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Motive for mergers


The introduction will discuss about the history and development of Merger and Acquisition (M&A) in Malaysian banking industry and the motive for mergers and acquisitions in Malaysian banking. This chapter will also include the background of the study, statement of the problem, objective of the study, research questions, research hypotheses, significance of the study, and the organisation of the study.

History and Development of Merger and Acquisition (M&A) in Malaysian Banking Industry

Merger and acquisition (M&A) activities in Malaysia obviously started in the 1970's which were largely confined to oil palm and rubber plantation companies. The involvement of foreign companies in the M&A activity was also noted to be quite significant especially in the plantation sector. In the 1980's, rapid growth particularly in the industrial sector coupled with the privatisation policy has boosted many companies to become more acquisitive in diversifying their businesses. However, in the 1990's, merger and acquisition activities started grabbing the headlines. Several Malaysian companies were involved in takeover proposals or acquisitions of substantially equity stakes in companies both foreign and local, while others acquired property and yet others were subjects of mergers. Accordingly, business consolidation through merger and acquisition has became a common practice globally to achieve economies of scale, higher productivity and to enhance capability to compete and retain market share in the face of a more challenging business environment.

Mergers and acquisitions in the banking industry are not just recent phenomena for Malaysia. In light of the financial crisis which broke out in July 1997, many companies in Asian countries in general and Malaysia in particular faced serious financial distress. Thus, consolidation of domestic banking institutions in these countries had become an essential concomitant for this strategy. In Malaysia, the proposed major restructuring plan for the banking sector was announced by the central bank of Malaysia, Bank Negara Malaysia (BNM) on July 1999. During the 1980s, the Malaysian central bank has always encouraged banks to merge in order to achieve economies of scale and higher level of efficiency. Besides, the plan to consolidate and rationalise the banking sector was also due to the creation of the large number of small banking institutions in the country compared to its real size. However, only a few mergers among the bank institutions have taken place.

In July 1999, Malaysian Central Bank accordingly decided to force banks to merge with the effort to make the industry more efficient. As a result, BNM made an announcement that there should only be six core banks in Malaysia and were known as 'anchor' banks: Malayan Banking (Maybank), Bumiputra Commerce Bank, Multi-Purpose Bank, Perwira Affin Bank, Public Bank and Southern Bank. These six core banking group were merged from the existing 21 commercial banks, 25 finance companies and 12 merchant banks. Indeed, the creation of the six domestic banking groups is to ensure that domestic financial institutions will be able to endure the pressure and challenges arising from globalisation and from an increasingly competitive global environment.

The six banking groups were later increased to ten banking groups in the following year. By the end of the year 2000, the ten anchor banking groups were created through the merging of 54 financial institutions is shown in Table 1.1. The ten anchor banks are Malayan Banking Berhad (Maybank), RHB Bank Berhad, Public Bank Berhad, Bumiputra-Commerce Bank Berhad, Multi-Purpose Bank Berhad, Hong Leong Bank Berhad, Perwira Affin Bank Berhad, Arab-Malaysian Bank Berhad (AmBank), EON Bank Berhad, and Southern Bank Berhad. The merger program was successfully completed in year 2000 and in this regard, each banking group was to have a minimum shareholders' fund, unimpaired by losses, of RM2 billion and a minimum total asset of RM25 billion with the intention of ensuring that all banks are in a sufficient size, and having a more credible set of financial players in the banking industry. (Bank Negara Malaysia, 1999)

To date, the domestic banking sector has successfully consolidated into nine banking groups which are well capitalised with a risk-weighted capital ratio of 12.5% and an average asset size of RM91.6 billion (as of February 2009); also, they have been able to maintain a market share of some 70% (Anna, 2009). The further reduced on the number of local commercial banks to nine is when two banks merged in 2006. All the domestic banking groups undertake full range of commercial banking, investment banking and Islamic banking activities. Figure 1.1 shows the latest nine banking groups in Malaysia.

