Is bigger necessarily better?

A PROPOSED banking merger is on the cards once again that could see RHB Bank Bhd and AMMB Holdings Bhd merging to create the fourth-largest banking group.

The merger comes at a time when banks are starting to enjoy a new lease of life, with cost-cutting measures improving the bottom lines of the two biggest banking groups and when the industry itself is weathering a slowdown in loan growth admirably.

The merger between RHB and AMMB is designed for it to get bigger. For one, revenue synergies from a merger will be almost a parallel move, as analysts think there will not be much difference in the combined loan book except for auto loans and also in Islamic finance.

Cost savings would top the agenda and that would mean cuts in the number of branches and staff.

There will likely be a large number of retrenchments, as the combined staff of both banks could be larger than Malayan Banking Bhd (Maybank), and with the cost-to-income ratio of the combined operations trailing Maybank, this is where the savings and benefits will probably come from.

The merger, should it go through, will see the creation of a banking group with sufficient size and scale. It will not be a top-three market anymore in Malaysia, but the big four.

Size and scale are two important ingredients in the banking sector. The big banks, as long as they are run efficiently, have the balance sheet muscle to do deals smaller banks cannot stomach. The vast number of branches they wield also allows such banks the reach into areas many competitors cannot afford to.

Big deals and reach means a better opportunity to capture a bigger slice of the market, and higher profits. It is worth noting that the largest bank in Malaysia, Maybank, is also its most profitable and has the biggest market capitalisation.

This is because the way it is run now. Thanks to good planning, execution and luck, it has maximised on the size and geographical reach it has.

The success of the larger banks and the higher market capitalisation and profits they generate make it important for the challengers to do the same.

This is why over the years since the first industry-wide banking consolidation after the Asian Financial Crisis, banks engaged in their own market-driven consolidation pro- cess. This has led to the number of banking groups in Malaysia shrinking from 11 to 8.

In that process of banking groups picking their own suitors, we have seen the newly created banking groups benefitting from revenue and cost synergies that have emerged from that process.

But what it has created is a market that is different from when the first consolidation process took place.

When 11 banking groups were created, what the market had was a gradient of banks from the largest to the smallest. That scope of size meant that access to financing was addressed comprehensively up to a point where Malaysia enjoys a very high ranking in the World Bank’s survey on the ease of doing business.

But with the number of banking groups shrinking and mega-banking groups being formed, what it will lead to is a fragmented structure where there will be two clusters; the larger banking groups and the smaller ones.

The fear might not be immediate, but there will be questions as to the benefit of allowing such a structure to form.

There is a likelihood that the bigger banking groups will have better net interest margins. That will come from either being more efficient or charging higher interest rates, as the level of competition will be stifled with there being fewer banks.

The other issue that needs watching is on the wholesale side. One executive wonders what will happen if the three big groups decide against funding an exercise? Where will companies then turn to to get the deal done?

Another issue is on what will happen to the smaller banking groups? In time, the pressure to merge will be evident and with the larger banks enjoying the fruits of scale, the smaller banks will feel the pressure to compete against banks that are just too big for them to be really effective and efficient.

The Internet will, however, level the playing field. As it is, banks are not really looking at creating a larger physical network than what they have now. Internet banking will make a lot of branches redundant and it is the employment of technology that will level things out in time.

What the regulators need to ensure, though, is that despite large banking groups being created in Malaysia, the process of financial intermediation needs to progress smoothly for all types of borrowers, failing which, the creation of large banking groups will not serve the interest of the greater economy as a whole.