In 2002. This paper is organised asIn 2002. This paper is organised as

 

In view of the liberalisation and globalisation of the banking sector,  the consolidation of
domestic banking  institutions  in  2000
is  inevitable.  A fragmented
 banking system will  only 
 increase   the 
 vulnerability    of  the   financial   system 
 and 
 indeed   the vulnerability of the economy  as a whole, according  to Tan  Sri Dato’  Seri Ali Abul Hassan Bin Sulaiman, Governor of Bank Negara Malaysia
on August 1999. There is a
need for a strong and efficient banking  system that is resilient in order to support the financing needs of the economy
 so that the nation
can continue  to achieve  a strong and sustainable economy.

 

 

This paper investigates the effectiveness between
 pre and post  merger  effect of the domestic
mergers in Malaysia
banking institutions, which arguably is the precondition for sustainable  industry growth,  according  to  Tan  Sri  Dato’  Dr.  Zeti  Akhtar  Aziz, Governor
of Bank Negara
Malaysia on 20 August 2002.

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This paper is organised
as follows. Chapter 1   presents the introduction of the domestic bank mergers
 and the rationale
 behind
 these  nationwide  consolidation  exercises.  It
reviews  the  theoretical
 framework
 of domestic  bank  merger
 exercise
 and  merger theories.  Chapter  2 reviews
 related
 literature.  Chapter
 3  discusses  the  recent  bank mergers
 in  Malaysia.   Chapter   4  discusses   the  variables   used 
 in  our  research methodology  to discuss
 the effect of domestic  bank mergers  on the performance of Malaysian banks.  Chapter 5 argues the results and assesses the magnitude
 of the effect of the variables on the merger exercise.  Chapter 6 concludes the paper.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

II

 

 

 

PAGE

 

Acknowledgement.
 
Abstract.

.i
 
ii

Table of Contents

iii

 
Chapter One:
 Introduction

 

1.1  Problem Statement.

1

1.2 The Banking Industry in Malaysia

1

1.3 The Rationale for Local Bank Mergers

4

1.4 Merger Theories

6

 
1.4.1  Differential Efficiency

 
7

1.4.2 Managerial  Synergy

8

1.4.3  Financial Synergy

9

1.4.4 Operating Synergy

10

1.4.5 Pure
Diversification

11

1.5 Conclusion

12

Chapter Two: Literature Review
 
2.1 Introduction

 
 
13

2.2 Performance

13

2.3 Conclusion

17

Chapter Three: Recent Bank  Mergers in Malaysia
 
3. I  Introduction

 
 
19

3.2  Domestic Bank Mergers

20

3.3 Conclusion

28

Chapter Four: Research Methodology
 
4.1  Introduction

 
 
28

4.2 Methodology

29

4.3 Operating Performance

30

 

 

 

 

 

 

Ill

 

4.3.1 Return on Assets-ROA

30

4.3.2 Return on Equity

ROE

31

4.3.3 Cost Efficiency Ratio-CER

33

4.4 Pre Merger Performance Measurement.

33

4.5 Post Merger Performance Measurement.

34

4.6 Industry Average Performance Measurement.

35

4.7 Strength and Limitation of Methodology

37

4.8 Conclusion

38

 

 

Chapter Five: Analysis and Results

 

5 .1  Introduction

3 9

5.2 Performance Ratio – Return on Assets, ROA

39

5.3 Performance Ratio – Return on Equity, ROE

.42

5.4 Performance Ratio – Cost Efficiency Ratio,
CER

44

5.5 Analysis for the Ten Anchor
Banks

48

5.5.1 Public Bank Berhad

.48

5.5.2 Malayan Banking Berhad

.51

5.5.3 Southern Bank Berhad and Alliance Bank
Berhad
5.5.4 Hong Leong
Bank Berhad, Affin Bank Berhad
and

54

Bumiputra-Commerce Bank Berhad

58

5.6     Conclusion                                                                                                 
 65

 

 

Chapter
Six: Conclusion and Recommendation

 

6.1 Introduction                                                                                                    66

 

6.2 Recommendation                                                                                         
 66

 

6.2.1 Distribution Channel.                                                                    67

6.2.2 E-banking                                                                                     
 68

6.2.3 Enhancing Operational Efficiency
and Cost Competitiveness 68

6.2.4 Outsourcing Backroom Operations                                              69

6.2.5 Islamic Banking – Setting a Global Benchmark.                        70

 

6.3 Conclusion                                                                                                    
 71

 

 

 

References                                                                                                                         74

 

Appendixes                                                                                                                      
 78

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Chapter 1

 

 

 

Introduction

 

 

 

1.1 Problem Statement

 

 

 

Whether  or  not  bank
 mergers   actually   achieve  the  expected  performance  gams is a critical question.  Hence,  the objective  of this research  is to evaluate
 the effectiveness  of the recent consolidation  of domestic banking  institutions  (Bls) by Bank Negara
 Malaysia (BNM).  We evaluate
the effectiveness of bank mergers by comparing the performance of the banking
system before and after the mergers.

 

 

Our study  follows  that
 of Rhoades  ( 1986,  1990),  Srinivasin  ( 1992)  and Pillo ff (1996), which assess  the
pre-merger  and post  merger  operating  performances  utilising
 pre
 and post 
merger  traditional
 accounting
 data
 to
 generate
 financial
 ratios,
 such
 as the  most commonly used  measure  for bank  performance –  Return  On Assets  (ROA),  Return  On Equity (ROE) and Cost Efficiency Ratio (CER). 
Post merger data are compared  with
pre merger  data  to determine  the performance changes
 that
 took
 place
 upon
 the  transition period from pre merger to post merger.

