M&A IN BANKING: BE VIGILANT
Aug 23 - 29, 2010
The repealing of Glass-Steagall Act of 1933 legislatively sponsored by Carter Glass and Henry B. Steagall in the aftermath of 1930 Great Depressions in November 1999 gave the speculative forces and free market capitalism a sort of free hand to wreak havoc on global financial system.
The Act drew a well-defined line between commercial and investment banks. Once this distinction was lost the Wall Street bankers joined forces to cross all limits for the sake of short term profits. Even after the subprime mortgage fiasco shook the very foundations of the global financial system the bankers hardly showed any signs of repentance. Instead they forced their respective governments to come up with hurriedly-thought-out, high-value rescue packages. This way the ordinary tax payers' money got way to the tills of high-profile private investors and bankers.
According to a Boston Consulting Group study, the wealth of private investors in 2009 stood at $112 trillion. Even after taking the biggest financial hit, the USA still boasts of housing the highest number of dollar millionaires (4,700,000) followed by Japan (1,200,000), China (670,000), Great Britain (485,000), and Germany (430,000).
As Goldman Sachs, one of the most renowned global investment bankers, announced their earning results, President Obama came up with his banking reform plan declaring "No bank or financial institution that contains a bank will own, invest in or sponsor a hedge fund or private equity fund." Obama's banking plan which might take years to become a law is being seen by the analysts as an attempt to safeguard the US financial system in the same way as Glass-Steagall Act was intended to do in 1933.
The restoration of historical line between commercial and investment banking might not be that easy as the Wall Street bankers, over the years, have changed into a lethal cartel power. How they respond to Obama plan remains to be seen.
Commercial banks, by the historical statute, are authorised to accept public deposits and make loans to business, commerce and industry. Alternative investments such as stock trading (including short selling), venture capital, buyouts, quantitative strategies, etc fall within the domain of investment banks, hedge funds and private equity funds. During the last two decades the free market capitalism has brought with it a wave of new financial products-known as derivatives-that have been used by the global financial sector to rack up profits at the expense of uninitiated common investors.
Pakistan's banking sector, operating under lax regulatory environment, made use of the opportunity either through buying of sizeable stakes in alternative investment institutions or by setting up their own subsidiaries and holding companies. The country's entire financial sector is owned and run by few selected groups who have a complex network of cross-corporate interests. They have become one of the most powerful cartel forces more ruthless and more lethal than the feudal forces of this country.
It is assumed that the unscathed emergence of Pakistan's banking system from the destructive onslaught of global financial crisis owes much to the system's lack of exposure to international financial markets. This may be partly true, but the actual immunity from the crisis came from the strength of their balance sheets. Banks have had been enjoying since long a banking spread of seven per cent plus. The banking spread in the country is the highest in the region like so many other highest(s) - SBP policy rate, inflation rate, poverty rate, illiteracy rate, corruption rate, to name a few.
Mergers and acquisitions are known as management strategic options to fight competition and increase market share. They essentially result in the concentration of market power. While limited use of this option under a well-regulated environment can be beneficial to the economy at large, its unbridled use can result in high-profile cartelization capable of tremendously improving corporate balance sheets on one hand and destroying consumer power on the other - through price monopoly.
Banking consumers are already under monopoly stress and further mergers and acquisitions will ultimately shatter their confidence and they will start looking for an exit which is already available to them in the form of national savings scheme. Any further strengthening of banking cartel may, therefore, bring about banking industry's downfall.
The bank ownership concentration in Pakistan has never been challenged by an effective regulatory system with the result that the much needed diversified ownership of financial institutions has ever remained elusive. The leading capital market players owning banks and other financial undertakings down the line have already discounted undue risk taking habits in yesteryears' cool and calculative banking community. The cross-ownership of commercial banks, investment banks, equity funds etc. presents a fuzzy picture of Pakistan's financial sector.
The fine functionary distinction among various financial institutions has blurred. Everybody appears doing every thing; banks trading on equity market, leasing and modaraba companies accepting public deposits, funds and investment banks making almost all types of investments, funds trying their hands at money and credit markets, etc. Perhaps, there is a need to redefining of plans like one Obama has visualised. There is certainly also a need to separate banking and investment functions to control speculation, diversify financial sector ownership, and to save the banking industry from a mass-scale consumer exodus.
The non-compliance of MCR condition by a number of smaller banks in Pakistan has heated up the debate for need of (forced) mergers and acquisitions. Although state bank, in view of the rampant recessionary onslaught triggered by the recent global financial crisis, has relaxed the minimum capital requirement for banks - by bringing down the required amount from Rs23 billion to Rs10 billion by 2013, yet the future of smaller banks looks in jeopardy as 10 of them have closed down their 60 branches across the country during the last financial year.
Is M&A the right answer to this problem? The attainment of financial security used to be the overriding concern of state bank and it certainly has the right and power to ensure achievement of this objective. But at the same time, it is also responsible for ensuring fair competition, safeguarding banking consumer interest, and above all discouraging cartelisation. Mere rushing for mergers and acquisitions without legal and operational policy frameworks that take into consideration the interests of all stakeholders is going to be counterproductive. Mergers and acquisitions in banking are known to be "not so successful" in the Asian region. Strategically, they cut both ways, so better be careful.