The financial market is not going to be in the dumps forever. Nepal has witnessed stagnancy in financial activities that have remained largely weak in the last few years due to the recent liquidity crisis. As I have pointed out in my previous articles, the liquidity crisis in Nepal was primarily the result of banks and financial institutions (BFIs) providing the majority of their loans to the real estate sector. The real estate market slowed down in late 2008. As a result, borrowers could not pay interests, let alone the principle amount of the loans. The banks, thus, lost money, and this created a liquidity crisis.
However, the real estate sector will eventually start improving again and will its activities will pick up. Then, the borrowers—who have so far defaulted in their payments—are going to start making their payments again. When that happens, our BFIs are going to be flush with cash. The question then is, what will they do with that excess cash?
Since their investment and loan portfolio is not diverse, the BFIs will have to choose between two options. First, they will have to take risks and start providing loans to the real estate sector again. This could lead to another liquidity crisis if the real estate market slows down again. Second, to move away from the risky real estate portfolio, the BFIs could use their cash to purchase securities which are much safer than issuing real estate loans; though securities yield much lower returns compared to the latter.
This could create a dilemma for BFIs. On one hand, the BFIs would not want to go back and issue excessive loans to the real estate sector because that was what caused them anguish in the last few years. On the other hand, the securities option gives relatively poor returns. If BFIs are flush with cash and do nothing with it, they will have to face intense pressure from their shareholders. When this pressure becomes unbearable, experience from around the world suggests that a third outcome becomes most likely - a merger spree.
The bottom line for the BFIs is to ensure that their shareholders are satisfied and the best way to do this is to show them that their institution is growing. The most appropriate option for that is to acquire assets. And the best asset a strong and cash flush BFI can acquire is another BFI. Once the real estate market in Nepal wakes up from its hibernation and starts making money again, the most logical option for our BFIs would be to enter into mergers for the growth of their assets.
While shareholders may be happy seeing their institution grow through such mergers, the latter in themselves do not guarantee a healthy BFI or a robust financial market. Today, the mergers happening in the market are not the result of choice but compulsion of having to save the institutions. In future as well, mergers will not be out of choice but will become a compulsion—to “show” the shareholders that the excess cash is being used in asset-building.
However, there are multiple reasons why shareholders should not feel too pleased about mergers and acquisitions. First, as the New York Times reported during the merger surge in 2005 in the US, shareholders’ stakes in the acquiring firm typically declines post-merger. The structure of BFIs in the US and Nepal are not very different. So this decline could happen in the case of merging Nepali BFIs as well. Second, evidences from past mergers worldwide show that CEOs end up pocketing around 8 percent of the merger cost as their own ‘compensation’.
The New York Times report also mentions that there has been a strong correlation between the size of a financial institution and the salary of its CEO. It did not matter whether an institution was faring well or poorly in the market. The CEOs of larger BFIs always get paid more than those in smaller BFIs. Therefore, the shareholders need to be cautious and skeptical when their CEO argues in favor of a merger. Who benefits the most from the merger is a question that should be asked and considered. We are not even aware of how much our BFI CEOs are pocketing from their merger deals.
Despite these warnings, more mergers will certainly happen in the future in Nepal’s financial industry. I am also confident that the BFIs are going lead the discussions, set the agenda and finalize the details of the merger propositions. However, the Nepal Rastra Bank (NRB) has to monitor and facilitate the merger processes to ensure that the shareholders are not kept in the dark by their greedy CEOs, that the consumers of the financial services do not suffer as a result of mergers and that the BFIs that are merging do not get weakened after the merger. The NRB should ensure a robust and stable financial market in Nepal and ensure it does not become frail and uneven as a result of mergers.
The author is an economist
mukhanal@gmail.com
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