The Gloves Are Off

In the overcrowded Malaysian banking system, the battle of the fittest has begun. Liberalization measures recently unleashed by Bank Negara Malaysia (central bank) have bolstered the strongest commercial banks at the expense of their weaker competitors. The harsher conditions will force the smaller fry to reassess their prospects - they may have to seek mergers to survive.

Liberalization is taking place against a backdrop of rapid economic growth. Real gross domestic product (GDP) has been hurtling at a high rate for eight consecutive years; in 1995, it grew at 9.5 per cent. the economy is now feeling side-effects, such as inflationary pressures, labor shortages and a "savings-investment gap". To contain inflationary pressures, the Malaysian authorities took a series of monetary tightening measures in 1995, particularly in the second-half. As a result, inflation moderated to 3.4 per cent in 1995. For 1996, the government forecasts GDP growth of 8.3 per cent.

 

The burgeoning current acco- deficit is giving the authorities a headache. In August, prime minister Mahathir Mohamad warned that quotas and import permits might be imposed to curb imports of non-essential goods, which appeared to reflect concern over the current account deficit.

However, the government has insisted it will not slow down big infrastructure projects despite criticism that they are fuelling huge imports of capital goods. Having reached M$17.8 billion ($7.15 billion) by the end of 1995, the deficit has been forecast to increase to M$19.2 billion this year by the Malaysian Institute of Economic Research, a leading think tank, after merchandise exports and imports grew slower than expected this year. Nevertheless, this represents a projected decline in terms of percentage of nominal GNP, to 8.4 from 8.8 per cent in 1995.

In a recent report, the institute also said: "The rapid economic expansion will continue to exert strong pressures on the already tight labour market. This will mean sustained supply side constraints adding to inflationary concerns." Wong Yit Fan, chief economist for South East Asia of Standard Chartered Bank, argues that the greatest risk factor for the economy is that wage growth has been in excess of productivity growth, which threatens to erode the country's competitiveness.

Bank Negara Malaysia's latest liberalization measures, adopted in July, favour Tier One commercial banks above Tier Two commercial banks drive to encourage consolidation in the industry.

The two-tier regulatory system introduced in December 1994 set out criteria for Tier One banks, including minimum shareholders' funds of M$500 million, which is to be raised to M$1 billion over a period of time, and standards for capital adequacy, asset quality, management efficiency, earnings performance and liquidity position.

On 26 July, Bank Negara announced that Tier One commercial banks, with immediate effect would be allowed to undertake the following activities, subject to prudential limits and conditions:

issue negotiable instruments of deposit (NID) up to five times their capital funds;

participate in equity derivatives;

nundertake securities borrowing and lending activities subject to the Securities Commission's approval

expand their regional operations through the establishment of branch offices, representative offices, subsidiary companies or joint ventures.

The ability to issue more NID increases the Tier One banks' flexibility in their funding base. A foreign banker in Malaysia comments that the ability to use equity derivatives is "very helpful"; on stock lending, however, he adds that the full extent of the regulations is not entirely clear. Bank Negara has also recently issued guidelines for risk management within banks.

Opportunities for derivatives trading have started to open up for the banks with the launch of Malaysia's first two futures contracts. In December 1995, the Kuala Lumpur Options & Financial Futures Exchange (KLOFFE) launched a futures contract on the Kuala Lumpur Stock Exchange Composite Index; and in May this year, the Malaysia Monetary exchange (MME) launched the three-month Kuala Lumpur Interbank Offered Rate (KLBOR) future.

Philippe Delhaise, president of Thomson Bank Watch Asia, the rating agency, on derivatives trading by the banks, comments: "Malaysia is one of the few countries in Asia where the central bank will have the strength, the skill, to make sure adequate controls are in place for that."

The two-tier regulatory system was extended to the merchant banks in early 1996, while the tiering system for finance companies was implemented in April 1996. In its 1995 annual report, Bank Negara Malaysia comments: "It was envisaged that the system would create a core of banking institutions which would be able to efficiently serve the needs of the economy and lead to a rationalisation of the industry, including the merger of banking institutions, to gain size and expertise to achieve Tier One status."

Of the 10 commercial banks that have already been granted Tier One status, six are domestically-controlled banks and four foreign-controlled. Three merchant banks have qualified for Tier One status.

There have already been a number of acquisitions and mergers of banks over the last two or three years. Since Bank Negara has been reluctant to allow new entrants into the banking industry, new players have had to acquire existing banks to gain entry.

Standard Chartered Bank Malaysia comments: "The possibility of mergers in Malaysia has now become a distinct reality, with the merger of Pacific Bank and OCBC(M) in May this year. it was the first merger of a Malaysian and Singaporean-owned bank in the country's banking history and was viewed by the market as an emphatic signpost for the direction that Bank Negara wants the banking community to head towards."

Two other notable acquisitions were those by the Hong Leong group in November 1993 of MUI Bank, which was subsequently renamed Hong Leong Bank; and the purchase by Sime Darby of a 60 per cent controlling interest in United Malayan Banking Corporation (UMBC) from Datuk Kermat Holdings in November 1995. Sime Darby is one of the leading conglomerates in Malaysia and majority-owned by the Malaysian government. Delhaise comments: "There are very strong signs that Hong Leong has done a very good job in turning it (MUI Bank) around."

In financial year 1995, pre-tax profit of the banking system rose by 32.7 per cent to M$6.9 billion, compared with 37.4 per cent in the preceding year, according to Bank Negara's annual report. "Having fully recovered from the recession of the mid-80s, the performance of the banking system strengthened considerably in recent years. Over the period 1990-95, the pre-tax profit of the banking system increased at an annual rate of 23.1 per cent." says the report. The return on average assets of the banking system also improved by 0.2 percentage points to 1.9 per cent; while the return on average shareholders' funds increased to 27.6 per cent in 1995 from 24.2 per cent in 1994.

Looking ahead, it is clear that while the rapidly expanding domestic economy will furnish the 23 Malaysian banks with plenty of opportunities for growth, not all are equally well positioned to take advantage of them.

Capital Intelligence, the Cyprus-based rating agency, points out in a recent banking report on Malaysia that there is a heavy concentration of business within the top five local banks, which have a combined market share of about 50 per cent. A further 27 per cent share is fragmented among the other 18 local banks (while the foreign banks have 23 per cent). The smaller players are unable to achieve efficiencies from economies of scale, points out the rating agency, and the massive investments needed in technology will be beyond their resources.

In contrast, the larger banks have built big networks and have set up subsidiaries or affiliates to undertake finance-related activities, thereby widening their earnings base.

Capital Intelligence predicts: "The introduction of the two-tier regulatory system will force the smaller banks to reassess their prospects in the new landscape. They could work towards achieving Tier One status, either on their own or through mergers, or they could find and cater to profitable niches in the market...

The two-tier regulatory system will hasten the process of consolidation in the industry and give rise to a smaller number of institutions which are well managed and strongly capitalized and are better able to serve the other economic sectors."

In the fight to avoid extinction among the smaller of the species, only the most quick-footed will survive.

Reprinted with permission from The Banker, F T Publications.