Motive for Mergers and Acquisitions of Banks in Malaysia

In the previous years, Malaysian merger and acquisition activities, as with most of Malaysia's neighbours within the East Asian region, are non-market driven. The 1997 Asian financial crisis exposed the fragilities of the Malaysian banking sector and economy. The financial crisis gave a much needed push for the industry to consolidate as weaknesses in the banking system were detected. Therefore, it was vital to hasten the merging of the banking system to face the more competitive and globalised business environment. At the same time, the competitive landscape in Asia, rapid technological change, and changes in the way intermediation is channeled evoked the concern among countries. Malaysia has been subject to dramatic changes as a result of the financial crisis. These changes have reduced traditional banking activities, leading banks to merge with other banks as well as with non-bank financial institutions.

The Malaysian government saw that the development of the banking system, particularly the domestic banking institutions, as imperative in facilitating recovery and contributing to the long-term resilience of the economy. Hence, it provided a strong rationale for the Malaysian Central Bank, Bank Negara Malaysia (BNM) to speed up the consolidation process to create a cluster of strong and competitive local banks, and to restore stability to the banking arena. Thus, in the year of 1999, the government announced a major consolidation that would reduce the number of domestic banking institutions to ten banking groups by 2000. Another motive is to have access to an extended governmental safety net. It is believed that very large institutions will not be allowed to fail because their failure could cause widespread panic. Furthermore, the anchor bank system was to consolidate the financial system to generate efficiency improvements in banking operations, to enhance competitiveness and to reduce the number of bankruptcies in the financial system.

By 2003 the banking industry expanded its activities into other related operations as well as their scope of activities both locally and across borders. With a leaner and healthier banking industry, the Malaysian banking industry began expanding.

Background of the study

In the context of mergers and acquisitions, a number of empirical studies have been found in different industries and different countries. The issues of the impacts of the mergers and acquisitions towards banking industry have caught the attention of many researchers not only in Malaysia but also around the world. Up to now, the research on the effect of banks merger on performance has been conducted in many countries with various findings. For instance, there is a past research by Lim, Randhawa and Heng (2004), which examined on the efficacy of the mandatory bank merger program in Malaysia by using five different measures of non-stochastic efficiency scores; overall cost, allocative, overall technical, pure technical and scale efficiency. The recent study by Sufian and Habibullah (2009) further examined the impact of mergers and acquisitions on the technical efficiency of the Malaysian banking sector by using the Data Envelopment Analysis (DEA) approach and a series of parametric and nonparametric univariate tests towards individual banks.

Also, there is a research that has been conducted to examine the effect of mergers on banks' performance in the Indonesian banking industry (Viverita, 2008). It is believed that merger and acquisition activity can improve bank's performance in two ways: Merger can improve the banks financial performance, and enhance their productivity performance (efficiency effect). A parallel strand of the literature uses event study methodology and a comparison of pre- and post-merger performance was done by Altunbas and Ibanez (2004) on the mergers and acquisitions in the European Union banking sector. Their study revealed the differences in their capitalisation and investment in technology and financial innovation are performance enhancing for domestic mergers. Thus, this study will focus on the profitability rather than productivity performance.

In spite of the extensive and ongoing consolidation process in the banking industry, Beccalli and Frantz (2009) found that M&A operations are associated to a slight deterioration in return on equity, cash-flow returns, and profit efficiency and a pronounced improvement in cost efficiency in a period of 5 to 6 years following the deals. Nevertheless, several studies on the bank performance generally based on the return on equity, return on assets or operating cash flow found that there are numerous determinants that might influence on the performance such as bank-specific, macroeconomic or industry determinants. This research project's scope is limited to bank-specific characteristics that might affect the profitability by comparing the performance to after merger and acquisition.

Problem Statement

As in other industries, the process of mergers and acquisitions in the banking industry has attracted substantial attention from managers and shareholders. Despite the efforts of analysts to explain the consolidation effect, no theoretical explanation has satisfied researchers yet. Many explanations for the consolidation effect in efficiency improvement, productivity effectiveness or share price performance have been examined. The impact of mergers and acquisitions on the efficiency and profitability of the combined firm with the consequent effect on shareholder value has been the focus of empirical research in the finance and accounting literature. This paper intends to point out the problems associated with the performance measures used in prior studies, particularly the accounting-based studies as most academic studies are using the accounting data approach to determine whether consolidation leads to changes in reported costs, revenue or profit figures.

