By Shabiya Ali Ahlam
Top heads of the financial sector were recently brought on to one platform to share their thoughts on the widely-discussed topic of consolidation.
With financial sector consolidation being the hot topic in the industry at present, a forum organised by MTI Consulting saw nine top personalities of banking and non-banking institutions sharing their views in this regard. Amongst the nine top profiles was CB Governor Ajith Nivard Cabraal who graced the occasion as Chief Guest.
With the forum being the 10th of its kind to take place since the announcement for consolidation made earlier this year, the audience that consisted of members of the financial sector were able to gain first hand insights from these industry leaders.
Following are the excerpts of individual comments made during the panel discussions on ‘Synergy and Strategy’ and ‘Structure, Staff and Systems’.
National Development Bank CEO Rajendra Theagarajah
Cabraal points out possible challenges resulting from financial sector consolidation
Since the announcement for consolidation that was made earlier this year, the Central Bank (CB) has continuously extended its support to ensure the process takes place in a seamless manner.
However, despite the assurance on the process taking place with minimal negative impact, Central Bank Governor Ajith Nivard Cabraal at the MTI forum on financial sector consolidation highlighted few possible challenges that could arise in the near future.
He pointed out five challenges that are likely to pop up and shared ways in which they could be addressed, both at the regulatory and institutional level.
First he said will be the tax challenge. Noting there is a deep commitment from the political hierarchy to go forward with the scheme, he stressed there must be tax neutrality and tax incentives. “There cannot be a tax burden that is caused to anyone as a result of this exercise. The tax laws will be framed in consultation with the private sector. We need to make sure there is no burden but at least neutrality, and at best an incentive, that will provide for the consolidation to take place,” said Cabraal, delivering the keynote address.
The second is in ensuring there will be no weak institutions and with the consolidation the companies will only be made stronger. The Governor assured that if there will be a weaker institution the CB will step in to strengthen it further, ensuring that the final outcome will be a stronger institution or a stronger combined institution.
The third is tackling labour issues. Referring to the commitment given by the Government where it said the number of staff members will not be reduced, he stressed the sector cannot grow by retrenching today and searching for people tomorrow. “That is not a good way of handling consolidation of this nature. We are a growing country and we will see many people coming into opportunities as a result of growing the economy and sector. We have to ensure that those who have got proficiency in this area are retained for the future. In order to retain them we need to ensure there is no retrenchment now,” said Cabraal.
He added that in the short term there might be instances where someone might believe there is some benefit that could be realised as a result of some retrenchment, but the CB went beyond that short term vision, to a medium and long term one. “We find that there is no need to do that since there will be ample opportunities that would be created as a result of the growing economy and the sector that also has to be catered for.”
The fourth challenge will be in the area of valuation where issues are likely to pop up. To address this issue the CB had put forward certain guidelines that would serve as a basis for the valuations to be done. The guidelines were essentially drawn up to ensure uniformity and that companies will understand the perspective of both, the buyers and sellers view points.
The fifth challenge will be regarding ownership. The Governor assured that this issue is also dealt with in a manner that is satisfactory to all the people. However, he didn’t go into the details on ways in which this issue will be addressed.
Cabraal emphasised that new business models will have to be evolved. According to him it will be a business model that will bring synergy and that will ensure that there will be a higher level of accountability, governance, stability where newly emerged institutions are concerned, and this needs thinking and support which has to be factored in all the consolidation processes.
While it is imperative to ensure that the business itself is transformed smoothly, he cautioned that one of the greatest challenges is that there can be issues that will most likely crop up from a personnel and leadership point of view.
“There will be the soldiers who will be retained, but some of the generals will have to be axed. So when the generals are to be axed they will not take it too kindly and they may also have certain ways in which the whole situation will be adjusted. In a way that could delay the process therefore such also have to be nurtured through. It is a sensitive situation. This requires finesse and skills which need to be put in place and that is where all of you will have to put your thinking caps on. To ensure that this is a seamless transition into something new and exciting and something that is sustainable for the future,” Cabraal told audience.
Having pointed out the challenges the Governor expressed they cannot be resolved overnight since there will be new ones that will crop up and those require engagement. “That is where you will have to continue with your process to make sure the tremendous potential that our economies has and will have in time to come,” he expressed.
