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Asia-PacificFebruary 7 2020

What is behind Asia’s wave of banking consolidation?

Mounting pressures on banks across Asia-Pacific are pushing many towards consolidation as they fight to remain profitable, and relevant, in a rapidly diversifying banking sector. Kimberley Long reports. 
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Baoshang

For several years, Asia has enjoyed a scale of growth that has been the envy of the rest of the world. From China’s soaring gross domestic product (GDP) to the emergence of digital banking and mobile payments, the region seemed to be on an endless upward curve. But under the surface, problems were brewing. The fall in banking revenues as the financial industry began to diversify started to bite, hurting smaller regional and agricultural banks the most. 

“Asia saw significant growth between 2010 and 2015, but since then it has slowed to single digits,” says Joydeep Sengupta, senior partner at McKinsey. “The rise of non-performing loans and declining asset quality has left a stain on the balance sheet. The developed banks have shored up capital and avoided the worst of this, but it has been hard for the other banks that don’t have strong capital positions.” 

Running a profitable bank in Asia has become much harder in recent years. “Banks are facing more problems as they attempt to make money as traditional revenue streams decline,” says Mr Sengupta. “For example, the banks and non-banks in many ways eroded the profitability of payments, so much so that it is pretty much free now. To compete they need to focus on providing specific services.” 

The difficulties some banks are facing are linked to the natural evolution of the banking sector, some experts believe. “The banking market in the region has become more mature, and the Asian banks are facing challenges typical of this maturity,” says Ho Kok Yong, financial services industry leader at Deloitte Southeast Asia. “The challenges include higher risks, increased competition, slowing growth and dwindling margins.” 

India takes action 

Across Asia, countries have been taking an individual approach to dealing with banking problems. In response to economic decline and the continuing pressures from bad loans, India announced it would begin a process of merging a number of its smaller banks to create new financial institutions. 

The mergers pushed through under the guidance of finance minister Nirmala Sitharaman will see Punjab National Bank, Oriental Bank of Commerce and United Bank of India combine, Union Bank of India merge with Andhra Bank and Corporation Bank, and Canara Bank join Syndicate Bank. On top of benefiting from the combined balance sheets, the government gave these new banks a Rs552.5bn ($7.7bn) cash injection. 

Even with these steps, S&P Global Ratings senior director Geeta Chugh warns the banks cannot afford to become complacent. “Unless these banks implement substantial reforms to improve risk management, the need for capital will recur,” she says.

Taking control of the market is part of the Indian government’s plans to stabilise the country’s declining finances. In December 2019, the Reserve Bank of India cut the GDP growth forecast for 2020 from 6.1% to 5%. Therefore it is hoped that overhauling the banking system will do more than make the regional banking network stronger. “The main reason for consolidation in India is to spur the economy,” says Mr Ho. “With a combination of banking consolidation and the capital injection by the government, the Indian government is of the view that larger and healthier banks will spur fresh credit and revive economic growth. This allows for more resources and helps drive down lending costs.” 

China’s quest for control 

Bringing troubled banks under state or regulator control through consolidation is another method of containing a problem. In China, there have been cases of smaller banks struggling, and the regulators are stepping in. 

“In the case of China, the reason behind consolidation is largely to contain risk,” says Mr Ho. “Consolidation is one of the pillars used by the Chinese government as part of its comprehensive solution to deal with problematic banks. With fewer banks, it is easier for the regulator to monitor risk.” 

Alicia García-Herrero, chief economist for Asia-Pacific at Natixis, adds: “The regulators and the People’s Bank of China jointly created this route to consolidation, and are becoming more forceful about it. Agricultural banks and co-operatives are most likely to be pushed into consolidating. It is a general trend across the country; some banks are in trouble.” 

