M&A in Islamic finance — achieving sustainable change

Malaysia has seen a lot of banking mergers and acquisitions (M&As) over the past three decades. For instance, in the aftermath of the 1997 financial crisis, Bank Negara Malaysia implemented a guided merger of the financial institutions in Malaysia, to improve on the size, scale and efficiency of the Malaysian banking industry. At that time, the financial system in Malaysia had 21 commercial banks, 25 nance companies and 12 investment banks.

The original plan was to merge all these disparate financial entities into six large banking groups. The industry eventually ended up with 10 banking groups and subsequently whittled further down, following the merger between BumiputraCommerce Holdings Bhd and Southern Bank, and separately the merger between Hong Leong Bank Bhd and EON Capital Bhd.

More recently, on Nov 6, 2017, Malaysia Building Society Bhd (MBSB) announced its acquisition of Asian Finance Bank which, once completed, would create the second-largest standalone Islamic bank in Malaysia with total assets exceeding RM40 billion.

This marks a successful end to MBSB’s search for a banking partner to become a full-fledged Islamic bank. However, it also marks the beginning of a new chapter for the merged entity, which in many respects is the more difficult part — integrating the two distinct entities and operating within an already crowded Islamic banking industry in Malaysia.

Setting Right Strategy

In a merger, setting the right strategy for sustainable growth of the combined entity is paramount. Michael Porter of the US outlined the nature of rivalry within the industry, and balance of power between its suppliers and customers, substitute products and potential new entrants, as the five forces that shape the industry’s competitive landscape. An understanding and appreciation of how these forces affect the playing field will allow leaders to set sustainable strategies to compete and create positive value for their companies.

Within the banking industry globally, regulatory compliance serves as a barrier to entry, but at the same time, it has disrupted the operational costs of existing players in the industry, too.

Compliance to Basel 3, for instance, has resulted in banks scrambling to raise more stable deposits from the retail market, which in some jurisdictions has resulted in a price war for deposit rates. This rise in cost of funds, in turn, has had the effect of squeezing margins, and thus the returns on equity have contracted while valuations have been on a downward slope.

On the other hand, the emergence of substitutes, such as financial technologies which coincided with the changing preference and eroding sense of loyalty of customers, are disrupting the business model of banking institutions and chipping away at clients’ wallet size, thus negatively impacting the profitability of banks.

Apart from sustainable strategy, merger exercises have to deal with the intricacies of change management. Complexities of change management cannot be underestimated, in particular, the impact of the change to people, to the culture and the customers.

Eyeing Improved Efficiencies

Following the merger exercises in the aftermath of the 1997 Asian financial crisis, several researchers conducted studies to evaluate whether merger exercises within the financial sector in Malaysia actually achieved improved efficiencies. The general conclusion was that during the imme

diate period following a merger, the efficiency levels dropped significantly, owing to redundant branches and staff, workforce and duplication of overhead costs. However, following the post-merger initiatives and change management efforts, the efficiency levels drastically improved.

Generally, merger exercises seek to achieve growth opportunities and create positive value through a diversification into newer segments, customers or products, and achieve positive gains in combined revenue of the merged entities and more efficient utilisation of technological investments.

A classic example is the Development Bank of Singapore Ltd’s (DBS Bank) acquisition of POSB Bank in the early 1990s that gave DBS Bank access to a million depositors in suburban areas of the city state. The integration of both banks allowed customers to use the technological and digital facilities of either bank, to perform their banking services.

Mergers also offer positive value through cost savings, typically from extinguishing redundant general administrative and marketing expenses, and also from reduced headcount as the merged entities rightsize their workforce. Herein lies one of the most vexing dilemmas in management in a merger situation —

that laying off personnel undeniably offers the most positive impact to cost efficiencies, but that is also the approach that has the biggest negative impact to social and morale indicators. As such, cost-cutting measures, especially ones that deal with the human factor, must be exercised with the most cautious and righteous approach, with proper integrity and accountability.

In conclusion, M&As will always be a time of great opportunities and also immense anxiety. To realise the opportunities, the merged entity will have to navigate their growth path carefully, equipped with the wisdom and courage to design a strategy and implement it with a clearly defined purpose, and backed by a set of mutually reinforcing effective action plans.

At the same time, it is important to internalise the principles of ihsan (righteousness), to ensure that the interests of a broader set of stakeholders, which includes employees, are managed ethically to achieve sustainable change.

  • Syed Alwi Mohamed Sultan is Bank Muamalat Malaysia Bhd executive VP of strategic planning division. The views expressed here are entirely his own.