I would say that this is a done deal as far as the banking sector is concerned. I see this as a one off opportunity which is too good to be missed. In that perspective I think there is one misconception which should be cleared, that this is a regulatory driven initiative. It is not. It is more of a regulatory enabled initiative.
I will be surprised if anyone pretends to have the answers in doing this on their own. The use of advisors and consultants are certainly important. In doing that, one has to make sure that the move to situations will be alike and one must have to customise solutions. They should be homemade. They should make sense to your shareholders, and to other stakeholders, including employees.
Sri Lanka is a small market and good way of handling this is to create a space in improving the environment. Take some of the slack in the first year or two and then through natural growth absorb the surplus. But most importantly from a shareholder and stakeholder perspective. Given the sponsorship and the encouragement from the regulatory authorities, the way I would like to urge people to look at this is not in a short term view where two plus two makes four, but to look at as how two plus two will make it to a six, seven, and eight.
For that, whether it is a valuation exercise, weather it is a shareholder rationalisation, or whatever it is, do not to look at the immediate gain, but to look at what can be gained from the destination model and business. That I think will make the difference between success and failure.
The Finance Company Chairman Preethi Jayawardena
I think the consolidation is going to bring about large banks and large non-banks with strong balance sheets. It will encourage enhancing systemic stability and this in turn will boost the long term economic development of the country.
We know that we are marching towards the $ 4,000 per capita and a $ 100 billion economy by 2016, which we obviously reach before the set time frame. Therefore we need all the sectors of the economy to grow.
I would like to dwell into the non banking sector. Imagine 49 companies plus nine leasing companies, 58 together, competing for business. There is so much acute competition that nobody follows a live and let live policy. All wants to live if possible by cutting throat of the competitor. That is not going to do well to grow the business and that is what is happening.
What we wanted were a few companies with strong balance sheets. The problem here is that we did not have a proper capital structure. Ideally a finance company or a bank should have 1/3 in equity, 1/3 in long term debt and 1/3 in short term. But unfortunately due to the weak balance sheet of most of these companies were not able to raise the long term capital. They were predominantly dependent on the short term funds for deposits.
What they didn’t understand was that because of this acute competition even if one goes under, what will be the impact? You will have a negative impact across the board. When CIFL went down there was a negative impact. The public perception towards the non-bank sector was negative and therefore no one wants to deposit money in a finance company. That is what happened. Now with this consolidation, happening is that all the finance companies are going to have stronger balance sheets. Of course the regulator is going to monitor quite closely. With strong balance sheets they will be able to raise funds cheaper, at lower cost. Now when this can be done they will be able to invest that money, that too at cheaper rates.
Today what happens is that when we don’t have access to funds we need that money to be invested. If we cannot get cheap funds, then we cannot get proper investments. We have to give it out in proper investments rates and that means we have to take undue risks which will result in NPLs. Now with the synergy what happens is that with strong balance sheets we can raise funds at lower costs. We will definitely be able to increase the volumes. This is because the banks cater to the upper segment of the economy and the finance companies must be there to develop to the middle and lower end. If we don’t develop that end the inequality will widen.
Even at the CB Annual Report presentation the President during his speech said he is happy with the development but expressed fear in the inequality widening. Therefore finance companies are necessary to cater to the middle level. Most of the people in that segment do not have bank references and accounts. That segment has to be serviced. When we have cheap funds we can equally service the middle level and that will augur well. With that we will be able to improve the business through synergy. Once the synergism takes place the strategy will fall into place. With that about 90% of the problems are sorted out.
Nations Trust Bank Chairman Krishan Balendra
At a high level the process that we are going through, there are different types. In the more developed markets we have seen bank consolidation has been driven by the need to drive efficiencies, cost reduction, business expansion, and essentially to drive better shareholder returns. We have had examples such as Malaysia after the financial crisis where the regulator had to step in and force consolidation to avoid a repeat of what happened in 1997.
When we look at some of the pitfalls that we could have, it is important to put in context the process we will and are going through. It is hybrid that we are going through since it is a regulator enabled consolidation. We are not enabled the need to drive shareholder return. The regulator is not forcing this. It is encouraging to hear the Governor say that ultimately what the regulator wants is for the one plus one to be more than two. That is a very good starting point.
