SCORING CAPITAL ADEQUACY - A CHALLENGE FOR BANKS

CONSOLIDATION, MERGERS & ACQUISITIONS IN THE STORE

SUMAIRA FAZAL sumaira.fazal@gmail.com
Feb 23 - Mar 01, 2009

The ongoing era got to have great challenges for the entire world economies and financial markets. The economic recession in developed markets and its consequences on developing countries, along with lack of correct measures on policy-makers end, have all contributed to the financial chaos. Here one can say that the correct and supportive actions by regulators in developed countries have propped up to a large extent, for example, the US bailout strategy to address negative trends in the banking industry. However, the industries are still facing the music. This is a time when we are seeing, both on local and international fronts, increasing trend of mergers and acquisitions, which, in certain cases, are brought about by direct governmental interventions.

Pakistani financial sector and the entire economy are under pressure, when we see the exceptional kind of challenges faced by the industry. The State Bank of Pakistan is playing a vital role in taking corrective measures to address the sector's issues. Keeping in view the international standards and practices, SBP, as the apex regulator of the banking industry, has been very active in creating incentives which are likely to encourage the emergence of a stable and sound banking system.

The State bank issued guidelines and a road map to comply with the Basel-II requirements. Basel-II defines the mechanism to allocate capital to the risk weighted assets. The capital allocation under Basel-II is more risk sensitive and comprehensive and its implementation would result in improved risk management at banks. Nevertheless, the implementation of it is by no means an easy task. The time frame for adoption of Basel-II is (i) standardized approach for credit risk from 1st January 2008, (ii) Internal Ratings Based (IRB) approach from 1st January 2010.

This mainly emphasises on raising the capital base, whereby, raising the minimum capital to PKR 23bln by calendar year 2013. Further more, SBP increased the capital adequacy ratio (CAR) - which is the total equity divided by the risk weighted assets - to 10% from the previous level of 8%, for all locally incorporated banks as well as for all DFIs effective from December 31, 2008.

In addition, foreign banks (FBs) operating in the country were also directed to increase their assigned capital to PKR 23bln within the prescribed time. It would be easy for large banks to meet all the targets, and the strategy of the banks would be to retain profits rather than distributing it among the shareholders. This will lead to more of the bonus issues by the banks, rather than cash dividends. Further, the banks having large pool of reserves are likely to be at ease to meet all dead lines. However, smaller banks, specially foreign banks with small operations in Pakistan, would either be closed down or would more likely be merged with other organizations.

While all steps taken by the regulator flushed out the excess liquidity from the system, which also created a temporary shortfall, these actually created M&A activity in the sector.

This requirement is also to shake the smaller players in the industry, besides increasing number of consolidations. The spate of mergers and acquisitions, which has already begun, due to these initiatives of SBP, will change the shape of the entire sector. The real benefit would be in the form of improved risk management systems and sound controls.

This is becoming quite obvious with the initial mergers and acquisitions of banks with smaller capital base, as well as the restructuring exercise being undertaken such that greater capital is being injected into smaller capital based banks. This will provide financial stability to the sector, as the risk absorption capacity will inevitably be improved by raising the capital base.