At this point, merger and acquisition activities are being assumed to enhance the performance of banks in terms of profitability, and operating by increasing in the revenues and reducing in the costs. Therefore, a profound performance analysis is needed such as the traditional financial ratio analysis or known as accounting-based studies is mainly used for bank performance analysis (Aarma, Vainu and Vensel, 2004). However, this approach has several drawbacks. According to Berger and Humphrey (1994), most of the studies that examined the pre-merger and post-merger financial ratios found no impact on operating cost and profit ratios. Consequently, the comparison of the performance is vital to know whether there is improvement or deterioration with the involvement in merger and acquisition events.

Although accounting data are designed to measure actual performance, they may be inaccurate in an economic sense, for instance financial ratios do no control for product mix or input prices. This is due to data are based on historical figures and often neglect current market values. Furthermore, measured changes between the pre-merger and post-merger period may not be solely due to the merger. There are several mixed results emerging from various studies that employ the same methodology. For instance, Cornett and Tehranian (1992) found evidence for improvement in post-merger operating performance whereas Berger et al. (1994) do not find any evidence to support the increase in post-merger performance. There is also little empirical analysis on the determinants that might cause the performance of bank after the post-merger periods. So, this study will use the accounting data to determine whether consolidation leads to changes in the profitability performance such as return on equity or return on assets before and after merger as well as the relationship between the accounting figures.

Up to now, the problem statement of the research has been discussed. Therefore, the problem statement is to study the mergers and acquisitions effects on Malaysian anchor banks' performance according to the accounting-based studies.

Objective of the study

The objectives of this study are as follows:

  1. To analyse and determine the variables that influences the bank's performance before and after the merger and acquisition.
  2. To compare and contrast the performance of Malaysian banks before and after mergers and acquisitions.
  3. To evaluate the changes in the performance of the Malaysian banking groups' after mergers and acquisitions.
  4. To find out whether mergers and acquisitions benefit the banking groups in Malaysia.
1.6 Research Question

This study focuses on answering the following questions.

  • What are the bank-specific characteristics affecting the performance of Malaysia's banks before and after merger and acquisition?
  • Do mergers and acquisitions in Malaysian banking improve the profitability performance and efficiency of banks?
  • Is there any significant change in the performance based on the traditional accounting-based studies?
Hypotheses of the study

The present study will test the following hypotheses:

  1. Capital buffer ratio has an effect on the performance of banks before and after merger and acquisition.
  2. Loan growth has an effect on the performance of banks before and after merger and acquisition.
  3. Loan loss reserve ratio has an effect on the performance of banks before and after merger and acquisition.
  4. Cost efficiency has an effect on the performance of banks before and after merger and acquisition.
  5. Interest earning ratio has an effect on the performance of banks before and after merger and acquisition.
  6. Loan deposit ratio has an effect on the performance of banks before and after merger and acquisition.
Significance of the study

This research is a continuum to the stream of studies related to mergers and acquisitions in the banking industry. The contribution of this study is important as it is about the evaluation of performance of mergers before and after mergers in the banking industry. In recent years, there are many studies conducted to examine the effects of mergers and acquisition in emerging markets such as US and UK while less in developing ones like Malaysia. This study does not differ greatly from other studies in this field but it will only focus on bank-specific characteristics. Through this research, it will reveal the most important effects which stand on the way of providing a comparison on the pre- and post-merger performance and how it will affect the bank's performance after the merger. Therefore, we need to fill in the research gap of the empirical study by examining markets in Malaysia.

Banks' performance can be an important source of information for investors or shareholders that would be interested to know the impacts of the takeovers. This will help investors to make better decisions and to improve investment choices facing by investors. In this paper, return on common equity (ROE) was chosen as a measure as it is considered a critical performance indicator by both investors and management (Lindblom and VonKoch, 2002). Therefore, there is a need to investigate and examine the changes in ROE due to merger and acquisition.

The study has important significance such as guiding the government policy regarding deregulation mergers and providing the reference to the government and bank authorities as to provide the reliable financial information on the economic resources and on the estimation of the gaining capability of a bank. For instance, government policy makers and regulatory agencies such as Bank Negara Malaysia (BNM), Securities Commission (SC), and others would be interested in information on merger and acquisition, as well as distribution of ownership for planning and regulating economic development. Hence, decision makers ought to be more cautious in promoting merges as a means to enjoy the efficiency gains.

