Banking on mergers

By Niveen Wahish
Source: Central Bank of Egypt
Banking reform is the buzz word these days. The goal? Creating an efficient banking sector which offers better quality services. While the means to achieving this end are varied, it is merging banks that is making headlines these days. Prime Minister Atef Ebeid recently expressed the government's desire to merge Egypt's smaller banks in an effort to enable them to compete with the larger Egyptian entities as well as foreign financial institutions.
Recent liquidity shortages and foreign exchange complications may have highlighted the need for banking reform, but they are not the main impetus for it. According to Mahmoud Mohieddin, senior adviser to the minister of economy, the financial reform measures taken in the early 1990s emphasised reform of the monetary and fiscal policies, not the revamping of financial institutions. This, said Mohieddin, is quite typical of most emerging markets and developing economies. "It is now time to move on to the institutions," he said.
According to Mohieddin there are certain international and domestic developments that have intensified competition, something which should help to direct bankers in modifying the structure and improving the quality of services offered by Egypt's banks.
Firstly, there is the fact that the public sector's share of the market has dropped from 75 per cent -- in terms of assets -- to around to 53 per cent. Secondly, there are non-bank financial institutions that are providing similar services such as the securities market.
Thirdly, the issue of internationalisation of finance and the declining salience of the physical proximity of an institution to its clients are no longer theoretical issues. In fact, "Egyptian banks are facing competition from foreign banks that are not residing in Egypt due to the fact that the latter's transactions costs are cheaper," Mohieddin said.
Another challenge to be addressed is the fact that Egypt is over-banked and under-branched. There are 61 banks operating in Egypt, says Mohieddin, yet it has a low banking density ratio; there is a concentration of branches in areas such as Greater Cairo and Alexandria to the detriment of other areas. "The issue today is not the number of banks, but the kind and quality of services that they are providing to their clients," he said.
This issue, Mohieddin believes, may be addressed through consolidation. "Any professional banker would feel that Egypt would do better if the banking industry was more consolidated, managed more efficiently and there were fewer banks but a better distribution of branches."
Faika El-Rifa'i, former deputy governor of the Central Bank of Egypt and currently a full-time researcher at the Egyptian Centre for Economic Studies, is preparing a study on the issue. She, too, believes that Egyptian banks should merge. "We have banks which are smaller than the medium-sized banks in the international arena," she said.
The benefits that she believes can accrue from consolidation include increased capitalisation of banks, better management, expanded use of technology and diversification of services. Although she concedes that banks could improve their performance without merging, she suggests it would take them more time to do so and the end result would probably be less efficient than if they were receiving assistance from another more experienced bank.
She points out that effecting mergers will not be easy especially since none of the banks which are controlled by foreign owners are likely to be willing to give up their autonomy. This situation limits the candidates for mergers to smaller banks and public sector banks.
But size alone should not be the criterion by which the need for a merger is determined, says El-Rifa'i. In fact, if a bank is efficient, fulfilling the needs of its clientele and can continue and sustain itself amid competition, then it will certainly not be merged.
El-Rifa'i said that although the idea of mergers is often associated with fear of monopolies, this is not something that should raise concerns in the Egyptian context because it is the small banks that are being considered for consolidation, meaning that there would still be other banks -- ones established under joint ventures -- serving the local market. Furthermore, mergers are in part aimed at protecting local institutions and capital as Egypt's small banks currently face the prospect of increasing competition from foreign entrants into the market.
Labour layoffs, another issue that is often associated with mergers, are also not a concern in the Egyptian context, said El-Rifa'i. Since banking services need to be expanded to under-served areas, additional branches will need to be opened, in which case staff will be relocated rather than laid off.
Although the government has made bank mergers one of its priorities, it is not clear how it will be involved in this process. Mohieddin believes that once some banks begin to merge, others will follow suit. But for the time being the issue is how to get the ball rolling. Mohieddin says that the government can either persuade the concerned banks of the benefits of the idea or it can compel them to merge by demanding that they increase their capital.
The latter measure was adopted by the government to create bigger entities in the foreign exchange market when on 29 January it announced that foreign exchange companies must have at least $10 million in capital, much higher than the previous requirement of $1 million.
But before consolidation takes place there are many factors that need to be considered, says Mustafa Hablaz, Chairman of Suez Canal Bank. First, the general assemblies of the banks in question need to give their consent. And he warned against merging two weak entities in which case the merger would have defeated its purpose. "The targeted banks will need to be strengthened and developed before merging, otherwise the new entity could be a failure."
On a similar note, Mounir El-Zahid, deputy managing director and executive director of HSBC (Hong Kong Shanghai Banking Corporation) Egypt, notes that while merging banks does provide a larger capital base, it is not a cure-all. He said that Egyptian banks need to abide more strictly by international standards by having provisions for loan-loss and establishing risk rating systems to evaluate the credit performance of accounts. He said that, for example, Egyptian banks do not downgrade a credit account if an account is overdue 90 days. "This makes their profits overstated," he pointed out.
HSBC Egypt was until recently known as the Egyptian British Bank, having been only 40 per cent owned by HSBC plc and other investors. At the end of last year, HSBC bought out the other investors and raised its share to 90 per cent. That step, according to El-Zahid, was a positive move for the bank and represents value-added for the Egypt especially in view of HSBC's presence worldwide.
Even though mergers have dominated discussions concerning the banking sector's future of late, this does not mean that the government's plans for privatisation have been shelved. "The possibility of privatising one of the banks or selling a stake has always been there," Mohieddin of the Ministry of Economy said. But privatising public stakes in joint-venture banks is more of a priority than privatising wholly owned public banks at the moment.
In spite of the many positive implications of transferring assets to the private sector -- bringing in new management, better supervision of banks through the involvement of general assemblies -- expectations of what this can accomplish need to be realistic. "Privatisation is not an end in itself," said Mohieddin.
Egyptian banks are an attractive buy, suggests Mohieddin. Most of them are extremely undervalued and "whenever we indicate that one of the good banks is on offer, a number of buyers express their interest in purchasing it," he explained. Potential buyers are not put off by any of the problems faced by the economy during the last two years, he asserted. "Those are short-term phenomena which may delay certain decisions for a few months or years, but would not deter any long-term investor with his eye on a country with considerable potential. [Egypt] which offers fertile ground for banking services, is a country which, after taking a few simple measures, can become an effective regional financial centre," he said.
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