Bank mergers and the market
           Government should reconsider the scheme
                              This editorial appears in the 11 August 1999 edition
                                      of The Asian Wall Street Journal.
                            It seems the trend of state-directed mergers in
                            Malaysia's financial sector is still going strong. Second
                            Finance Minister Mustapa Mohamad yesterday
                            confirmed reports that the government is interested in
                            getting the country's 65 brokerage firms to merge,
                            although he said there was no fixed deadline for this
                            exercise. This comes just two weeks after Bank
                            Negara, the central bank, unveiled a plan to restructure
                            Malaysia's banking industry into six large institutions.
                            Prime Minister Mahathir Mohamad's government
                            apparently has been emboldened by the lack of any dire
                            consequences from its capital control regime to take
                            further steps toward micromanaging the economy. But
                            it's a dangerous sign when officials start thinking they are
                            smarter than the market.

                            And that's clearly what is happening with the forced
                            merger of 58 financial institutions into six 'anchor banks.'
                            Bank Negara took the country's bankers aside and told
                            them who they would merge with. They were given until
                            the end of September to do all the necessary
                            paperwork. Deputy Prime Minister Abdullah Badawi
                            explained, 'The government wanted to see local banks
                            play a dynamic role which can accelerate development
                            efforts.' In other words, we know better than you or
                            your shareholders how to build a banking system that
                            will promote economic growth.

                            In itself consolidation is no bad thing, and analysts are
                            largely agreed that combining some of Malaysia's banks
                            could bring gains in efficiency, as unneeded branches
                            are closed down and some combined operations reap
                            the benefits of economies of scale. The same may be
                            true in the brokerage industry, or indeed in others Kuala
                            Lumpur has its eye on. So why worry if Kuala Lumpur
                            plays matchmaker?

                            The simple answer is that the way mergers take place,
                            and the management structures created in the process,
                            are critical to their success. Corporate mergers and
                            acquisitions usually happen when market signals lead
                            managers to believe that such combinations will allow
                            them to create more value with the same assets. For
                            example, a bank with untapped potential usually has a
                            depressed share price, which in turn makes it an
                            attractive takeover target for other banks that think they
                            can effect a turnaround. And a bank which is well
                            managed usually has a healthy share price, which
                            enables it to use the leverage of its own shares to
                            finance a takeover. The net result is that good managers
                            are given more to manage, and poor ones leave the
                            business. That's how you really build a banking system
                            that promotes growth.

         The plan has no logic
                            Unfortunately, market signals seem to have been
                            ignored in Malaysia, as bankers are left scratching their
                            heads trying to understand the logic behind the mergers
                            plans they now must follow. The speed of the process
                            suggests that creating bigger banks quickly was the
                            primary consideration, rather than value or management
                            expertise or synergy. The head of the opposition, Lim
                            Kit Siang, has pointed out that just two weeks before
                            the merger plan was announced, the central bank was
                            working on a different plan to reduce the number of
                            finance companies to 10 from the 39 at the time. A
                            hasty switch in policy, combined with Bank Negara's
                            poor record of bank supervision, leads Mr. Lim to
                            question whether it should be trusted to pick winners
                            and losers in the financial sector.

                            Questions also have been raised on whether the mergers
                            were designed to disadvantage ethnic Chinese bankers,
                            or reward Mr. Mahathir's political allies and punish the
                            friends of former Deputy Prime Minister Anwar
                            Ibrahim. Bank Negara has denied this, but Mr. Lim has
                            called for an independent commission to supervise bank
                            mergers in order to make sure that it is not the case.
                            Even if these allegations are untrue, the government has
                            only itself to blame for their spread since it has
                            conducted the decision-making process behind closed
                            doors. These questions not only aren't going away, they
                            will probably become more divisive as it comes time to
                            value the acquired banks.

                            Malaysia will be the poorer if it loses a banking system
                            that, for all its faults, did have a measure of market
                            discipline. What will the new order look like? The best
                            case scenario is Japan's convoy system, and we all
                            know how that turned out. The worst case is a
                            crony-run system like Indonesia's under Suharto. The
                            bank merger plan was cooked up in a matter of weeks.
                            Maybe the government should devote a few more
                            weeks, or years, to reconsideration.