Organisation of the study

The research of the topic is about the effects of mergers and acquisitions on the performance of banks in Malaysia. This research project is completed based on step-by-step approach which is presented in the Figure 1.2.

In Chapter One, the study begins with a few short introductory paragraphs which will clearly describe about the topic and the background of the study. In more details, it explains briefly the importance of mergers and acquisitions towards banking industry in Malaysia. In this part, it also presents the statement of problem which is the focal point of the research. In problem statement, it showed numerous issues happened in Malaysia. Besides, it will address all the problems and factors related to the study in the form of research questions. Furthermore, this chapter describes the objectives of the study and the purpose of the study. The contribution of the study is created to point out how the study relates to the larger issues and uses a persuasive rationale to justify the reason of the study. List of the hypotheses developed and the organisation of the study will be included too.

In Chapter Two, it is a review of the literature. In this chapter, journals papers and other publications related to the study is being summarised and reviewed in order to come out with clear gaps in the past studies in this area and provide solutions to close these gaps. It is important because it shows what previous researchers have discovered on the impacts of banks merger and acquisition. This part offers a good foundation to understand the topic and it serves as a fundamental part to develop the model and hypothesis.

In Chapter Three, it is about building the research model and constructing the hypothesis based on the previous research presented in chapter two. Based on the literature review, a framework is developed by identifying independent and dependent variables of the study. This chapter concentrates on explaining each variable in the model, and reasons for choosing them to be included in the research model. After presenting the model, the chapter explains the empirical part of the study. This part discusses the method used for collecting data to test the hypothesis, and analyses the data received.

In Chapter Four, it represents the results and discussions which will illustrate the findings that the study gained from the empirical results. This chapter will provide the overall data analysis of the research

In Chapter Five, it provides the summary of the study. Besides, the implication of study is well-documented in this chapter. Finally, the limitation of the study is presented and some recommendation is suggested for further improvement in the future research.


Chapter one basically is the introduction of the research. This chapter discusses the overview of effects of mergers and acquisitions on the performance of banking industry. Chapter one is started with the history and development of mergers and acquisitions in Malaysian banking industry and the explanations on the importance of merger and acquisition activities and bank performance. The next chapter will proceed with the literature review.


This chapter will discuss the published information in a particular subject area, and sometimes information in a particular subject area within a certain time period. This chapter details the relevant secondary data obtained to present various works published by various authors. The literature review usually precedes a research proposal, methodology and results section. This chapter is organised according to several components. First of all, this chapter will explain on the merger and acquisition terminology, follow by the determinants of profitability performance. This chapter will elaborate the performance effects for mergers and acquisitions in the banking industry and other industries. The assessment of pre- and post- merger performance in several countries will be discussed.

Terminology of Merger and Acquisition

Generally, merger and acquisition (M&A) can be defined as the combination of two or more firms and the resulting firm maintains the identity of one of the firms. The term is normally used for a deals activity, including mergers, acquisitions, consolidations and takeovers. Merger and acquisition have always been associated with the strengthening of firms' financial entity and increasing in value (Harjito and Sulong, 2006). Most of the time, the larger firm will retain its identity and usually, the assets and liabilities of one firm are transferred into the other firm. In details, mergers may result from the negotiation between two companies that have interest to combine or when one or more companies target another for acquisition. Consolidation, by contrast, has the similarity meaning as merger which involves the combination of two or more firms to form a completely new corporation.

On the other hand, the term acquisition tends to be used when one company takes control of another. The firm that attempts to acquire another firm is commonly known as acquiring company while the firm that the acquiring company is pursuing is referred as the target company. Furthermore, mergers and acquisitions can occur on either voluntary (friendly) or hostile. A voluntary or friendly mergers occurs when the shareholders and management of a firm approve decide to sell the firm to an acquirer. Hostile mergers is when a takeover take place opposition from the target's firm management, causing the acquiring firm to try to gain control of the firm by buying shares in the marketplace (Wikipedia, 2009).