Notable was the China Banking and Insurance Regulatory Commission’s (CBIRC’s) intervention in Baoshang Bank. The Mongolian bank had been struggling for some time when the regulator stepped in, and had not filed an annual report since 2017. State-owned China Construction Bank was appointed to oversee operations. Ms García-Herrero believes this was a turning point, and further interventions have followed. “Baoshang Bank’s transfer to the state-owned bank started the process of regulatory intervention in mid-2019. Joint-stock bank Hengfeng Bank then received a liquidity injection at the end of 2019,” she says. 

As more troubled banks emerge, the regulator may become more open to stepping in with assistance. “Consolidation is becoming the natural choice for the banks beyond the group of state-owned banks,” says Ms García-Herrero. “It is uncharacteristic for banks to directly ask for financial assistance, so the push from the regulator to consolidate is a preferable solution.” 

Ms García-Herrero believes China needs to define the reasons why banks should consolidate, especially given that it is as a result of regulatory pressure rather than a market response. “It is about stopping these banks from failing, rather than the financial benefits,” she says. 

Diversification may be the key for banks to avoid consolidation and stay competitive. Wealth management has emerged as a strong banking product since the CBIRC introduced rules for running a wealth management business at the end of 2018. Setting up a wealth management subsidiary could bring in additional deposits and fees. 

For others, digital banking could be a solution. “In the past three or four years, there has been the move towards digital banking and money market funds, which have taken deposits away from the smaller banks,” says Gary Ng, economist for Asia-Pacific at Natixis. “The types of deposits the banks can accept depends on the regulation.” 

Indonesia’s requirements 

In some countries, the desire by the regulator to champion consolidation has been overt. Indonesia’s Otoritas Jasa Keuangan (OJK) – the country’s financial services authority – removed regulatory barriers that were hampering consolidation. For example, institutions acquiring a bank were previously limited to holding 40% ownership, but are now able to hold a higher percentage provided they merge it with any additional banks they own. Furthermore, new regulations stipulate that a controlling entity can have control over only one bank, with the aim of promoting consolidation and reducing the number of banks in Indonesia. The same regulations apply to both domestic and international banks. 

A large number of banks also creates operational issues for the regulators. “The high number of banks [in Indonesia] causes inefficiency in supervision for OJK,” says a spokesperson for the authority. “As an illustration, from a total of 110 banks in Indonesia, 78 banks have core capital under Rp5000bn [$367m] and contribute only 14% of total banking assets.” 

The OJK also hopes that bank consolidation will strengthen bank capital levels. It wants every bank in the country to have core capital levels of at least Rp3000bn by the end of 2022, although small banks as subsidiaries of large banks can meet the requirements with Rp1000bn. 

Which banks end up together remains to be seen. Matchmaking banks for consolidation, as was done in India, is not a viable option for Indonesia. “It is harder to consolidate the smaller banks due to the country’s diverse geography. [In Indonesia there needs to be] a more thoughtful approach to dealing with banks that are subscale,” says McKinsey’s Mr Sengupta. 

The OJK’s decision to allow foreign banks to engage in consolidations in Indonesia on an even playing field with domestic banks stands in contrast to what is allowed in other south-east Asian countries. “In many countries, foreign ownership restrictions limit foreign investors to a minority stake, which can be unattractive because investors typically prefer a controlling stake to drive strategy and fully integrate their acquisitions,” says S&P’s Ms Chugh. “That said, some countries have taken incremental steps to spur consolidation.” 

In April 2019, Japan’s Mitsubishi UFJ Financial Group (MUFG) increased its share in Indonesia’s Bank Danamon to 94%. This has allowed MUFG to gain a foothold in Indonesia, and specifically in the small and medium-sized enterprise segment, where Bank Danamon is particularly strong. 

“The Indonesian government believes that with this move to allow international banks into the market, the competition that foreign entrants brings will drive the local banks to come up with better strategies to offer the best services to their customers,” says Deloitte’s Mr Ho. 

