An open letter to the Governor: Consider bank consolidation to achieve financial sector stability

CBSL Governor Dr. Nandalal Weerasinghe

“Maintaining a sound and adequately capitalised banking system is important. Implementing a bank recapitalisation plan and strengthening financial supervision and crisis management framework are crucial to ensure financial sector stability.” Press Release included in the IMF Country Report No.23/116 released in March 2023.

The measures introduced to soften the impact of the pandemic on borrowers are gradually being rolled back. This, together with the high interest charged due to the current crisis that will constrain the ability of borrowers to service their debt and the losses that may arise as a result of restructuring government debt would result in the need for further provisioning and writing off debt. This would have a significant adverse impact on bank profits that will lead to capital shortfalls and defeat the objective set out by the IMF to ensure financial sector stability.

The recent IMF staff report states that “Private sector capital may be difficult to secure until the economy has stabilised.” In the light of this situation, should bank consolidation be seriously considered as an option to recapitalise the banking system?

Larger commercial banks created through bank mergers will have the capability of raising equity through capital markets on a much larger scale than is possible at present. Limitations caused by restrictions imposed by the Central Bank on ownership of issued capital carrying voting rights can be overcome when there is a significant quantum of issued capital. The stipulated percentage of a bigger issued capital will be large enough to encourage high net worth individuals and institutional investors to make investments that will conform to their minimum investment criteria.

A bank consolidation program will bring immediate benefits towards stabilising the financial system when smaller banks, that are more vulnerable to organic growth being hampered by NPLs, are amalgamated with the bigger banks. 

Surviving entities will have higher profitability through economies of scale resulting from bigger single borrower limits, stronger retail loan growth and deposit mobilisation utilising its larger loan portfolios and depositor bases, lower cost of funds due to higher CASA ratios and the ability to raise equity and issue debentures at lower rates, lower cost income ratios as a result of operations rationalisation backed by digitalisation, cost effective branch administration and prudent tax management.

Larger banks will be capable of implementing efficient compliance and risk management processes to support its capacity to operate on a much larger scale.

With an enhanced capacity to expand its balance sheet, the merged entities will be capable of organic growth to build comfortable capital cushions which can insulate them from asset quality stress.

The IMF Country Report issued in March 2023 refers to an asset quality report for the two largest state-owned commercial banks and the three largest private commercial banks to be completed by end of this month. By July 2023 the CBSL will develop a roadmap for financial sector restructuring and recapitalisation. It was heartening to see you talking of the need for bank consolidation at a recent interview. We are hopeful that CBSL would consider what has been raised in this letter when completing the financial sector restructuring and recapitalisation exercise.