Another point, not wanting to be negative, is that most statistics research indicate that majority of bank consolidation have failed to deliver shareholder value. We need to also focus on all those issues because they are very real and history seems to show that majority of such consolidation have been value destructive.
The strategic fit is obviously critical. There are various types of strategic fits. There are mergers and acquisitions where institutions are expanding their reach through branches in new geographic areas, or where a company is brought since it may have products which the purchasing institution is not offering. That is an incremental acquisition. An example of that is where NTB in 2009 merged with Mercantile Leasing. Until then very few banks were into leasing and it brought a significant portfolio into NTB and that has been quite good for the bank.
The other type of merger would be eliminating overlaps, and by doing so there is a significant opportunity to create value.
In that process you have to be unemotional about it. In that, some of the key issues are people decisions and it goes right to the top. Most research show that the joint environment does not work. There has to be one boss and those are hard decisions that have to be made in the best interest of all the stakeholders.
The other is the issue on valuation. This process started a few months back and there have been discussions from potential target companies and the valuation expectation of some owners are ridiculous actually. They are putting three to four times the book value. These are institutions that established about two or three years ago so what was done to add value to the capital invested within that period? So again the CB has intervened and brought some sense to the process by getting independent value. This is important since that is where the CB will have to play an enabling role to make sure sense prevails. When going back to that issue that most consolidation worldwide or majority being destructive, the starting point has to be the valuation. There is no point in having synergies, strategic fits and eliminating overlaps if you begin with a very high valuation.
A macro issue also pops up when you consolidate banks. When you end up with a significantly fewer number of banks, some economies have shown that it can create an oligopoly effect. In post consolidation you actually see lending rates gradually going up, deposit rates going down and margins for the banks improving, which is obviously not good for the economy. So that is also something that we will have to watch out for.
Central Bank of Sri Lanka Assistant Governor C.J.P. Siriwardana
This is the 10th public seminar on consolidation. This shows the interest shown by various parties and stakeholders, and well as the players in the market to educate and gain better understanding on this subject.
As the Governor mentioned, we announced the master plan on 17 January and since then we have been working very closely with the partners. We have 58 finance and leasing companies, and 22 local banks. Altogether 72 institutions and that is too much fragmentation in the market.
That is the whole idea of the consolidation. Looking at the future of the economy, where we hope to be a $ 100 billion economy by 2016, to cater to that future requirement, we prefer to bring in the reform ahead of the requirement time.
We can achieve much from this consolidation if we can get the right partner. From the overall process we have requested the big banks and big finance companies to acquire and merge with the small finance companies. That is the plan in the overall consolidation process.
But finding a partner is very important so the entire synergy depends on this. You have to look at the characteristics of the owning company as well as that of the partner. Only when the characters match one another you can get synergy. In that process you have to look at key areas, such as loan structure, IT systems, accounting systems, and other features of the two companies.
Therefore finding the right partner is critical and we need to ensure we are not lost in the process. There are some companies that are searching all over for entities to merge with, and I am sure they will end up with none since they are taking too much time. Some of the smaller companies are also asking for too much of a premium. At the end of the day there also is a time frame and they will have no partner by the end of that.
The most sensitive and critical factor in this situation is the valuation. That is why the CB is stepping in by having a professional process for the companies and based on that the negotiation process can start.
In the buying and selling process it is necessary to look into the soft factors, those that are difficult to take into the valuation process. With that they can ask for a fair value for their company.
I must also share that in the first deadline that was given to submit the proposals, 31 March 2014, all companies have submitted their proposal within that date. And this indicates their willingness to actively take part in the process.
We are also sure we can finalise the valuation process since the nine auditors selected to undertake this process, will submit the reports by 2 May. This will be shared with prospective buyers and by the end of second quarter we will be able to finalise the second round of the matching process.
Union Bank of Colombo Director/CEO Anil Amarasuriya
Once you have chosen your partner or partners, you will have to do a lot of re-engineering. Do not look at tomorrow but look 10 years ahead. Look at what you are going to achieve based on the strategy and what you want to do in the five to 10 year horizon. In doing that it is important to get your structure right.
