This is in line with the proposed consolidation programme, which is a pre-emptive strategy to establish a strong and dynamic banking and Non Bank Financial Institutes (NBFIs) sector in the future, according to last year’s budget proposals.
At a recent programme on “Consolidation of the Financial Services Sector organised by the CA Sri Lanka”, CB Assistant Governor C J P Siriwardena said that expected outcomes in consolidation in the banking sector are that there will be a reduced number of banks – at least five Sri Lankan banks will have assets of Rs. 1 trillion or more, with such banks also having a strong regional presence, there will be a large development bank that will provide a substantial impetus to development banking activities in the country and domestic banks which had assets less than Rs. 100 billion will have assets of Rs. 100 billion or more, through organic growth and merger/absorption with other banks and NBFIs over a reasonable time horizon.
Greater participation by foreign banks
“Foreign banks in Sri Lanka will demonstrate a greater participation in economic activities and will be making significant contributions to the economy, banks will rely on new and effective IT applications and they will have substantially lower interest margins through increased efficiency and prudent management of assets and liabilities,” he said.
The state banks will be expected to contribute significantly towards building a strong and dynamic banking sector, he said, adding that the two large state commercial banks, Bank of Ceylon and People’s Bank will be encouraged to grow and expand towards a stronger regional presence, and to operate with higher levels of capital. “They will also be expected to strengthen their off-shore banking operations and be able to attract funds, as well as conduct private banking on a wider scale and the NSB would be encouraged to broad-base their banking activities to contribute to the economy on a larger scale,” Mr. Siriwardena added.
The Pradeshiya Sanwardhana Bank (Regional Development Bank) will be encouraged to serve the niche market of microfinance, targeting inclusive growth in the provinces and the other smaller state banks will be encouraged to merge with the bigger state banks or with one another and play a more cohesive role, since at present these banks account for just 1.1 per cent of the market share. Larger foreign banks will be expected to further strengthen operations, he said, adding that smaller foreign banks will be expected to develop new strategies to grow, and to increase participation in the domestic economic activities through expansion of the necessary skills, product development and display of greater enthusiasm in private banking, off-shore banking, infrastructure financing and support for 5 + 1 Hub activities.
There will be about 20 NBFIs, of which around three would be specialized in micro finance, according to Mr. Siriwardena who said that that each NBFI will have an asset base of over Rs. 20 billion over the period.
Immediate disclosure requirement by CSE
The seriousness of the envisaged consolidation process is confirmed by having tax benefits provided in the Budget 2014, he said, adding that the exact details and implementation of such benefits are now being finalised with the Ministry of Finance and Planning and the Department of Inland Revenue and will be notified soon.
This merger/absorption process must not adversely affect the staff of the respective institutions, he said, adding that no staff member is to be forcibly retrenched as a result of these merger/absorption processes. “No salary of any employee is to be reduced from that prevailing as at 31st December 2013. Those involved in the merger/absorption process will be encouraged to appoint competent Human Resource Consultants to perform independent reviews on senior management.”
In the case of any capital infusion by the acquiring bank a matching long term advance will be made through the Sri Lanka Deposit Insurance and Liquidity Support Scheme on concessionary terms.
The CB will issue public notifications from time to time, to appraise the overall progress of the process. The CB will also liaise with other authorities such as Securities and Exchange Commission, Colombo Stock Exchange (CSE) and Registrar of Companies,wherever such support is needed.
The CSE rules require immediate disclosure of merger activity, Naomal Goonewardena, Partner Nithya Partners said in his presentation. “The Company Take-Over and Mergers Code may get triggered if the shareholdings thresholds of 30 per cent are triggered in the amalgamated company.” He said that ownership limits in banks may be exceeded and that loan covenants may be breached if succeeding entity is weaker. “If the objects of the amalgamating entities are different there may be a narrowing down of activities.”
Senior Partner of Ernst & Young, deleted Hulangamuwa in his presentation on what the industry needs to be aware of in a consolidation process, said that amongst the taxes to be considered, Income Tax, Value Added Tax, Stamp Duty, Economic Service Charge (ESC) and Administration Tax are primary in the consolidation process.