China, by comparison, has not been receptive to letting international banks fully enter its financial system. “There is some foreign interest in investing but so far only ING has taken a stake in a Chinese bank in its joint venture with Bank of Beijing,” says Ms García-Herrera. “All other international involvement comes from insurance and asset management. It is very hard for foreign banks to get a foothold.” 

Going digital?

A threat that is consistent across Asian banking is the rise of digital banks. As savvy consumers demand more from their banks, be it speed in the cities or having banking at their fingertips in rural locations without a branch, banks of all sizes are feeling the pressure.

McKinsey’s June 2019 report ‘Bracing for consolidation: The quest for scale’ warns that banks “need to reinvent themselves, or risk disappearing” as the industry continues to change. The creation of a number of virtual banks in Hong Kong, Singapore, Taiwan and Malaysia during 2019 will likely increase the anxiety felt by incumbents that their market share is ebbing away. 

“The issuance of digital banking licences is changing the landscape again,” says Mr Sengupta. “From a customer point of view it is a good thing, because it doesn’t affect the availability of products.” 

Another worry for traditional banks is just how well resourced digital banks are. Without the need for a large workforce or physical branches, they make sizable savings on overheads. But even more significantly, they have considerable financial backing. “The valuations of the traditional banks are low at this point compared with the valuation of the new entrants that are privately funded,” says Mr Sengupta. 

There is the possibility incumbents will look to virtual banks as potential partners. While the new banks are well leveraged they may lack experience in meeting regulatory requirements. This is where the existing banks may have the advantage. 

“For the medium-sized banks, they have the option to consolidate with larger banks, to combine with other smaller banks, or to join with the new digital banks to provide them with banking expertise and infrastructure,” says Mr Sengupta. 

Which countries are next? 

As Asia’s economy continues to evolve, the need for consolidation is likely to spread to emerging and established economies alike. Vietnam has been edging towards increased consolidation since introducing legislation in 2018 to deal with underperforming financial institutions. The State Bank of Vietnam identified banks that will be subject to special controls that include bankruptcy, recovery and mergers or consolidations of shares and capital. 

Thailand may also be poised for a wave of consolidation. The country’s Office of the National Economic and Social Development Council reported that the country saw a 2.4% increase in GDP growth in the third quarter of 2019, compared with the same period in the previous year. 

“Thailand’s challenge is the lack of growth,” says Mr Sengupta. “It is moving towards consolidation because it doesn’t have the level of growth to sustain so many banks.” 

The Thai government has taken steps before to encourage consolidation. In 2018 it introduced tax exemptions on corporate income tax and personal tax for shareholders of commercial banks that have merged. There was some success: in 2019 Thanachart Bank and TMB merged in a deal worth Bt140bn ($4.61bn), creating Thailand’s sixth largest bank. 

Rather than merging domestically, Thai banks have been exploring options across Asia to boost their coffers. Bangkok Bank acquired Indonesia’s Bank Permata in December 2019, taking an 89.1% stake for about $2.67bn. 

Ms Chugh believes Thai banks will be willing to look strategically at other options. “They are also exploring opportunities outside the banking sector: the strategic investment into the ride-hailing tech unicorn Gojek by Siam Commercial Bank shows an increasing need among Thai banks to diversify and transform themselves,” she says. 

In the established markets, the prospect of consolidation has been avoided, but this may be about to change as banks search for growth. “Japanese, South Korean and Taiwanese banks have seen low returns and fragmentation. It is likely we will start to see some degree of consolidation happening,” says Mr Sengupta.  

Whether Asia’s economies continue to grow or contract, it seems there will be fewer, but hopefully stronger, banks to carry on doing business. 

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Kimberley Long is the Asia editor at The Banker. She joined from Euromoney, where she spent four years as transaction services editor. She has a BA in English Language and Literature from the University of Liverpool, and an MA in Print Journalism from the University of Sheffield. Between degrees she spent a year teaching English in Japan as part of the JET Programme.
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