Lessons from Malaysia

Tuesday, 18 March 2014 00:22 - - {{hitsCtrl.values.hits}}

After the Asian financial crisis, Malaysia pushed for consolidation and initiated a merger program in 1997 to consolidate the financial industry. Within one year the sector was strengthened and the number of banks and financial institutions was rationalised. By 1998 the number of finance companies was reduced from 39 to eight and by 2000, 50 out of 54 banking institutions were consolidated into 10 banking groups, and today all finance companies have been merged with commercial banks. What led to consolidation? In the 1970s, Malaysia’s economy was highly dependent on agriculture and to reach higher economic growth it decided to industrialise. Along with the progress there was high volatility in the financial market. It was a highly fragmented industry with 39 financial companies. In addition to that, the interest rates were in double digits and the NPL rates were continuing to rise. Sharing the Malaysian experience in this regard, visiting Consultant Arnold Kwan spoke about the process that the country successfully went through resulting is the strengthening of its financial sector. In 1985 the country was in recession and with that five cooperative banks were faced with a troubled situation since their capital was much reduced. As early as 1988 there were plans to consolidate the finance companies following two cases of mismanagement with cooperative companies in the late 1980s which cost the Government Rm. 10 billion to resolve. “The Central Bank being the big brother to all the financial services companies pushed for the companies to ‘talk amongst themselves’ and consolidate. The Bank Negara Malaysia (BNM) like all central banks is responsible for financial market stability and the resilience of the institutions to an economic slowdown. The prime intention was to increase public and private confidence,” said Kwan. Finance companies did not have economies of scale and economies of scope and were not adequately capitalised to withstand economic volatility. To address this in 1997 the BNM took the lead in formulating plan for the consolidation of finance companies. Looking at the evolution of the Malaysian financial sector starting from 1998, pre 1998 it had 71 financial institutions of which 20 were commercial banks, 12 were merchant banks, and 39 were finance companies. The asset base in 1998 of the total financial sector was Rm. 289 million, and the banking sector had Rm.180 million of that. However by the end of October 1999 here were 20 commercial banks of which 10 were local and 10 were foreign. As of 2013 there are 27 commercial banks of which 8 are local banks and 19 are foreign banks. The consolidation process Although it was in the beginning of 1998 that the central bank came out to talk about the consolidation, in 1997 that it selected 10 anchor banks for the process. While the central bank had given a period of 10 years for the banks to consolidate amongst them, it took over the matchmaking responsibilities since the companies didn’t merge before the given deadline. The anchor banks were chosen since they were qualified for the year 2000 capitalisation target set by the central bank. The rest were smaller ones, therefore basically an arranged marriage for the smaller companies in 1998, said Kwan. The foreign banks were requested to absorb their finance companies into their banking operations but were allowed to retain their branches. “If the portfolio dropped, the central bank planned to put the loss amount by the end of year. Those particular assets that were not profitable were planned to be transferred to the credit control area of that bank. If the loss was ever recovered the profit sharing at point was decided to be 80% for Central Bank and 20% for the bank. As far as the shareholders of the acquiring bank, they were assured that they will not lose any money due to the consolidation,” he explained. If the banks had to write off for their IT systems that were duplicated due to the consolidation, they were able to claim that as an expense for the first year by writing it off. The government also expressed it would guarantee any of the anchor banks they will not lose their liquidity when they acquired other finance companies. Furthermore, the target for capitalisation required by finance company licence was pushed up from Rm. 50 million to Rm. 600 million. This was decided to allow the companies to be able to absorb any losses. Method used While the industry was given a year to submit the proposals and a year to execute, 70% of the total consolidation were acquisition whereas the rest were value merger. 14 finance companies were merged with their related commercial banks and 19 were acquired by the anchors. Approved independent professional auditors were appointed and they audited the entities to arrive at risk weighted assets valuations. These were compared to the market valuations where available and were approximately 1 to 1.5 times the loan book value. Negative net worth finance companies were wound down by appointed banks. The acquired companies were expected to adopt the acquirer system, policies and procedures within a period of 6-12 months. It was planned that all staff would initially be retained except for some management positions. Within six months a voluntary separation scheme was be offered to staff who were disgruntle or redundant. Post-amalgamation structure All operations of the company were integrated. There were no cost savings if the entities were not merged or integrated. Resource rationalisation which resulted in losses was given tax credit. Kwan noted that although financial integration took place in 1999, practical integration of systems, staff and procedures took about two to three years. With regard to taxation and funding, there were no taxes on asset transfers. Stamping duty was waived and tax credits were allocated for any resulting losses. Government guarantee for the assets in the merger were mitigated by due diligence done by approved professional auditors and had allocated funds for the consolidation under the 1998-99 budget. In the case a finance company did not agree with the consolidation and did not have a proposal or was unable to meet the capital requirement by 2000, the license could have been revoked. However the situation did not arise. “The consolidation process is market driven with incentives from BNM but it did not get involved with the corporate structure or the mechanisms of the M&. In the case of minority shareholders it follows the Memorandum and Articles of the Sri Lanka Companies Act,” said Kwan. The Malaysian Government through its annual budget process from 1998-2000 made allocations of approximately Rm. 60 billion for the consolidation exercise. The allocation consisted for loss in revenue from stamping and property transfer tax, tax credit given for Voluntary Separation Scheme, tax credit for technology write-offs due to redundancies, and the actual payment for losses under the ‘Value Guarantee’.