Forced bank mergers: Who wins and who loses?
Merging a weak bank with a strong bank without addressing the issues that caused the weak banks to fail in the first place might bring down both the banks
On 2 April, the World Bank published a report titled 'Bangladesh Development Update, Special Focus: Strengthening Domestic Resource Mobilisation'. The report expressed concerns about the hurried bank mergers, saying that such moves might exacerbate the current crisis.
"A consolidation process will require careful assessment and prudent implementation of procedures to avoid weakening good banks acquiring bad banks. An assessment of the asset quality of weak banks will be required," the report stated.
"Rapidly implementing bank mergers before addressing these issues may further undermine confidence in the sector, deterring intermediation capacity," the report added.
Experts in the country have also been calling for a more cautious approach to bank mergers as the process is too complicated to be rushed.
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Mergers can be a way out for banks who have not been managed properly, as they might piggyback on the stronger banks. Nonetheless, if governance cannot be ensured, the financial sector will continue to be plagued by mismanagement.
Merging two weak banks might not create a stronger entity, while strong banks are unlikely to be interested in absorbing the liabilities - particularly bad loans of weaker banks - without significant government subsidies.
Merging a weak bank with a strong bank without addressing the issues that caused the weak banks to fail in the first place might bring down both the banks.
The Bangladesh Bank introduced the prompt corrective action (PCA) framework on 5 December 2023, under which the forced mergers would be conducted.
Recently, Exim Bank has taken over the struggling Padma Bank. Bangladesh Bank has also asked four state banks -- Bangladesh Development Bank Ltd, Sonali Bank Rajshahi Krishi Unnayan Bank and Bangladesh Krishi Bank -- to combine their operations in its bid to reduce vulnerabilities. Up to 21 out of 61 Bangladeshi banks could be classified as weak and targeted for mergers.
A complex task
Mergers are not common in Bangladesh's financial sector. Bangladesh's last successful merger was in 2009 when two specialised banks, Bangladesh Shilpa Bank and the Bangladesh Shilpa Rin Sangstha, merged to form Bangladesh Development Bank Limited.
Before that, in 2000, Standard Chartered and ANZ Grindlays Bank merged together; and Mohammad A (Rumee) Ali, who was the country head of ANZ Grindlays, oversaw the process.
After the merger, he took over as the CEO of Standard Chartered Bangladesh, before moving on to Bangladesh Bank as the Deputy Governor.
He said, "Merger of banks is a highly complex process with spillover into human and social elements, besides the direct economic impact. Having experienced a merger and being very closely involved with it, I know how difficult it is to pull it off, even with two successful banks. With a weak partner, whether the marriage is forced or willing, it takes on even greater complexity."
Dr Saleh Uddin Ahmed, former governor of the Bangladesh Bank, harked back to the collapse of the Bank of Credit and Commerce International (BCCI). When the global bank collapsed due to irregularities and mismanagement in 1991, its Bangladesh wing was also affected.
After restructuring of ownership, Eastern Bank Ltd, BCCI's Bangladesh chapter, was established in 1992 with 100% Bangladeshi ownership. It has since been operating successfully as one of the country's well-performing banks.
"We have positive examples of successful restructuring in our country, such as Eastern Bank, but we must ensure that the influence of struggling banks does not jeopardise the stability of stronger institutions," he said.
A successful merger hinges on a thorough assessment of both banks' assets and liabilities to ensure smooth integration. However, even a well-executed merger might not address the root causes of the problems.
Political influence in bank approvals, loan sanctions and appointments, along with concessions offered to loan defaulters and negligent officials, are factors contributing to the current state of affairs as well.
The World Bank report also pointed it out: "Given the high prevalence of NPLs and undercapitalised banks, additional tools will likely be required to address vulnerabilities, including strengthening corporate governance, and introducing stronger financial safety nets such as modern least cost resolution tools for insolvent banks, and stronger deposit insurance."
Dr Saleh Uddin Ahmed thinks that unless governance is ensured, the problems in the financial sector will remain. "It's a welcome move to merge banks but getting its outcome is complex. The predominant issue in our country is the lack of implementation of laws, even when they exist," he said.
"Our banks are weak, and our institutions are weak. Any policy change implementation, including successful merger, will be hard because of the weakness of our institutions. Unless this is solved, the disease will persist," he added.
In order to solve the governance issues, Bangladesh Bank has issued a guideline on 5 April. As stated in the guideline, board members and top executives of the banks and financial institutions involved in the merger would not be allowed to have any position in the acquiring company. This may ensure better management by getting rid of the ones who failed to manage their banks properly.
Rumee Ali supported the notion as well, saying, "The main issue with our industry is governance, lack of robust systems and processes, and a strong regulator able to exercise its authority independently for the benefit of the economy."
Stakeholders at risk
The merger process may also have negative consequences for shareholders, depositors, and employees of weak banks. Shareholders may see their ownership stake diluted, depositors may face delays in accessing their funds or even experience losses, and employees may lose their jobs due to branch closures.
And such a damp mood is evident in the market, as the investors are looking at the merger of weak banks with strong banks negatively.
After the merger of Padma Bank with Exim Bank, the latter's shares slipped 3% below their face value. The very day Exim Bank signed the MoU, its shares dropped to Tk9.70 at the Dhaka Stock Exchange (DSE) from a face value of Tk10.
Rumee Ali explained the trend, "Since the market has revalued the price of the share downwards, this means they [investors and shareholders] have judged the merger as not only adding any value, but also reducing the bank's value. Unless the market recovers, every shareholder will lose money."
Bank mergers will also require an evaluation of internal systems, branch networks, staffing levels, adequacy of management arrangements, impacts on banks' cross-border business and international risk ratings. And the perception of banks' strength must be ensured among the public.
He said, "Customers' perception of the status of a bank is an important factor of its strength and it lies at the core of the trust the bank enjoys. This must be protected throughout the merger process of strong banks. People do understand that a weak bank can take a strong bank down unless proper safeguards are in place."
Where is the accountability?
Given the high prevalence of NPLs (non-performing loans) and undercapitalised banks, additional tools will likely be required to address the vulnerabilities. And the weak banks must be brought under scrutiny lest the mergers should appear as letting them off the hook.
"It is an unexpected policy response to one of the most vexing issues of our financial core. There are other policy options and action steps that would be more appropriate. These could take into account the wrong doing, negligence and uncalled for indulgence shown by banks/other decision makers to those who have participated in some of the largest fraud/con games of this sector," Rumee Ali added.
Dr Saleh Uddin Ahmed said liquidation of banks is more important than reorganisations such as mergers, to salvage the problem-ridden banking sector.
Rumee Ali also supported the notion of liquidating weak banks, saying, "It makes economic sense and would also be the right thing to do as far as social justice is concerned, because it would make the ones who own the bank responsible. They would be held accountable by the liquidator through a legal process because they have defrauded the depositors."
"However, the rebranding/merger process which is being put in motion, will protect these powerful people," he said, adding, "The other negative is, if the unprovisioned NPLs are large enough to wipe out the equity or erode the equity of the parent bank, it could be an existential threat to the merged bank."
Shadique Mahbub Islam is a journalist working at the Business Standard.
Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard.
