transactions and services. Differential pricing in favour of electronic transactions will be used to move customers out of branches. Then the banks will slowly increase the fees attached to electronic transactions. As long as all banks do this - move fees upwards together - then customers are left with little or no choice. Such a situation will rise in Malaysia if there are only 6 big banks.

7. We argue that banks occupy a special place in the economy. Industries that provide essential services and are dominated by a few large players tend to marginalise significant groups of consumers. This remains true even where there is a high level of competition - the industry targets only the profitable segments of the market, takes profit where it can, and engages in predatory pricing only where and when a new competitor emerges. Good examples are telecommunications and electricity.

G     HUMAN RESOURCES

14     In order to minimise the difficulties involved, particularly to those employed in the industry, an attractive separation scheme can be devised where the costs are borne by the merged entities. The Government could assist by giving some tax incentives to smoothen the merger process…

19.     ……In fact, the decision to hasten this merger programme is inevitable given the present increasingly competitive and globalised business environment. There is a pressing need now to push and accelerate the consolidation and merger process to prepare the domestic banking institutions to face the inevitable opening up of the banking sector to foreign participation. However, Bank Negara Malaysia is discussing with the merging banks to ensure retrenchment, if any, is minimised through redeployment. With the growth expected in the economy the expanded banking services may be able to retain a sizeable portion of the staff after rationalisation together with new job opportunities arising from the development of the domestic bond market. Even in the cases of retrenchment, appropriate compensation will be given to those affected.

1. Despite assurances by Ministers that redundancies would be managed through voluntary separation schemes, 400 employees of Amanah finance are already retrenched and BNM ignore our appeals. The package for the forced retrenchment offered is even worse than the Voluntary scheme offered by other banks & Finance company

2. BNM must ensure that the management accorded recognition to those merger entities to unions to represent employees, including executives. The acquiring partners must be compelled to absorb all staff of the acquired party with no loss adverse change in the terms and conditions of employment. Any redundancies must be addressed by Voluntary Separation Scheme.

3. The time frame of the mergers must be stretched to allow the market to absorb the retrenched staff. The expected growth and the domestic bond market will not take off immediately; the merger must therefore be staggered to minimise the impact.

4. It must be remembered that in Malaysia we do not have employment benefit unlike countries like UK and Australia when more than 4000 bank and building societies closed and 130,000 jobs have been lost in UK and 40,000 in Australia since 1990, principally as a result of mergers.

5. We welcomed the assurances by the Governor on 9 September 1999 that there will be no retrenchments even after the merger exercise. We will continue to monitor the situation very closely

H     CONCLUSIONS/RECOMMENDATIONS

11    It is also ironic that some analysts appear to question the motives of the merger, when they themselves were accusing Malaysia for not moving fast enough on the merger programme before. When good progress in bank restructuring through Danamodal, Danaharta and CDRC was evident early this year, most analysts changed their views of Malaysia for the better. However, the nagging issues raised were the lack of progress on bank merger. Now that Malaysia moves ahead with the merger, a few seem to doubt our intention. In fact, the need for rapid and major merger programme has also been one of the advice given by our professional advisers, including Smith Solomon Barney.

FEBFI accepts that mergers is the way ahead but given the numerous issues that need to be addressed, and it is still debatable what are the real benefits of mergers, we are urging BNM to tread carefully or we will play into the hands of the foreigners.

We submit that the accelerated merger plans be reviewed as follows:

1. Time frame to be stretch- to allow the employment markets to absorb the redundant staff as well as for the public to better integrate with the merged banks.

2. A group should be merged first and the effects to be scrutinized and study and the lessons learned will benefit the next mergers. Prospective anchor groups must bid for the right to be anchor groups and they must demonstrated the ability to lead and managed a merger to a successful conclusion and to achieve the objectives et out in the merger

3. A select number of small banks be allowed to continue to be independent. The selection must be based on geographical location of branch networks and track record

4. There must be conditions on branch closures- public access to branch network must not be taken away. Access to bank accounts and affordable financial products are basic necessities

5. Human Resource issues must be resolved with the involvement of all parties especially with the unions. Union recognition is a prerequisite for a meaningful discussion and dialogue. There must be a guarantee of no retrenchment but VSS

6. There must be a strong emphasis on management ability and competencies. There must be a clear post merger strategy. What is needed is professional management, greater transparency and no undue and unwanted pressures on the banks; be it to grant more loans to the stock market, or to merge; to propel the Malaysian Banking Industry into the new millenium. Political interference in credit decisions and management must be removed.

7. Mergers will only work if there is meaningful, thorough and transparent consultations with all affected groups. There must be public and meaningful inquiry. Failure to review mergers publicly and openly would tend to aggravate public concerns over whether they were getting a fair deal from banks.

8. Take-overs and mergers need to meet a test of wider public interest - including customer service and community needs.

9. It is easy to assume that mergers should be a good thing. It has been said about the Australia financial market:

"the replacement of many competing institutions by a few mega- institutions will lead to economies of scale that should result in cheaper fees for Australians . This has turn out to be fallacy.

10. Lastly to quote Dato Seri Mahattir Mohammed, our Prime Minister who was commenting on the national economic recovery:

. "There is no quick fix and the government is realistic enough not to expect them."

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