Banks facing thin margins, evolving markets need to consolidate


MALAYSIAN banks need to consolidate to cope with declining net interest margins (NIMs) and build the capabilities to meet rapidly changing consumer patterns, according to McKinsey & Co.

In its flagship regional banking report, the global consulting firm said margins, return on equity and price-to-book multiples in the Asia-Pacific banking industry are converging with global averages as emerging markets mature.

Consequently, regional banks are grappling with thinning margins, declining asset quality and rising capital costs, while digital attackers are entering the market and challenging incumbents in terms of customer acquisition and share of wallet, it said.

Malaysia is not exempted from these challenges and McKinsey senior partner Gabriel Vigo said consolidation is needed for local banks to achieve scale and to innovate.

“Large banks do not have the bandwidth to innovate and, consequently, cannot adapt to changing consumer needs quickly,” he told The Malaysian Reserve.

“Smaller banks, in contrast, are nimbler and can capture better opportunities in the market, but lack the scale and visibility associated with larger entities.”

In the report, return on average equity among domestic banks was shown to have dropped from 12.8% in 2014 to 10.9% in 2018 on declining margins and lower capital.

The fact that the top four banking groups in the country by assets control 51% of the domestic market share points to the potential for consolidation, it added.

While smaller banks stand to benefit from scale and the resultant improvements on returns and cost, consolidation is an opportunity for larger players to expand their presence in growing

markets and build new capabilities. “Large banks rely on a solid business model and only start innovating when that business model gets challenged,” Vigo said.

“So, banks that are quick to innovate, especially in the digitalisation of sales, have the most to gain.”

He said fee-based business and digitalisation of sales are among the opportunities that banks should capitalise on, especially as the industry is facing declining NIM and net interest income on increased competition and moderating growth.

Fee-based income will mostly be driven by wealth management and financial services — for what is a growing affluent market in Malaysia over the next three to five years, while digitalisation will see basic financial services such as personal loan applications going online, Vigo said.

Key to capturing these opportunities is the ability to leverage on new sources of data via, among others, digitalisation, artificial intelligence and machine learning to have access to customers.

“What differentiates an excellent bank from an average bank is the ability to finance a single customer even within a struggling sector,” Vigo said.

“It is no longer about moving away from specific sectors, but assessing customers, and innovation plays a key role in doing so.”

The growing but largely underserved small and medium enterprise market in Malaysia, of which only 30% is financed by banks, is an example of an untapped market that requires a data-driven approach.

The call for consolidation among domestic banks can be traced as far back as before the turn of the century, but latest efforts to consolidate via mergers and acquisitions (M&A) have been mixed.

While Malaysia Building Society Bhd became a full-fledged Islamic bank following its RM645 million acquisition of Asian Finance Bank, AMMB Holdings Bhd and RHB Bank Bhd were forced to abort their proposed merger on suspected valuation issues.

The proposed merger between Malaysian Industrial Development Finance Bhd and Al Rajhi Banking & Investment Corp (M) Bhd remains in the balance after missing the June 27 deadline to complete the deal.

Banking mergers usually fall through on valuation disagreements between both parties, but consolidation is also a lengthy process, making it difficult to react quickly to the need for innovation, according to Vigo.

Thus, while there are obvious benefits to consolidation and banks are typically keen to do so, time constraints and valuation issues are likely to hold back M&A deals in the near future.