From the horse’s mouth

Sandy Weil, the legendary American banker and former chairman of the Citigroup, built the empire called Citigroup by buying other banks and insurance companies. After a series of acquisitions, which included Salomon Brothers in 1997, the US $73 billion merger of Weil’s Travelers group with Citicorp in 1998 led to the formation of a mammoth financial institution called Citigroup. That merger, the biggest merger in the global banking history till date, was largely a success owing to strong lobbying from Weil, who was successful in persuading Robert Rubin, then Treasury Secretary of the United States, to do away with the Glass Steagal Act.

The series of events which led to the formation of Citigroup is vividly captured in a recent book about Jamie Dimon, a former protégé of Weil and now Chairman of JP Morgan Chase, called The Last Man Standing: The rise of Jamie Dimon and JP Morgan Chase written by Duff McDonald. Dimon was the key man involved in all of Weil’s acquisitions that culminated in the Travelers-Citicorp deal in 1998. Dimon, who was later fired from Citigroup after a fallout with Weil, became the most important player in the Wall Street during the financial crisis of 2008 as his firm (JP Morgan Chase) bought Bear Stearns and Washington Mutual—mainly at US treasury’s behest—to quell the panic in the financial market. From Citigroup to JP Morgan Chase to Washington Mutual, the book provides intricate details regarding key recent mergers and acquisition (M&A) in the US banking history. The book exposes how it’s not only the right valuation and synergies that drive M&A but also the big fat egos of the top executives involved in these massive deals and their quest for power and fame.

At a time when voices are being raised in favour of introducing necessary regulations for M&A amongst financial institutions in Nepal, there are lessons to be drawn from this book as it provides key insights to what makes a good M&A deal for a financial institution and how, like in the case of Citigroup, mammoth financial institutions fail to generate synergy and subsequently flounder due to their unmanageable size. There is no doubt that the government should encourage M&A among financial institutions by introducing necessary regulations. However, both government and shareholders needs to scrutinise the M&A deals as there will be scope for creating a monopolistic entity as well as enrich top management at the cost of shareholders.

One area where M&A can possibly help Nepali banks is in increasing their capital base. The biggest problem with the banks in Nepal right now is that they have too little paid up capital to fund large scale projects. Even a small hydropower project needs consortium financing. Another area is cost cutting: duplication of space, technology and human resources can be drastically reduced. However, the major potential obstacle for M&A amongst Nepali financial institutions is lack of opportunities to create synergy. Synergy exists when two banks with different revenue models, different clientele bases, different geographic presence and different core expertise decide to merge.

For example, it makes sense to merge a bank with a strong presence in Eastern zone with another bank with a stronghold in Central zone. Or it makes sense to merge a bank with core expertise in retail lending to one with a large corporate loan book. Or it makes sense for a bank with large retail client to buy a bank with institutional clients, strong private banking and wealth management division. However, in Nepal almost all of the banks operate in the same geographic area, offer the same plain vanilla banking and have the same revenue model and, hence, the potential to create “synergy” is limited. Recently ICICI bank, a leading private sector bank in India, decided to buy Bank of Rajasthan because it wants to increase its presence in Northern and Western parts of India. This deal has business logic as there are opportunities, granted right valuation and proper execution, to create synergy and increase shareholder value.As the liquidity crisis in the banking system shows no signs of easing, recent conversations among bankers and policymakers have veered towards M&A as a potential tool to shore up the capital base of the banks—and strengthen their balance sheets in the event of systemic banking crisis—in order to capture the so called “synergies” that are possible due to M&A.

In a way, many people see M&A as a panacea to all of the current problems in the domestic banking sector. However, M&A doesn’t always increase shareholders value and more often than not M&A are guided by top management’s lust for more power and fame. Moreover, as banks grow large in size after M&A, the big size becomes hindrance to progress as executives fail to execute the deal property to realise the synergy. Citigroup is a classic example of an M&A deal gone woefully wrong.

For an M&A to work, in the words of Jamie Dimon, the deal needs to have business logic, the price must be right and, last but not the least, the top management should know how to execute the deal. Time and again, M&A, while destroying shareholders value, have only made CEOs, lawyers and consultants involved in the deal richer.

First Published in The Kathmandu Post on 27th June, 2010

Link: http://www.ekantipur.com/the-kathmandu-post/2010/06/26/oped/from-the-horses-mouth/209841/

Speculate This!!!

Recent comments from the Governor of the Nepal Rastra Bank (NRB) published in the Financial Times (FT) — a leading United Kingdom based newspaper — has once again put Nepali currency’s (NC) fixed exchange rate system vis-à-vis Indian currency (IC) into the spotlight. Though appropriate and beneficial for the Nepali economy in the long run, the governor’s quote on FT’s May 23 edition to the effect that Nepal needs to reconsider its long standing currency peg “in the medium term” and the subsequent issuance of a press release to neutralise the possible negative effects of the governor’s statement by the NRB next day — that categorically stated that the exchange rate peg would not be changed — has created a lot of uncertainty in the market.

In the same story, the governor also said that Nepal has no option in the short term but to maintain the currency peg, and the country would only be able to alter the peg when there is political stability, greater confidence in the economy, lower inflation and higher reserves. However, why would a speculator, or a smart investor, hold on to the NC when she knows that the currency would eventually be devalued?

For example, if someone can figure out that the current NC to IC peg of 1.6 would be changed to 1.8 in one year, she is better off taking her money out of the Nepali banks and putting in the Indian banks. Let’s assume that the investor can earn 6 percent in the FD account in India, then if she were to convert NC to IC at existing exchange rate her total return would be 19.25 percent (6 percent from FD, 12.5 percent from the appreciation of the IC, and 0.75 per cent from the interaction effect between FD return and IC appreciation) in the event of possible devaluation of the NC in a year’s time. When everyone starts doing this it would create a self-fulfilling prophecy, and then Nepal would have to abandon the currency peg sooner rather than later because of the acute shortage of the IC in the market and its inability of support the peg through the selling of the foreign currency reserves to satisfy the demand for IC.

Nepal will have to eventually devalue its currency at some point. The current level of the peg is just unsustainable. The growth differential between Nepal and India will compel the government to devalue. The million dollar question is: when? In a perfect world, as the governor said, it would be beneficial for the economy if Nepal can devalue when there is a stable political system, a well performing economy, lower inflation and higher reserves. However, there isn’t anything called perfect world in foreign exchange market. History is testament to this as evident from the events in Mexico in 1994 and Thailand in 1997. When there is a word out that the government is mulling to devaluate its currency, it won’t be the government that will decide when to devalue but the market. A speculator anticipating the devaluation would not stay idle and keep her money in NC — she will covert to IC. Taking the cue from the speculator, everyone would then follow the suit. When everyone starts doing the same, government will be left with no option but to devalue.

It’s a cardinal sin in the fixed exchange regime to even talk about possible devaluation even though it would likely benefit the economy in the long run. One cannot just talk about possible devaluation in the future and expect the market not to react, especially when the foreign reserves are dwindling. By just bringing forward the topic — which though has a lot of merit on its own right but which should not have been divulged in public — the governor has possibly put the fate of the NC in the hands of the speculators.

This article was first published in the Kathmandu Post on June 13, 2010

Link: http://www.ekantipur.com/the-kathmandu-post/2010/06/12/oped/speculate-this/209344/