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Even before the dust gets settled on the regulator-forced banking sector consolidation   programme which has now been set aside, a veteran banker in the country sees the need for the sector to consolidate through mergers and acquisitions in order to achieve economies of scale.

According to the NDB Bank PLC CEO, Rajendra Theagarajah, the sector is over-crowded and needs shrinking. However he is of the view that leaving the process entirely to the private sector does not help the course.

“I think we should (shrink),” he said responding to a question on whether the banking sector needs consolidation.

 “I have gone through this journey for the last two to three years and I have not given it up. The issue is that leaving it entirely to the private sector to drive it and leaving it to the democratic process doesn’t work,” he said at an event organized by the research arm of the stock brokerage, Asia Securities (Private) Limited to launch their banking sector report.

It is in the grapevine that NDB is in talks to buy a controlling stake in another major commercial bank.

The report titled, ‘Banks: An evolving story of elephants and cheetahs,’ Asia Securities said Seylan Bank PLC could become a takeover target for either NDB Bank PLC or DFCC Bank PLC.

“Strong branch network, high Current And Savings Account (CASA), strong presence in SME and retail banking and exposure to credit card business has led the bank to be a prime takeover and merger target for growing banks like NDB and DFCC,” the report stated.

In March this year, NDB Bank PLC bought 8.5 percent stake in Seylan Bank PLC which many believed strategic. As of March 31, 2015 NDB Bank PLC had an 8.72 percent stake in Seylan, being the fifth largest shareholder.

Theagarajah believes that an “occasional nudge” needed to stimulate the process because the frontier markets might not have seen banking sector consolidation before.

“When it comes to an emerging, frontier economy, they are seeing the consolidation (banking sector) for the first time. An occasional nudge is needed, at least to give a jump start (to the process)”, he said.

Currently there are 25 licensed commercial banks, including 12 foreign banks and 9 licensed specialized banks operating 6,554 branches and other outlets in Sri Lanka. The bank density – the measure of number of bank branches per 100,000 persons – has increased to 17 by end 2014, 16.8 a year ago.

In view of the immediate requirement to increase the minimum core capital base up to Rs.10 billion from the current Rs.5 billion, Asia Securities is also of the view that Pan Asia Banking Corporation PLC too will see a possible merger in the short term or at least a new capital infusion from a foreign investor.
Japan-based Bansei Securities Co., Ltd already has 15 percent stake in the bank.
 

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Upcoming regulations to put pressure on profitability

Asia Securities further said the forthcoming regulations by the Central Bank which will lead to a stricter credit approval process resulting in slower credit growth will have knock-on effect on banking sector profitability.

“Risk-sensitive pricing where more credit towards customers with higher credit ratings at lower rates will affect margins while any reduction of securitization exposure, including credit card business, would further deteriorate margins (the credit card business is a highly profitable business),” Asia Securities Manager Research Srimal Liyanage who authored the report noted.

According to latest data, banking sector total credit grew by 19.9 percent year-on-year (YoY) in March 2015 while the private credit grew by 13.9 percent yoy.
Lower interest rates in the economy have dented banking sector interest margins during the last 5 years but the recent data available for April 2015 shows that the margins have edged up by 50 basis points to 3.7 percent from 3.2 percent a year ago, predominantly due to rise in low cost CASA basis.

During the first four months, banking sector CASA base increased by Rs.81.5 billion while the total deposits increased by 159.2 billion, and out of this, savings deposits accounted for 48 percent.

Limits on lending and the margin pressure would further put pressure on the Return on Assets (RoA) and Return on Equity (RoE) in the banking sector.

Therefore Asia Securities is of the belief that this pressure on profitability combined with the Central Bank’s Rs.10 billion minimum core-capital requirement will promote consolidation or force banks to raise additional capital.

“While this will be slightly dilutive in the short run, we believe that this will further strengthen the banking system to face external financial shocks and safeguard investments,” Liyanage said.