Benefits of mergers in banking sector

By Alex Tawanda Magaisa

THE prevailing crisis in the financial sector has prompted calls for comprehensive investigations and major reorganisation of financial institutions. This article profiles and assesse

s the role of mergers and acquisitions and how they are connected to the improvement in the quality of corporate governance.



Mergers and takeovers


Basically, a merger involves a marriage of two or more companies. A merger can be effected by mutual arrangements or more frequently by means of a friendly takeover which involves one company acquiring the ownership or control of the other company. The dominant company taking control is called the acquiring company and the company being taken over is the target company.


On the other hand a takeover can be hostile in the sense that the management of the target company vigorously resists the overtures of the acquiring company. In that case, hostile takeovers often lead to hard-fought and costly battles as management of the target company fight to protect their interests. It is necessary in such situations to ensure that the defensive tactics that are adopted by the management do not hurt the economic interests of the company and other stakeholders.


Types of mergers


There are at least three types of mergers, which are: horizontal, vertical and conglomerate.


Horizontal mergers take place between companies at the same stage of production or firms producing essentially similar products or services. These are the most common as they often produce the desired results with limited complications. Previous examples include the mergers between PG Industries and Johnson & Fletcher, Zimnat and Lion Insurance companies and the one between First Merchant Bank and Heritage Investment Bank in the late 1990s.


Vertical mergers involve the marriage of companies at different stages in the production process. This happens for example where one company is a supplier of goods or services to the other and the merger might result in improvement of the flow of production. Sometimes the differences between vertical and horizontal mergers are subtle such as the mergers involved in the creation of the African Banking Corporation or the takeover of the struggling Universal Merchant Bank by CFX.


Conglomerate mergers involve the marriage of companies in unrelated industries. The aim of this type is to diversify the company’s activities and spread risk by engaging in a number of economic activities. This was quite common during the era of the closed economic set-up post-UDI and pre-Esap hence the formation of such conglomerates as TA Holdings, Anglo-American Corporation, LonRho, Astra Holdings, Delta Corporation. Many of these conglomerates began to break up in the Esap era as market requirements called for concentration on core-areas of operations.


Significance of mergers


It is generally accepted that mergers pro-mote synergies. The basic idea is that individual companies will create more value when combined than as independent entities. Economists refer to the phenomenon of the “2 + 2 = 5” effect brought about by synergy. The result of the combination is greater than the sum of the entities trading separately. The resulting combined entity gains from operating and financial synergies. Operational synergies generally refer to gains in economies of scale and economies of scope.

Economies of scale refer to the lower operating costs (per-unit) arising from spreading the fixed costs over a wider scale of production and economies of scope refer to the utilisation of skill assets employed in the production in order to produce similar products or services.


In a combined entity, the skill used to produce separate and limited results will be used to produce results on a wider scale. Additionally, financial synergies refer to the effect of a merger on the financial activities of the resulting company. The cash flows arising from the merger are expected to present opportunities in respect of the cost of financing and investment. The argument is that combining two firms gives rise to savings in costs, maximisation in the use of resources and increase in revenues. For banks in Zimbabwe mergers can also present opportunities for acquisition of new technology and introduction of new lines of products and services thus enhancing efficiency.


Quality


It is believed that the market can be a major monitoring tool and takeovers play a crucial role in this respect. When a company is not performing as expected others will notice that the assets of that company are not being put to their most efficient use. The acquiring company will believe that under new management those assets could be fully-utilised to produce better results. To that extent mergers and takeovers play a crucial economic role of moving resources from zones of under-utilisation to zones of better utilisation.


In order to avoid being a target for takeover, managers are forced to adopt good corporate governance to operate more efficiently. Poorly run companies are more prone to being taken over by the powerful and managers have an incentive to ensure that their company is governed properly and resources are used to produce maximum value.

Takeovers in the banking sector will ensure that the boards and management of institutions will improve corporate governance to avoid being targets in future. Additionally, the consolidation of entities will increase the pool of directors available for non-executive positions.


