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Consolidation and Its Impact on Assets Quality

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The process of globalization and liberalization has strongly influenced the banking sector. During this period, the banks put in place effective risk management mechanisms, which is very important to the banking industry.

By concentrating on the top line and bottom line, banks across the board have improved their profit while reducing their operational costs and more number of banks has improved their financial performance by using the concept of mergers and acquisitions.CAMEL rating is used by most banks across the world as a performance evaluation technique.

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It undertakes all the important criteria, i. .

, Capital, Assets, Management, Earnings and Liquidity (CAMEL), for the evaluation of any bank. The study investigates the extent to which merger lead to efficiency. It is found that the private sector merged banks are dominating over the public sector merged banks in profitability and liquidity but in case of capital adequacy and NPAs, the results are contrary to the public sector merged banks. Keywords: Banking Sector, CAMELS, Financial Performance, Mergers & Acquisitions, consolidation.

Background A sound banking system is important for smooth development of banking sectors.It can play a key role in the economy as it gathers savings from all over the country and provides liquidity for industry and trade. In the context of Nepal, it is very difficult to trace the correct chorological history of the banking systems because there are no sufficient historical records and data about the banking in Nepal. At present there are 31 commercial banks, 87 development banks, 79 financial companies, 21 micro credit development banks and 16 saving and credit co-operatives (licensed by Nepal Rastra Bank) established so far in Nepal.

These commercial banks and financial institutions have played significant roles in creating banking habit among the people, widening area and business communities and the government in various ways on the one hand, while on the other hand it increased the complexities and risks of failure, too. Gradually, industry realized the need for consolidation. The result of this has started to be seen in the increasing number of mergers in the Industry. The very recent trend of consolidation seen in banking industry had caused a decrease in the total number of Banks and Financial Institutions (BFIs).

By the end of id-July 2012, seventeen BFIs have decided for merger and a few are in the pipeline, some more have got letter of intent and some others are in process of getting letter of intent. With the growth in the number of BFIs, financial market was growing more rapidly which fostered competition together with complexity in the market. With the revolutionary developments in the field of information and communication technology risk and complexity in the banking industry has also increased by a greater degree. Of course, growth of BFIs has supported financial deepening, product and service diversification and innovation in banking facilities.

Besides, growing competition and slower economic activities have impeded the expansion of financial services. These complexities have made the industry realize that it needs consolidation. The increasing number of mergers is the evidence of the same. Commercial banks have a variety of assets with loan and advances accounting to about three fifth of the total assets followed by investments, cash and bank balance.

In mid-July 2012, the proportions of loan and advances, investment and cash and bank balance are 59 percent, 18 percent and 16 percent respectively.The Government of Nepal has also prioritized the mergers of the banks and financial institutions with promulgation in the annual budget itself. The opinion of the central bank has come immediately after the collapse of certain banks Nepal Development Bank being the first followed by other financial institutions such as Crystal Finance Limited, Gurkha Development Bank Limited, Nepal Share Market and Finance Limited etc. There has been an increasing question on the assets quality of the banks and the NRB has come up with different guidelines and circulars with stringent conditions on maintaining the assets quality.

Limiting the exposure of the financial institutions in the real estate portfolio, restricting loan to finance second hand vehicle for the commercial banks etc are some of the moves from the central bank which shows deep concern on the assets quality. Based on the stringent clauses expressed by the central bank, our team seeks to analyze whether the move by the central bank emphasizing the consolidation and the maintenance of the assets quality are somewhat related with each other or not. For the sake of simplicity, we shall focus on the loans and advances granted by the financial institutions i. .

, the effect of the consolidation in the credit portfolio of the banks before and after the consolidation. Consolidation is a combination in which all the combining companies legally dissolved and a new company is formed. The two firm of business combination are however generally referred to as merger. Acquisition is a situation whereby one company absorbs the other company in totality.

Merger is a combination in which only one corporation survives and the merged company goes out of the existence (Agarwal, 2007) 1. 1 Definition of consolidationConsolidation can be understood as merger and acquisition of the institutions. Mergers and Acquisitions have always played a vital role in corporate history, ranging from ‘greed is good’ corporate raiders buying companies in a hostile manner and breaking them apart, to today’s trend to use mergers and acquisition for external and industry consolidation. The terms mergers and acquisition are often used interchangeably but it is important to understand the differences between the two.

