An open letter to Ajith Nivard cabraal: it’s time for bank consolidation

The masterplan for consolidation of Non-Bank Financial Institutions is progressing with a number of mergers taking place. The surge in share prices of finance companies that took place in the recent past is enough proof of shareholder expectationsfrom theconsolidation program. This is also a strong indication of the possibility for these merged NBFIs to raise further funds through the stock market.

Sri Lanka currently has 23 Licensed Commercial Banks. Only 5 of these banks have total assets exceeding one trillion. The assets of these five banks make up approximately 80 percent of the total assets of local LCBs. In this scenario, would it not be in the interest of the banking industry to implement a consolidation programme.

My recollection is that finance sector consolidation was initially proposed by the Central Bank in 2013 when it was under your stewardship and a significant amount of work was done in this regard. By October 2014, 41 NBFIs and 9 banks had confirmed their consolidation plans to the Central Bank. Guidelines on tax incentivesto support the consolidation of Banks were approved by the Monetary Board.

Implementing a master plan for consolidation of Licensed Commercial Banks would help spearhead growth of the Sri Lankan economy. Larger banks with lower cost funds resulting from higher CASA ratios, lower debenture interest rates and capability to raise equity through the stock market, can on lend at lower interest rates to important sectors such as the SME sector.There can be greater financial inclusion with larger banks capable of bringing more Sri Lankans to use formal financial services at an affordable cost.

At present Licensed Commercial Banks raise funds to satisfy core capital requirements by the issue of debentures. These are issued between 1.5 percent and 3-4 percent above the rate offered by government securities. The rate at which these funds are raised can be reduced when debentures are issued by larger commercial banks. This can be very clearly seen if one studies therecent debenture issues by banks.

Larger banks with the capability to raise funds at a lower cost and the ability to offer more facilities without exceeding single borrower limits will enjoy better economies of scale and increased net interest income.

More sophisticated financial services can be offered by pooling the management and technical capabilities of the combined entities. At a time the investment phase of the port city project is commencing, with the possibility of greater involvement of international banks, this would be a necessity if our local banks are to benefit from business generated within the port city.

The cost income ratios of our LCBs far exceed the cost income ratios of LCBs in neighbouring countries like India and Singapore.

The two most significant costs that make up the total Operating Expenses of LCBs in Sri Lanka are Personnel Costs and Establishment costs. 

These two costs are approximately 60 percent to 65 percent of the total Operating Expenses of LCBs.The income generated through these costs can be increased substantially through consolidation that would lead to lower cost income ratios that would in turn increase earnings per share. EPS is a critical measure of shareholder satisfaction.
Shareholders are important stakeholders of banks. Increased EPS results in higher dividends per share and an increase in the share price. A rights issue of a leading bank in Sri Lanka will amply demonstrate the importance of meeting shareholder expectations. The share of this bank is presently trading at less than the rights issue price. It would not take a genius to predict how successful this rights issue would be.

Considering the fact that at least two major stakeholders of banks, its customers and shareholders stand to benefit from bank consolidation, is it not time to reconsider bank consolidation?