Bank mergers in Ethiopia: inevitable or avoidable?

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Since the government expressed its intention to open the financial market to foreign providers, one of the hotly discussed topics has been the weakness of domestic banks to withstand the ensuing competition from their foreigner counterparties. This narrative is followed by a proposition for their merger towards creating fewer numbers of larger banks. On many occasions National Bank authorities have indicated merger among the existing providers to be desirable, if not inevitable. Is merger the only survival mechanism for Ethiopian banks post opening of the market? Not necessarily for all. While most of the small banks may have difficulty to cope with the changing financial market without merger, especially after entry of foreign players, a few of them can avoid unwanted consolidation.
It is true that Ethiopian banks are small in comparison to some of their African counterparts. According to the 2021 Banker Magazine of the Financial Times, only 2 of the top 25 African banks have a tier-1 capital of less than a billion USD (Banque du Cairo and First Bank of Nigeria). While South Africa and Egypt have each six of these big firms, Nigeria and Morocco respectively claim five and four places. The remaining four are from Kenya (2), Mauritius and Togo. Another report, African Business of 2021 provides a slightly different rank without segregating the tier 1 capital structure. In this later report the Commercial Bank of Ethiopia takes 26th place with a total capital of USD 1.173 Billion and an asset of USD 23.849 Billion. In this ranking which lists 100 biggest African banks Awash Bank is the only private bank from Ethiopia that comes at the 83rd place with a capital of 243 million USD. All the three big Ghanaian banks come after 87th rank, while none is listed from Uganda, Tanzania, DRC or the Sudan-countries that have opened their markets to foreign banks long ago. In a way, this indicates that it is possible to open the banking market even if a country doesn’t have big domestic players.
Nevertheless, by these standards Ethiopian banks are rather small in size. If Ethiopia wants its banks to become competitive, encouraging the emergence of bigger entities is necessary. I don’t mean to suggest that size of capital is the only determinant of success in competition. Technological and human resource development is as important. However, capital base is a key consideration as it enables companies to acquire the other key factors of success. If so, organic growth by raising capital from internal sources will not be fast enough since foreign banks are knocking at the gates. The quicker way is merger of existing firms and the emergence of a handful of big players.
Indeed, bank mergers will be desirable, but not necessarily inevitable. Thus, there should not be any compulsion to force consolidation. If anything consolidation in the sector should be voluntary. Forced bank mergers are said to have occurred in India and Malaysia among others. In India the forced merger applied to the various state owned banks (regional and central state banks). In effect the element of compulsion was not there strictly speaking since the state that adopted the policy of consolidation in the sector was the owner of these banks. These mergers did indeed create giant banks, but it was widely reported that these consolidations did not result in efficiency gain in service quality, cost effectiveness or profitability. In Malaysia, forced mergers between private banks resulted in consolidating 71 institutions into 10 mega banks. However, subsequent studies indicated that only two out of the ten resultant mega banks showed improvement in cost efficiency. From profitability point of view, none of the banks experienced significant difference in profit efficiency level after the merger exercise.
In contrast Nigeria’s voluntary merger resulted positively both in terms of operational efficiency and profitability. Nigeria policy was not to force consolidation, in as much as it didn’t select the anchor banks and the targets, and instruct them to converge. This is in marked contrast to Malaysia which seeded the 71 banks into anchors, subsidiaries and targets. Nigeria’s central bank raised the minimum capital to 25 billion Naira only (in today’s rate roughly less than 4 billion ETB), and left the decision to consolidate to the institutions.
The direction Ethiopia’s NBE is taking seems to be similar with Nigeria’s. It has raised the minimum capital for bank formation to 5 billion ETB, and has been constantly stressing the need for consolidation in the sector. For a good number of the existing banks consolidation is unavoidable. A few of them have already surpassed the 5 billion thresholds, and can avoid mergers. Most of these also have huge legal reserves accumulated throughout their profitable years. These reserves can be converted into equity in as far as Ethiopian law allows such an exercise. However this option is a non starter for smaller and newer banks. Therefore, it is only a matter of time for the new entrants and those that could not muster the minimum 5 billion to converge.
However consolidation is easier said than done. Especially, in the Ethiopian financial sector regulatory environment and market practice there appear many barriers to mergers. A few of the challenges can be lack of experience, regulatory challenges, and possible management resistance.
First there is acute dearth of experience of mergers and acquisitions in the corporate culture in Ethiopia. To begin with, in corporate law parlance, the word merger represents three different procedures, i.e., amalgamation, acquisition and takeover: 1) amalgamation-the full combination of two entities to create one new entity; 2) acquisition-the full absorption of one entity by another; and 3) takeover-the acquisition controlling shares by one company in another. The call for consolidation in the financial sector refers to the first two only. Looking at the experience of the market, in Ethiopia amalgamations and acquisitions involving share companies with dispersed ownership are very few and far between. Most capital restructurings hitherto reported as mergers are simply takeovers, and of no useful lesson to what is being contemplated in the banking sector. If anyone thinks that the Commercial Bank of Ethiopia’s acquisition of Construction and Business Bank as an important source of experience, they will soon be disappointed. That was merely a process of a sole owner (the state) merging its two properties. Perhaps the only known experience one can mention is the acquisition of Raya Breweries by BGI a few years ago.