In the academic literature, there are number of authors, who define merger, acquisition and takeover differently.A merger takes place when two or more corporations come together to combine and share their resources to achieve common objectives. The shareholders of the combining firms often remain as joint owners of the combined entity. A merger is a combination of two or more companies in which the assets and liabilities of the selling firms are absorbed by the buying firm.

Mergers and acquisition are friendly transactions in which the senior management of the companies negotiates the terms of the deal and the terms are then put in front of the shareholders of the target company for their approval.Whereas in a takeover, a different set of communication takes place between the target and the bidder, which involves att6orney and courts. Bidders here try to appeal directly to the shareholders often against the recommendations of the management. Asset quality is related to the left-hand side of the bank balance sheet.

Bank mergers are concerned with the quality of their loans since that provides earnings for the bank. Loan quality and asset quality are two terms with basically the same meaning. ” Further it stresses that government bonds nd Treasury-bills are considered as good quality loans whereas junk bonds, corporate credits to low credit score firms etc. are bad quality loans.

A bad quality loan has a higher probability of becoming a non-performing loan with no return. For a bank, Non Performing Asset (NPA) or bad debt is usually a loan that is not producing income. Earlier it was largely applicable to businesses. But things have changed with banks widely extending consumer loans (home, car, personal and education, among others) and strict asset classification norms.

If a borrower misses paying his equated monthly installment (EMI) for 90 days, the loan is considered bad, or an NPA. High NPAs are a sign of bad financial health. This has wide-ranging ramifications for a bank, especially in the stock market and money market. So, as soon as a debt goes bad, the banks want it either made better or taken out of their books.

There are many reasons as to why a loan goes bad. For a business, it could be because it fails to take off. Such a situation may arise because of sudden health expenditure or job loss or death.Often, as in the US today, it can be because of over-leveraging, when consumers borrow against most of their assets and, maybe, have unsecured loans too.

In such a case, any hit on income can jeopardize all repayments. In India, the situation has worsened due to banks aggressively pushing loans, even unsecured ones, to individuals to prevent idle assets on their books. President and founder of International Consumer Rights Protection Council, an NGO, says most customers in India are not financially educated and banks are luring them to take more and more loans, often without checking their financial positionAn asset is classified as non-performing asset (NPAs) if dues in the form of principal and interest are not paid by the borrower for a period of 180 days. If any advance or credit facilities granted by bank to a borrower become non-performing, then the bank will have to treat all the advances/credit facilities granted to that borrower as non-performing without having any regard to the fact that there may still exist certain advances / credit facilities having performing status.

Nepal Experience and ProspectusNIC bank and Bank of Asia have recently merged to each other in named NIC Asia. Laxmi bank with Himalayan saving finance co, Global bank with Lord Buddha finance co. and IME finance are the very important events of merging in financial market of Nepal. These events should be understood in depth for the future strategy, way, process and practices.

Government and NRB suggest and guided to merge of banks to extend of assets quality, financial strength and efficiency as well as to minimize of cost, risk, cultural crisis and uncertainty.Theoretical Framework: There are quite a number of economic theories that provide theoretical underpinning for bank consolidation. Some of these theories are bank efficiency theory, synergy theory; too big to fail Agency, share holders value and financial intermediation theories, however for the purpose of this study the research shall be based on synergy and financial intermediation theories. Synergy theory suggests value enhancement resulting from consolidation.

Synergy implies a situation where the combined firm is more valuable than the sum of the individual combining firms. It is defined as one plus one equals to greater one. Synergy refers to benefit other than those related to economies of scale. However, according to the “non-performing loan hypothesis” when banks are in poor condition ridden by high level of non-performing loans, the willingness for the banks to expand loans is decreased, which implies that loan growth will not be consistent with expansion of deposits.

Cite this Consolidation and Its Impact on Assets Quality

Consolidation and Its Impact on Assets Quality. (2017, Jun 01). Retrieved from https://graduateway.com/consolidation-and-its-impact-on-assets-quality/

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