“The disposal of assets is normally taxable on the excess of selling price over the tax written down value and one can claim capital allowances for the merging entity. There’s a deduction of cost incurred for the merger and current losses, if any, of the transferor company,” he said.
The proposal is to grant some concessions via guidelines to be issued by CB on a case by case basis, he said, adding that amongst them, no income tax on any profits arising on the transfer of assets, capital allowance is to be claimed by the merged entity on the original cost, expenses incurred for the merger will be a deductible expense, qualifying payment relief will be granted on the investment made in the merged entity and tax credits, refunds, etc of the transferor entity will be available for the merged entity.
On the transfer of shares, financial assets/liabilities, mortgages, land and building could attract stamp duties, he said, adding that a gazette will be issued exempting stamps duties other than for immovable properties.
“Unutilized ESC of both entities should be allowed to be carried forward in full, but so far no provisions have been proposed,” he said, adding that all pending assets of the transferor entity are to be taken over by the merge entity.
Due diligence is very important pertaining to this process Vajira Kulatilleke, CEO NDB said in a presentation on due diligence and other issues.
Valuation will establish upper and lower limits, he said, highlighting the need to negotiate after the merger and the importance of ‘avoiding negotiation ego’. “Post-integration management is extremely important,” he reiterated.
In an acquisition, the “buyer” aims to assume control of the target firm by acquiring a majority stake and establishes ownership of the acquired firm, Manilka Fernando, Management Consultant Financial Institutions in his presentation said. He said that a merger is usually the agreement between two firms to form a single entity where the outcome is by mutual agreement of the shareholders of the two firms. “This is often considered to be a “merger of equals.”
Not a merger of equals
He added that believing that a merger of equals can occur, the vast majority self-destruct because of this very premise. “By focusing so intently on strategic fit you fail to assess cultural fit, which is just as important to a merger’s success, if not more so. The conqueror syndrome by the acquiring company and entering into a “reverse hostage situation” should also be avoided.”
He pointed out that integrating too timidly and the employee resistances from the acquired company’s people as well as ‘paying too high a premium’ are issues.
“One needs to identify and communicate merger benefits early in the process while having a dedicated integration team to be in place before transaction closes,” he said, highlighting the importance of measuring and reviewing constantly what you plan to achieve. He said that the end is not concluding the transaction, but it is delivering value.
During 1988-90, 13 registered finance companies failed; two such companies were revived by new investments; 11 companies were liquidated.
In 2002, a bank failed. It was only in 2007 that the deposits of that bank were transferred to a new savings bank.
In 2009, eight NBFIs faced liquidity problems, mainly because of the collapse of a related company in a particular group; Those NBFIs were gradually revived under restructuring processes, as agreed with the Central Bank.
In 2013, an NBFI faced liquidity problems due to certain directors of that company siphoning out funds; the Central Bank started a process of restructure, although that has now been interrupted as a result of a stay order by Court.
“After the Asian Financial Crisis, most Asian countries realised the importance of consolidation and initiated merger programmes to consolidate the financial industry,” Central Bank Assistant Governor C.J.P. Siriwardena said.
In Malaysia, the financial sector was strengthened and the number of banks and financial institutions was rationalised during 1998-2000.
Singapore also consolidated its banks in early 2000 leading to bigger and stronger banks whose interests were aligned to the long term interests of the economy.
Other key Asian countries such as Indonesia, Korea and Thailand also followed this process.
Although the financial sector in Sri Lanka is stable and plays an important role, it is highly fragmented, Mr.Siriwardena said, adding that Sri Lanka’s present financial system now needs some structural changes to ensure that banks and NBFIs are well positioned in the envisaged US$100 billion economy.
Banks and NBFIs account for 64 per cent of the entire financial system assets: the banking sector comprises 22 local banks and 12 foreign banks and the NBFIs include 49 finance companies and nine leasing companies.