Pre- and Post- Merger and Acquisition Performance Measurement

Several studies on the effects of merger and acquisition activities influence the institution performance have been done by prior researchers. Different techniques and assumptions have been found by all the researchers and practitioners on the related topic. Moreover, different countries and industries involved especially banking industry were presented in the literature.

This study will focus on the bank-specific determinants that significantly affect performance of a financial institution such as profitability, efficiency, operating and financial positions. Profitability comparisons have been used to assess whether mergers and acquisitions create real economic gains. In the literature, bank profitability is measured by the return on assets (ROA) and/or return on common equity (ROE). According to Athanasoglou, Delis and Staikouras (2006), both ROA and ROE is typically expressed as a function of internal determinants. Internal determinants are factors that mainly influenced by a bank's management decisions and policy objectives. Such profitability determinants are the level of liquidity, provisioning policy, capital adequacy, expenses management and bank size. Umakrishnan and Bandyopadhyay (2005) pointed out that the shift from traditional social banking to profit banking, implementation of prudential norms pertaining to capital adequacy, income recognition asset classification and provisioning, exposure norms have given rise to increased competition and thrown greater challenges in the banking sector. Based on the studies by Mylonidis et al. (2005), they claimed that the findings of the US studies are generally consistent as they find that on average mergers improve profitability, especially when they involved banks being inefficient prior to the merger.

A review of literature and cross-references obtained from there revealed many researchers who have explicitly studied the effects of mergers and acquisitions on banks performance. In addition, there are numerous studies of performance, however, very few, if any, employ the exact same set of bank-specific variables or, more generally, control variables.

In the paper of Badreldin and Kalhoefer (2009), they focused on the analysis of the banks that have undergone merger and acquisition in the Egyptian banking sector during the period from 2004 to 2007 by means of Basic ROE Scheme. Their findings through ROE indicated that M&A had no clear effects on the profitability of banks in the Egyptian banking sector. Only minor positive changes to risk provisions reflecting improved credit risk positions were found. Hence, their findings show that not all banks that have undergone deals of mergers or acquisitions have shown significant improvements in performance and return on equity when compared to their performance before the deals. In addition, evidence is obtained from the ten banks which were divided based on the home-country of the acquiring bank for the period of two years before and after the merger, using the mean of ROE. The motivation for doing this paper is come from the increased liberalisations and economic reforms in some countries in the Middle East and North Africa region, resulting in more and more banks are engaging in expansionary activities including mergers and acquisitions. According to them, some of the analysed banks have not shown similar profitability improvements as those witnessed in the United States and European Union could be the result of the not-so-mature economy of Egypt compared to those of the United States and European Union.

An analysis on the impetus behind the merger from both Bank of America and FleetBoston was done by Rodriguez (2004) to examine how the newly merged bank will benefit from the merger. The analysis is based on the profitability characteristic which is measured by return on equity (ROE) from both banks for pre-merger during the period from 2001 to 2003. In order to provide a glimpse of what future financial performance might be the 2003 ROE analysis for Bank of America and FleetBoston have been combined into the New Bank of America pro forma 2004 and 2005. From the study, it indicates that the combined ROE for the new bank in year 2005 cannot compete with the performance of Bank of America in 2003. A sensitivity analysis is used to reflect that the ROE changes based upon varying levels of cost savings. The Bank of America management believes synergies between the combined operations will provide additional growth opportunities that will improve performance in the future. However, for the short-term analysis, Bank of America's performance will likely be hampered by merger costs and by absorbing a less profitable company than itself. Thus, it caused Bank of America faces significant operational risks associated with a merger of this magnitude. The results show that Bank of America's acquisition of FleetBoston creates a mega-sized bank with impressive geographic and market coverage no matter the acquisition will profitable or not, yet, in long-term, it might enhance their growth.