Get outside experts to come in and do the structure for you. And after they do the structure from ground zero, the two teams will have to sit with these experts and modify the structure somewhat, but not to meet their own liking. So the structure is very important. After you do the structure then you will have to think of fitting in your staff and the other institution into that stricture.
The next most important thing is the IT systems. I don’t think there is any bank or finance company that is not using technology today. Manual ledgers are all gone and everybody is on high-end technology. Now to merge that technology is a big challenge. So you will have to get outside experts to come and see whether the technology, software systems, and the hardware, can be used in the merged entity, or whether you have to discard everything and buy new systems with new hardware.
Whatever you do, it will take time because system migration normally is done once in 10 years. It will be difficult to do the system integration and then stabilise the system. So you have to plan for a 10 year horizon. Get outsiders to come and tell you if the software is good enough for the merged entity and good enough to take you 10 years forward. Or to say that the software and hardware are not good and to get new ones. That is a huge cost, it is not cheap. And whatever has already been invested has to be written off. That will have to be built in when doing the valuation. So the software and hardware integration and the structure with the staff are very important. Also be mindful that immediately after any merger there is lot of unforeseen tinkering and fine-tuning that will have to be done. Get a separate team to do that so you can clear the merger issues that will crop up from the time you start the merger process.
DFCC Bank CEO Arjun Fernando
I would like to first present a general comment regarding the timing of the consolidation. If you look at Tiger Woods when he became number one in the world, he changed his golf swing and everyone questioned that. For this his answer was that in order to sustain it is imperative to change.
In that light I would say that the financial services sector is strong and it is a good time to re-strategise and get into a consolidation mode. Because when you are strong, you can afford to make mistakes and take calculated risks, whereas when your back is against the wall, you don’t have that luxury.
I am a firm believer that structure has to be in line with the strategy. If you look at organisations in Sri Lanka today, the number of layers, there may be about 10. We need to see if there is value addition taking place right throughout. And if you were given a clean sheet of paper to draw an organisation structure, will you draw it the way it is today?
I believe that when you get the structure right and if you get the strategy right, there will be ample opportunities for staff. In that, they need to re-skill themselves and be able to be agile in terms of the changing needs of the new structure.
On the systems side I agree that we need to try and match. For this we need to look at IT systems and business processes which is relevant and far thinking as to what it should be in the future. So you shouldn’t have any emotional attachment for any current systems. There may be a need to look into a new system altogether.
I was fortunate to be a part of a business transformation with an international bank from 2010 to 2012. There the lessons learnt were that they went through a de-layering process. They went from a structure that had 13 layers to an eight layer model. They achieved a lot of synergy and they found staff at senior level doing two to three rows in the new structure. I guess in that the learning point was that they didn’t really think through the whole strategy. In the next month or so they were re-hiring in another area of the business. I think the key here is that if you have the strategy very clear you can minimise the disruption and the unpleasantness.
Sampath Bank MD Aravinda Perera
Tackling the 5S in consolidation: Strategy, Synergy, Structure, Staff and Systems
In an attempt to share with the members of the financial sector on certain view points on the on-going consolidation process, MTI Consulting CEO Hilmy Cader at the forum shared ways of ensuring effective integration and synergies in this regard.
Addressing an audience that consisted of senior and professionals of the industry, Cader presented his views on the topics ‘Strategy and Synergy’, and ‘Structure, Staff and Systems’, where he identified pitfalls and best practices that the sector should be mindful of when going forward with the consolidation process which was initiated earlier this year.
Drawing from the experiences from countries in the South Asian region that had undergone while going ahead with the consolidation, Cader pointed out that many markets had seen a drop in management focus due to being occupied with the merger process, thus resulting in the regular operations of the business to be neglected.
With valuation being a key step in the whole consolidation process, Cader noted that a pitfall to guard against in this regard is not adequately looking at the intangible assets. Particularly in emerging markets, hidden knowledge exists in grass root level in areas relating to the entire eco system. Very often in the transfer process some of this knowledge does not get transferred, which results in the assumptions made for the valuation process to get lost. “Looking at some of the intangible aspects when one does the valuation is a pitfall we have seen where the synergy is concerned,” noted Cader.
He added that when looking at the quality of the loan portfolio, particularly in markets where they may not have perfect or near perfect information; soft information not factored into the process is another area to be mindful of.