However, merger in the banking sector will not be so easy as the acquisition of Raya by BGI because of the structure of share ownership. Financial institutions are widely held mainly because the NBE requirement limits the maximum holding to just 5%. In fact, NBE’s policies tended to discourage concentration of ownership by placing stringent requirements for influential shareholders having stakes above 2%. However, the dispersion of ownership will come back to haunt the initiative for consolidation. This will prove a regulatory barrier. The fact that both the bidders and the targets are companies with dispersed ownership will make merger transactions complicated in the financial sector. This means diffuse shareholders at both sides should be convinced of the merits of the transaction. The new commercial code clarifies the procedures, but that doesn’t mean it will be easy. What is more, some of these institutions mean more than just business because they carry ethnic representations. Imbued in their value is their appeal among their respective ethnic or religious communities. Thus, while mergers should be rational market decisions, mergers between institutions carrying differing ethnic symbolism may appear to be unholy marriages. This will limit the menu both for bidders and targets. In other words, if you are bank A, you can’t bid to acquire bank X, because bank X symbolizes a different ethnic community. This will make merger transactions further complicated. Even if there are a few non-aligned banks; and their choices both as bidder or target will be likewise, limited to the non-aligned groups.
In view of the mechanics of effectuating mergers the selection between amalgamation and acquisition needs careful considerations. Amalgamation is more disruptive and complicated than acquisition. It disrupts the operation of all the entities participating in the transaction, and until the new entity is created with its bosses identified business operation will be slowed if not interrupted. Acquisition will be less disruptive, and more straightforward. It can be cash-for-shares acquisition (the bidder increases its capital and uses the proceeds to pay the shareholders of the target; the target disappears, its shareholders go, and assets of the target become assets of the acquirer). Or such an acquisition can be share-for-share transaction (the bidder exchanges x number of its shares for y number of the target’s shares. The target’s disappears, but its shareholders are allowed to remain shareholders of the acquirer, except those that reject the proposition which will be forced to leave taking cash compensation.)
Thirdly, like in all other countries there will be managerial barrier. Executives at target companies are natural obstacles to mergers. This is especially true in companies with diffuse ownership like in Ethiopian financial institutions giving senior management and the board effectively full control of major decisions. Even if the decision on mergers is theoretically made by the shareholders’ meeting, practically it is only the management/board that can initiate such decisions. Minority shareholders can initiate decisions under the new commercial code, but the management/board can always dissuade the general meeting from taking any decision it doesn’t favor. So much so that, mergers that the management doesn’t like have less likelihood of success. Target management disfavors acquisitions because it means loss of position. In other countries the market for corporate control has long introduced effective remedies for hostile target management such as golden parachutes, golden handshakes, etc. Under such arrangements, target management is paid generation compensation for job losses from the mergers. In fact most senior management employment contracts will have such clauses. It is not clear how many of bank CEOs in Ethiopia contemplated job losses from mergers and included such clauses in their employment contracts. Nevertheless, such clauses can be useful in as much as they can remove one of the potential barriers against consolidation in the financial sector. Post merger integrations are also problematic because each institution will have its own corporate culture.
Way forward
Where does all this leave us? Merger of banks is not necessarily a must for all. Some can avoid mergers. Older banks that have surpassed the minimum capital threshold of 5 billion can withstand the threat of merger. First of all, most of these have accumulated legal reserves which they can easily convert into equity. Second most of these institutions have assets in real-estate, and other investments. Newer ones don’t have that luxury, and must plan for merger.
The NBE should take the initiative and support them in providing guidelines, trainings and coordinate knowledge/experience sharing. In as far as compulsory mergers can’t be effective, guidelines will be more appropriate than directives. Such guidelines should explain procedures, identify issues of valuations and indicate possible methods of solving such issues. If the NBE decides to issue directives, such an instrument should not enforce compulsory mergers. A directive can be issued to clarify as to how merger can take place, how cash-for-share or share-for-share acquisitions can be made, how disruptions can be minimized during such transactions, disclosure and due diligence matters, etc. To ensure the optimum success of the consolidation program, in particular the post consolidation integration issues, there is the need for the NBE to sponsor training programmers’ on post-consolidation integration and corporate culture conflict management. This would assist to mitigate conflicts associated with consolidation, thereby facilitating the sustainability of the merged institutions.
Coordinating experience sharing with foreign counterparts can provide key lessons. Ethiopian financial industry is probably unique because of dispersion of ownership and the presence of ethnic elements in some of the players. May be it is hard to find parallels for such elements in other countries. Yet, the experience of financial institutions in other countries can give us useful lessons. Bank mergers either market driven or policy driven such as that being contemplated in Ethiopia has occurred in many countries. Why not learn from them and avoid the errors they made and capitalize on the positives?

Fekadu Petros is Managing Partner at Fekadu Petros & Partners Law Office