The Singapore banking industry has not been subjected to substantial research as compared to the other countries such as U.S., Europe, and Asia-Pacific banking industries which have performed several studies in regard to the efficiency and productivity of the financial institutions. This may partly due to the lack of available data sources and the small sample of banks. In view of these considerations, it became the rationale for Sufian, Abdul Majid and Haron (2007) to analyse the impact of the merger and acquisition in the Singapore banking sector by employing both Financial Ratio Analysis and Data Envelopment Analysis (DEA) to examine the changes in profitability, cost efficiency, risk and efficiency of a sample of 5 domestically incorporated Singaporean commercial banks. From the findings, they found out that merger did not resulted in a higher profitability for the Singapore banking groups during post-merger period which may be attributed to the higher costs incurred but merger has resulted in a more prudent risk management by the Singapore banking groups. They also found that more efficient banks tend to maintain higher degree of capitalization, post higher profits and incur higher overhead costs. Based on the DEA analysis, they found that beside merger, size (scale efficiency) is the biggest source in influencing the inefficiency of the Singapore banking system. However, they cannot conclude on possible less efficient bank will become a merger target as they revealed mixed findings from the evidence. In contrary, there is evidence that do not support the findings which is from the research by Berger and Humphrey (1992) which stated that large bank acquirers tend to be more efficient than their targets which suggested mergers are to aim for improving the target's efficiency.

Mantravadi and Reddy (2007) compared the pre- and post-merger operating performance for acquiring companies in Indian industry during the post-reform period, from 1991 to 2003 based on the different relative size of acquiring and acquired companies. The objective behind the study is to analyse whether the mergers and acquisitions in India in the post-reform period have improved the operating performance of acquiring firms by using the fol­lowing financial ratios: operating profit margin, gross profit margin, net profit margin, return on net worth, return on capital employed and debt-equity ratio. Results showed a decline in the net profit margin while other profitability ratios remain unchanged after the merger. It indicates that the increase in financial leverage after merger and following increase in interest costs, have affected the net profits of the acquiring firms. The mergers in Indian industry had not improved the operating efficiency of acquiring firms.

According to Beccalli and Frantz (2009) studies, there are few studies that compare efficiency gains from cross-border and domestic M&As with a relatively large country coverage. Their analysis is based on 714 deals of EU acquirers and worldwide targets announced between 1991 and 2005. They investigated the effects of mergers and acquisitions on banks' performance according to several complementary measures such as accounting ratios, cost efficiency and profit efficiency. Thus, in this paper, it aims to extend and integrate the existing literature by enlarging the geographical coverage of the sample, by contemporaneously testing several different performance measures, and by distinguishing the part of the change in performance due to the M&A itself. Both of the authors found that in domestic deals there are cost efficiency gains but there is no improvement in ROE or profit efficiency. On the other hand, in cross-border deals there are cost efficiency improvements but profitability deteriorates. Furthermore, an important finding reveal from this paper is concerning the set of institutional, regulatory, bank-specific and deal-specific variables has a significant influence on the changes in cost and profit efficiency. In short, institutional variables are correlated with the performance improvements from mergers.

In general, financial leverage means the use of debts in terms of loan or borrowings to reinvest with the intent to earn a greater rate of return than the cost of interest. According to Antikainen (2002), if the financial leverage ratio increases, it means that mergers are means of increasing financial leverage whereas it also can be considered that if the financial leverage decreases after the merger, the company has been able to reduce its long-term debt and at the same time its assets have grown.

Another study by Altunbas and Ibanez (2004) examined the impacts of merger and acquisitions taking place in the European Union banking sector between 1992 and 2001. In this paper, they analyse the impact of strategic similarities in bank mergers on bank performance, by associating the resource allocation patterns as indicators of the underlying strategies. The authors tried to shed light on the process of financial consolidation in the European Union by assessing whether strategic and organisational fit between financial institutions involved in mergers and acquisitions plays an important role in improving financial performance after merger. Such relationship has been tested and verified mainly in the US-based but there is a paucity of studies in the European Union. Therefore, in their study, they measured the strategic similarity of firms involved in M&A activity, by using a simple indicator of the strategic similarity of firms given their financial characteristics is calculated for each strategic variable and individual merger in domestic and cross-border mergers of the European Union. The financial indicators include measures of financial performance: asset and liability composition; capital structure; liquidity; risk exposure; profitability; financial innovation and efficiency. Therefore, the study showed that consistency on the efficiency and deposits strategies of merging partners are performance enhancing both for domestic and cross-border M&As. They concluded that the overall results showed that broad similarities among merging partners were conducive to an improved performance, although there are important differences between domestic and cross-border M&As and across strategic dimensions. For instance, in the domestic mergers, the differences in their capitalisation and investment in technology and financial innovation were found to improve performance, whereas for cross-border M&As, differences in their loan and credit risks strategies are performance enhancing.