 

 

1.2 The Banking
Industry in Malaysia

 

 

 

The
banking  sector
plays  an important role as a financial  intermediary and is a primary source of financing
 by mobilising  and channeling  the 
scarce resources  of the economy. These resources
 would then be used to their optimum  level in order to achieve maximum economic development  of the nation.  Malaysia’s banking
 sector had recorded
 a rapid and extensive  growth by building
 up branch  network  throughout  the country  aggressively,  is

 

 

 

able to deliver  specialised  value  added  banking  services  and products  as well as highly sophisticated range of facilities and increasingly flexible credit
activities.

 

 

Malaysia’s Bis comprises licensed institutions namely 
commercial  banks,  domestic  and foreign, finance companies,  merchant  banks, discount houses, money brokers
and Islamic banks,  which   are  licensed  under   the  Banking 
 and  Financial   Institutions  Act   1989 (BAFIA)  and supervised  by BNM, the Central
Bank of Malaysia.  Commercial  banks are the largest financial
entities and provide  the greatest
number of services  to both corporate and retail
customers  (BNM, 2001 ).

 

 

The measures 
initiated by the  World
Trade Organisation  (WTO) and General
 Agreement on Trade in Services  (GATS) have great social and economic
 implications
 on Malaysia’s landscape of its domestic
 banking
 sector.
 This
 move was  seen  as the
 start  of BNM  in embarking  on a widespread  awareness
 programme   of strengthening   the banking
 sector for
long term survival
and growth of the Malaysian  banking  sector via nationwide
 merger exercise. Thrust of the merger  and
consolidation programme  is a necessary  pre condition to create a core group of strong, efficient,  well capitalised  and competitive  domestic  Bis in order to achieve a more effective banking  system. The whole merger 
programme is to
consolidate the perceived  smaller  financial
 institutions with  the bigger  ones,  where 
the anchor banks are first chosen.

 

 

As a member  of the  World  Trade  Organisation  (WTO),  Malaysia  is  under  increasing pressure
to open up her financial 
markets  for greater foreign participation. Therefore, the need to push and accelerate  the consolidation and merger
process  is now very obvious  in order to survive
the entry of larger and more competitive
 foreign banks.

 

 

However,  the  domestic   banking 
 merger 
 pace  is   still
 considered   slow,  according   to

 

Governor of BNM,  10  August  1999,  Tan Sri Dato’ Seri Ali Abul Hassan  Bin Sulaiman.

 

 

 

As shown in Table  1.1  below, after almost two decades, the number of banks in Malaysia still remains relatively  large.

 

 

Table 1.1:  Total Banks in Malaysia

 

1980

1990

1997

1999

 
Commercial banks:

•    Domestic

21

22

22

21

•    Foreign

17

16

13

13

Finance Companies

47

45

39

25

Merchant Banks

12

12

12

12

TOTAL
 
Source: Bank
Negara
Malaysia,

97
 
10 August  1999

95

86

71

 

 

In February
 2000, BNM gave  approval
 to consolidate  the  country’s  fifty four domestic financial
 institutions  under   ten  
“anchor”  banks. The
 plan   expanded   on  an  earlier, controversial, directed  merger program  under  which  domestic  institutions
 had been told to  merge under
 six pre  selected  anchor  banks.
 This
 merger
 process
 was
 completed
 by March 2003
 (with  the  operational  integration  between
 RHB
 Bank
 Berhad
 and
 Utama Bank Berhad) and the ten anchor banks still stand as of today. Although managing
 to take huge steps
 forward,  one
 can
 argue
 to
 support
 the
 former Governor’s claims  of a
slow banking  merger
 pace,
 when
 comparing  Malaysia
to  a  more  mature  economy
 such
 as
Singapore,  which has only three  local/anchor banks – DBS, UOB and OCBC.  The main factors that attribute to the number
of banks being reduced will be discussed  next.

 

 

1.3 The Rationale for Domestic Bank Mergers

 

 

Bls merge for a variety of reasons:  to increase economic
efficiency, to  acquire  market power, to
expand into different geographic
 markets,  to enhance liquidity condition and
to pursue financial synergies.

 

 

The main motivation
of domestic mergers
 is  to search  for  economies  of scale.  Scale economies is particularly
important for merger
of small banks,
as small institutions aim to
achieve a critical mass to exploit synergies arising from size and diversification.

 

 

On the other hand, merger
of large banks often reflect a repositioning of the
institutions involved, that
is, the pursuit of size increase reflects the perceived  need
 to become  big enough for the domestic  market, increasing their market
power  (European  Central Bank,

2000).  Therefore, one of the requirements   to increase  the  size
 of the  merged  banking groups is  the  asset base at least RM25 billion
 funded by a minimum  shareholders’  funds of RM2 billion  (BNM, 
2001). The result had been proven
by
the ability of the domestic banks to withstand
pressures   and challenges   arising  from  an  increasingly competitive global environment.

 

 

In line  with  globalization,   the  banking 
 industry  aims  to  be  without   geographic 
 and territorial  boundaries,  resulting
 in unprecedented growth  in  competition, 
 the  continued liberalization
 of capital  flows,
the integration of national  and regional
 financial
 systems, and financial innovations. This further encourages
domestic banks to pursue mergers
and improve their acquisition strategy   as they
seek  to  outperform  one  another  and  also
outperform foreign competition.

 

 

Enhancing the liquidity condition is one immediate objective of the merger exercise. The liquidity position of the Malaysian banking sector remaine