In terms of best practices that have been observed in previous consolidations is the setting of specific KPIs during the merger process and having people in the organisation who are dedicated and responsible to these KPIs as opposed to it being a part-time responsibility in addition to the regular operations. Such include risk factors, customer satisfaction, shareholders and operational aspects.
Cader opined it will be useful for merged entities to look at a fresh strategic planning exercise and carry out its functions assuming it is a new business instead of working on an average of trying to combine two business plans together.
Areas to be concerned in this regard include customers, channels, the basis of competition, the new value proposition of the merged entity and ways of dealing with competition.
Looking at experiences in different markets it is observed that there is a tendency to continue to combine existing portfolio of customer and products versus considering a greater opportunity to rationalise portfolios.
One of the other pitfalls according to Cader that has clearly come out from different parts of the world is the tendency and reluctance to rationalise channels due to a lot of bottom up pressure. “Rationalising channels become a very important exercise and what is important is to look at the rationalising process as opposed to really giving into a lot of bottom up pressures,” he said.
Previous consolidations have also seen banks giving less focus in brand identity which led to many conflicts. Looking back at the post-merger history of bank around the world, there has been tendencies hurriedly put together acronyms from two banks. “One of the learning that you can take from lot of the banks outside financial institutions is that there is a lot more focus that goes into the new brand identity of the new entity or the merged entity,” noted Cader.
In terms of best practices, Cader opined it is an “excellent time” for institutions to re-strategise and very objectively rationalise customers, channels and products. “With the new entity there will a lot of overlaps of channels and products and customers, and this is a greater opportunity to go ground zero, look at the market and really rationalise customers, channels, and products,” he added.
The first pitfall to guard against when looking at structure is to forfeit one structure to another, which could result in creating additional layers.
Another area that institutions should be cautious about is the designing of structures around key people and personalities. “You need to address the staff issues and need to be unemotional when you look at the structure. Do not let staff aspects dictate what is best for the organisation,” cautioned Cader.
It is also necessary to be mindful of is larger financial institutions dominating the structural thinking. Just because the second entity has a small structure does not mean it is bad. There could be learning from that structure as well, he noted.
One area to keep an eye on is the existence of unwritten informal organisational structures in the midst of formal written structures. These are very often ignored in the merging process and can lead to a situation where there are lots of loopholes, particularly when the transition takes place.
Touching in best practices, Cader opined it is important to go ground zero on the structure instead of trying force fitting them together. “Virtually treat it has two businesses, without two limitations and look at the market and say what would be the best structure to serve this entity as opposed to trying to fit both together. For this to happen it is important to have joint teams from both sides. Successful mergers have seen this,” he pointed out.
Companies should be cautious during the selection process and should look into objectivity and transparency. Hard decisions are to be made and if the objectives and the selection criteria are clear, then it becomes easier.
It is a challenge to fit all staff into the structure, therefore it is important to not force all into the current structure and look at what is best.
One issue that arises when going through mergers is that when senior management are pre occupied with mergers, valuation, and bringing the process together, they tend to focus less on staff issues. “This is where experience shows that the systems implementation falls through the crack when the senior management focus tends to be on the bigger picture and the day-to-day operation gets neglected.
To ensure the process takes place in a seamless manner it will be useful to announce to the staff as to what the new structure is going to be, the selection criteria, selection process, and the VRS, if there will be, need to be clearly laid upfront to reduce ambiguity. However, this has to be done without compromising the transition during integration.
One of the pitfalls in this regard is addressing the systems before the human-ware, particularly the HR aspects. Transition teams are very useful in such situations since integration of the system can lead to a lot of preoccupation and the on-going business tends to get neglected.
If anyone asks me what the most valuable asset I have, I will say it is most definitely my staff. So it is correct to say that HR should come before the structure.
Informal organisation are important since within a formal structure there is an informal organisation happening. In some places both work together and there is synergy there itself. So when it becomes two organisations, it becomes two formal and informal organisations. One has to be mindful of the fact that informal organisations in some places are very strong. You have to take it in a positive manner.
So if the merger has to work, firstly the HR has to merge and that means both formal and informal organisations will have to work together to gain the synergy.
