Managerial Control: A Vital Step Before Amalgamation

 

The central bank of Bangladesh is reported to publish guidelines for amalgamation of banks. It contains two models - one is for voluntary amalgamation by one bank with another one or with other finance company, and other one is mandatory amalgamation. It is observed that there was a policy for amalgamation published in 2007 by central bank. With the signing of a memorandum of understanding between two banks for amalgamation in the form of merger, corporate marriage becomes the talk of the town.

Amalgamation, merger, acquisition and other forms are common in business world. These are not a new phenomenon. Theoretically amalgamation or other forms is done to dominate market.

It can be vertical or horizontal. In case of vertical amalgamation, a spinning mill takes over a textile mill, and a garment factory. This results in composite mill which can produce garments from cotton.  In case of horizontal amalgamation, two same lines of businesses become one. Two garment factories can be one with no change in production process as found in vertical cases.

In case of bank amalgamation, this is horizontal path. After amalgamation, the new bank will do the same business with same customer base. If it happens so, there comes a question of the causes of amalgamation. Banking is not a traditional path of business where owners start operations with owned capital and loan capital. In case of problems in profitability or liquidity or both, the business can make default in making repayments of loan capital. Lenders face problems in that situation; they need to proceed legal action for realization of loan proceeds. But banks work differently.

They cannot work with capital fund. They depend on loan fund and deposits. With respect to deposits, banks play the roles of intermediaries by which savers place funds which are used for lending. In this point of sense, banks’ roles are to catalyze the needs of two different parties. The operation is a risky game in case of disturbances from repayments.

According to Hyman Minsky, an economy experiences three credit lending stages with risk levels. (a) The hedge phase is the most stable phase, where borrowers have enough cash flow from business operations to cover both the principal and interest payments. In the hedge phase, lending standards continue to be high. (b) In the speculative borrowing phase, cash flows from business cover only the borrower’s interest payments, not the principal. Borrowers are speculating that cash flows will continue to increase, and the interest rates will not rise. (c) The Ponzi phase is the riskiest in the cycle. The borrowers’ cash flows from their businesses are not enough to cover the interest and principal payments.

There are two financial markets, it is said. One is capital market and another one is money market. Capital market works for equity, and debt securities of longer term.

On the other hand, money market is for short term period. Banks are said to operate money market products with a tenure of one year in case of lending. Despite banks are found to extend term loans in the form of project finance. It is called term loan but its tenure is not so long, rather medium period of 5 to 7 years.

Within this time, the loans need to be repaid. With regards to hedge phase as pointed out earlier, this is basically for working capital finance. Under the scheme, loans are repaid on realization of sales proceeds. In normal cases, cash conversion cycle is within one year. As a result, short term loan extended in the form of working capital can be suitable for banking industry. Term loan is not repaid by sales proceeds.

There are different works done by banks in open market economies. In addition to leading activities, banks extend different professional services against fees. There are transactions for external sectors pertaining to cross border trade and financial flows. This is one of the major activities of banks. These include without limiting to exports, imports, inward and outward remittances, etc. Every transaction brings exchange income and fee. Say exchange income for each foreign currency is 1 Taka and 0.50 Taka as fee income.

It can bring yearly income of 450 billion Taka a year if yearly transaction volume is 300 billion foreign currencies. Because of dependency on external sectors for every aspect, the transactions are found increasing. But all banks are not on equal footing for executing cross border transactions. There need relations with banks abroad. Relationship is required for supporting transactions such as confirmation service for import, trade finance, trade discounting, etc. These are expenses borne by our exporters and importers. But the degree of expenses depends on the relations of local banks with their counterparts abroad.

Relations depend on the strength of local banks. Based on assessments by external banks, they set counterparty limits and service charges. The better the position, the better the counterparty limit; and the lower service charges. This point of view is an indicator of the position of a bank. Despite it is not possible to be guessed by mass people. As such, all are equal unless negativity is spread.

In case of amalgamation, two banks are to be amalgamated into one. Selling bank is definitely in a bad shape. After washout of bad assets from the books of selling bank, the liabilities need to be supported by goodwill till its amortization.

This will automatically be incorporated in the amalgamated/purchasing bank. The central bank guidelines allow financial statements to maintain separately for three year. During the period, there is no assurance for improvement of selling bank’s financial statements. As such, there comes a question whether the position is to carry a different signal at the assessment of correspondent banks abroad. If it is so, cost for external transactions by the bank may increase to an upper level, with curtailment of counterparty limit. This is a prime issue requiring attention before taking decisions.

Alternatively, a negotiation can be made under which purchasing bank will take managerial control of selling bank for a period of, say 5 years, with dissolution of management by the authorities. With the involvement in the management, the selling bank is expected to be improved. On completion of the tenure, amalgamation can be executed. The proposition will not lead purchasing bank to face bottlenecks in any way immediately on amalgamation. Cannot this be a better option?  


Mehdi Rahman works in the
development sector.