Mylonidis and Kelnikola (2005) performed a similar study to provide evidence on the effects of M&As in the Greek banking sector over the period of 1999 to 2000 by using the operating performance methodology and event study. The results from their finding indicate that profits, operating efficiency and labour productivity of the bidding and target banks do not improve after merger. In addition, liquidity measures worsen in the post-merger period, hence raising credit risks and capital adequacy considerations. In brief, the operating performance results do not provide evidence of performance gains resulting from bank mergers which are consistent with others literature around the world. However, based on the event study approach, mergers did create value on a net aggregate basis.

The most recent study by Somoye (2008), investigated on the performances government induced banks consolidation and macro-economic performance in Nigeria in a post-consolidation period (2005-2006). The analysis is based on the published audited accounts of twenty banks that emerged from the consolidation exercise. The purpose of the paper is to review the effectiveness of bank consolidation programme in the banking and the real sectors of the economy. In summary, the author concluded that bank consolidation would reduce the insolvency risk through asset diversification, increase credit risk, and at the same time, bank consolidations do not significantly improve the performance and efficiency of the participant banks. The author also stated that the consolidation programme has not improved the overall performances of banks significantly and has contributed marginally to the growth of the real sector for sustainable development.

The most widely applied measure to banks' performance is financial measures and the non-parametric Data Envelopment Analysis (DEA) to compare the financial and productivity performance of banks pre- and post-merger and efficiency gains. Viverita (2008) employed these two approaches on the Indonesian banks between 1996 to 2006 by comparing the performance based on capital adequacy ratio (CAR), non-performing loans (NPL), loan-to-deposit ratio (LDR), net interest income (NII), return on assets (ROA), and return on equity (ROE). Besides, data envelopment analysis (DEA) is used as well to measure bank efficiency performance before and after the merger. The results of this study indicate that there is a significant productivity improvement of the merged banks which create synergy and by comparing the performance of banks before and after merger; it shows that being merged can boost operating efficiency. The findings of this paper revealed that merger did increase bank's ability to gain profits through the improvement in return on asset, return on equity, net interest margin, capital adequacy ratio and non-performing loans.

Okazaki and Sawada (2003) examined on the effects of a large wave of bank consolidations took place in Japan by focusing on the two characteristics of the financial system which are the governance structure of the bank and the extents and quality of the director interlocking between banks and industrial companies. Okazaki and Sawada used two performance measures, including the ability to collect deposits and profitability that reflect the stability of the financial system. They compiled a comprehensive database on the directors and auditors that controlled the interlocking between the banks and non-banking firms in the period from 1927 to 1929. In the second section, they examined on the relationship between bank mergers and stability of the financial system. The authors used the deposit growth rate to measure the ability of banks to attract deposits and the return on assets (ROA) for profitability assessment. In addition, they focus on ROA rather than ROE because they would like to examine how efficiency of asset management was improved by the consolidation. From their findings, consolidations had an effect of excluding the unfavourable director interlocking between banks and their related firms. Besides, they confirmed that consolidations had a positive impact on the deposit growth, but no evidence indicating a positive impact on the profitability of banks.

Basu, Druck, Marston, and Susmel (2004) examined a large panel of more than 100 banks from Argentina to study the effects of bank consolidation on performance from the year 1995 to 2000. From the results revealed, they found a positive and significant effect of bank consolidation on bank performance. The returns for the banks based on return on equity increase with consolidation and insolvency risk is reduced. Besides, the study also suggested that mergers and privatisations have a beneficial effect on bank returns. However, the effect of a bank acquisition on return on equity is negative. Basu et al. (2004) employed a variety of measures of bank performance, such as returns which is measured using accounting data and insolvency risk.