The second is that there are opinion leaders and opinion seekers in an organisation. Lucky is the CEO who happens to be an opinion leader as well. But it doesn’t always happen that way, so again, people who are doing the merger will have to appreciate the fact that there are opinion leaders in the organisation. So make them work for you rather than against you.
The third is the communication itself. To what extent and what time is critical. To what extent are you going to divulge information,and where do you stand in front of the senior staff, as well as others. It is important we handle that right from the beginning. The critical information has to be discussed at the correct level at the correct time. You need to also be careful as to how you are going to handle branding since a lot of change is going to happen to it in the next couple of years. When the merger process continues, lot of names will disappear and lot of names will come in. How within that total sphere of the branding are you going to maximise your brand is also very important to think about.
Hatton National Bank MD/CEO Jonathan Alles
I am trying to be positive and optimistic but to bring a slightly different perspective – I see a lot of bank CEOs here – I say do not merge.
It is not that I am negative and don’t see this as an opportunity, I just say that at the end of the day we will mess it up right royally. So what we need to do is keep the holding structure and keep our banks and not try to bring finance companies into banks.
It is time to take some parts of businesses into the finance companies and there are lot of inefficiencies in the way we do some of our work.
That needs to go out. Like all said this is a done deal and we needed to make the best of it. How you make the best of it is not by bringing a finance company into a bank, but by taking out some of the inefficient processes, products, and structure. The ideal structure is that.
I am still looking at how the one plus one will come in the branding, the parent strength,better risk rating and pricing. All that comes in with a stronger parent. But if you try to bring in merged structure, merged people and talk of bringing systems together, you are not going to get anywhere. Rather you focus on driving that finance company separately and efficiently.
My personal perspective and my recommendation to all my colleagues is, don’t touch it. At the end of the day keep it separate. Run it, bring in the corporate value. Where is the value addition? As a banker your value addition is that you have been regulated.
As a banker there is a lot of governance in the way you do your work. That is sadly what is missing in some of these companies so bring that goodness into it. The fact that it is there, it makes for a stronger finance company. It will bring the cost of funding down and you can also pass on the benefit to the customer.
Finance companies have better models in selling and better models in recovering. I would rather outsource some of my banks recoveries to the finance companies. We spoke of surplus staff. We could use them in different areas.
There will be new gaps almost immediately. You do not have to wait for the eventual outcome.
I am looking at scale and that is where you need to look at strategic stretch. That is where you get the value. To look at stretch you need to find what should be done at a finance company level and at a bank level. The stall can be mobile and can move in between but you don’t have to play with the structures.
I am not saying the bank structure is right, it is wrong. So is the finance company structure. As much as they are efficient, they also need to change. The technology part needs to come in, be it mobile banking or different aspect. It needs to get into their model.
That is where banks can help. They need to have their ideas as themselves but where they are lacking is the balance sheet strength and a bit on the governance side.
So the easy one is the one where the bank gets involved. The difficult one is actually to segregate this, where you drop banks and only talk of finance companies and you then allocate them to four groups.
You have category A and then B. In the A category you have an A+ and an A-, and then a B+ and a B-, the easy one is the A+. It is a fantastic company and most of them have got decent stakes in banks. Let alone banks trying to take over finance companies, they are really good.
Those companies are looking at acquiring two, three, four other finance companies and they get bigger. Then you have a pretty good A- actually which can stand on its own and can look at acquiring certain B+ institutions.
Where I see a challenge and mismatch is when three or four B+ gets together. It can be chaotic. For this the ground zero planning will be necessary and it has to be facilitated.
It makes a lot of sense to bring someone from outside to bring these parties together. These discussions are taking place at the moment.
The easy answer on B- is that on the day one you acquire to close it down because that might be the most value adding in terms of the holding company. You have to be very careful in bringing that company on board.
On banks, I would like to see a structure where the banks own finance companies, and to the latter its goodness, but leverage all the strength of the finance company. Not only to do the work of the finance company but also to outsource work of the bank.
But the change that you like to see is operating it more efficiently and bringing in more technology. The model, structure, and people will change not because of the consolidation. The banks can be changed in the way they are operating now and the finance companies need to change the way they address the growing market going forward.
Pix by Lasantha Kumara