Requirements


In the banking sector, companies are enjoined to meet certain capital adequacy and liquidity requirements. Some banks may have poor and inefficient capital structures or they may have poor management whose policies tie up resources in non-performing assets. In order to meet the regulatory requirements, it may be necessary for the numerous players to come together, pool their resources and form a single well-capitalised institution.


Prior to 1990 the traditional banks such as Barclays, Zimbank and Standard Chartered generally dominated Zimbabwe’s banking sector. The economic reforms introduced deregulation and liberalisation in most sectors of the economy and this brought in several avenues for entry by new players. The financial sector was the most affected as it witnessed the entry of numerous institutions many of which were owned by indigenous Zimbabweans.


A number of them such as NMB, Kingdom Bank, and Trust Bank initially came in as merchant banks which call for less onerous requirements and gradually transformed into commercial banks over time. It was good because it increased competition and consumer choice. It also challenged the monopolistic behaviour of the old banks and prevented their excessive abuse of their economic power. However it also introduced new problems. A number of financial institutions have fallen under or faced serious problems such as FNBS, Universal Merchant Bank and United Merchant Bank.


Most problems are related to poor corporate governance and poor capitalisation. If the Reserve Bank of Zimbabwe (RBZ) implements the Basle Accord II capital adequacy rules to the letter many of the small institutions might fail to meet the requirements. Mergers will improve their capital structures and increase revenue-generating avenues which will also help them to gain market power that can be essential in competition against the powerful foreign-owned banks.


Skills consolidation


The entry of new banks in the financial sector challenged the dominance and skills base of the traditional banks. In particular it meant that there was intense competition for skills which were scarce in the relatively small and conservative sector.


Traditional banks lost key employees to the new entrants and examples include the flow of employees from MBCA to the newly-formed NMB in 1992 and the loss of key personnel from FMB during the same period. The new players appeared to offer better packages and greater opportunities for career progression.


Similarly in the present crisis it is possible that key employees will take flight from those banks that are perceived to be standing on shaky ground. Mergers are significant because they bring together the skills and increase efficiency. They also help to retain key staff who may perceive more stability in a merged organisation. By bringing together sparsely-distributed skills, mergers enable greater utilisation of resources under a single roof.


Spaces creation


The liberalisation of the financial sector also had the effect of widening consumer choice which led to the loss of clients by the traditional banks to the new banks. For parastatals and individuals it was also politically correct to bank with the “indigenised” banks. The new indigenous elite flocked to the new banks which offered seemingly better investment opportunities.

Similarly, the present crisis has seen massive bank-runs leading to capital flight as depositors flee from the unstable indigenous banks to the better ones. In order to regain market positions and create confidence, the numerous organisations must come together to present more stable entities.

Mergers do not only reassure the market that steps have been taken to address the problems but they also consolidate the client base between organisations. Mergers enable banks to retain and regain lost clients and consequently assist in improving the market position of the consolidated institution.


Conclusion


Mergers and takeovers are likely to become more common in the financial industry in order to gain synergies and other advantages. There is intense debate over whether Zimbabwe is currently overbanked. It is significant that in a depressed economy in which so little core banking business was actually taking place, financial organisations were producing phenomenal profits. Either they were doing something very right or there was something fundamentally wrong which was taking place behind the scenes. With the current crisis, it is hard to resist the suggestion that there was something very wrong going on and the claims that there are far too many banks for the small market are not be easily dismissed.


It may be time for the small, under-capitalised and poorly-governed banks to merge and consolidate their operations. That way they will reassure the market, reclaim lost spaces, put their resources to efficient use and improve the quality of corporate governance.


Arguably mergers have their downside such as the reduction of competition and consequent losses but given the current scenario, there are more benefits to be gained from consolidation hence our bias to promoting mergers in the banking sector. It is vital to restore stability and confidence in the financial industry and that is one of the better routes to pursue.

* Alex Tawanda Magaisa is Baker &McKenzie Lecturer in Corporate & Commercial Law at the University of Not-tingham. He can be contacted at alexmagaisa@hotmail.com or alex.magaisa@nottingham.ac.uk