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/