The literature shows that there are numerous studies on the institution's performance resulted from the mergers and acquisitions exercise in various countries, including India, Egypt, U.S., Japan, Nigeria, European Union, Finnish, Greek, Argentina and Singapore. Most of the studies employed the accounting-based method to evaluate the pre- and post- merger performance. The literature delineated above has used return on assets, return on equity, productivity or efficiency as the measure of bank performance. From the above literature reviews, the summary of the pre- and post- merger and acquisition performance measurement is illustrated in Table 2.1.

Additionally, the recent decades of the banking sector has undergone substantial changes due to factors such as globalisation, liberalisation, deregulation, financial innovation and information technology developments and have contributed to the need for a more competitive, resilient and robust financial systems. These changes have become the key driving force for merger and acquisition activities as well as corporate restructuring in the financial service industry which lead to the emergence of larger banks and financial institutions. Thus, this study will focus on the banking sector in Malaysia by using the same practice as the prior researchers. For this paper, there are six bank variables that have affect the pre- and post- merger and acquisition performance for banks will be studied. These variables are adopted from the previous researchers' studies (Rasidah et al., 2008).

Determinants of mergers and acquisitions performance for banks

Capital Buffer Ratio

According to Rasidah et al. (2008), larger banks or banks with high capitalization tend to have a higher equity base and a higher loan loss reserve then their smaller counterparts. Their findings suggested that as the amount of capital of the banks increases, the ROE also increases. Other studies by Marimuthu (2009) describes that capital structure concerns the relative proportions of debt and equity financing that helps companies to minimize their overall financing cost (cost of capital). Even though leverage (overall capitalisation) has been demonstrated to be important in explaining the performance of financial institutions, its impact on bank profitability is ambiguous. This is supported by Sufian, and Chong (2008), which mentioned that capital structure is essential for financial institutions in developing economies as it provides additional strength to withstand financial crises and increased safety for depositors during unstable macroeconomic conditions.

Moreover, as lower capital ratios suggest a relatively risky position, one would expect a negative coefficient on this variable. However, it could be the case that higher levels of equity would decrease the cost of capital, leading to a positive impact on profitability. Moreover, an increase in capital may raise expected earnings by reducing the expected costs of financial distress, including bankruptcy. Indeed, most studies that use capital ratios as an explanatory variable of bank profitability (Goddard et al., 2004) observe a positive relationship. A number of definitions used for banks' capital from the prior research such as the ratio of capital to total assets (Shrieves and Dahl, 1992) and the ratio of capital to risk-weighted assets (Jacques and Nigro, 1997). Finally, Athanasoglou et al. (2005), suggest that capital is better modeled as an endogenous determinant of bank profitability, as higher profits may lead to an increase in capital.

Loan Growth

Typically, loans represent the majority of a bank's assets. Total assets controls for the size of the bank and can be considered as a proxy for economies of scale (De Bandt and Davies, 2000). When a bank increase it lending activities, means that there is growth in their loan and at the same time, assets for the bank will be increasing as well and hence the size of bank will be larger. However, Rasidah et al. (2008) stated that loan growth indicates that banks increase their lending activities but profitability is decrease.

According to Flamini, McDonald, and Schumacher (2009), size signals the specific bank risk, although the expected sign is ambiguous. Other researchers, however, conclude that few cost savings can be achieved by increasing the size of a banking firm, especially as markets develop (Boyd and Runkle, 1993; Athanasoglou et al., 2005). This evidence is supported by the results from Berger and Humphrey (1994) stated that the merger process has not generally produced cost savings for large banks. Eichengreen and Gibson (2001), suggest that the effect of a growing bank's size on profitability may be positive up to a certain limit. Beyond this point the effect of size could be negative due to bureaucratic and other reasons. Hence, the size-profitability relationship may be expected to be non-linear. Goddard et al. (2004) study the performance of European banks across six countries. They find a relatively weak relationship between size and profitability measured by ROE. Similar results are obtained by Boyd and Runkle (1993), in their banking performance study, concluded that an inverse relation exists between size and profitability.

Loan Loss Reserve Ratio

According to Poghosyan and Hesse (2009), loan loss reserve ratio is used as a proxy for bank credit risk. They stated that higher risk exposure is normally associated with lower profitability due to write-offs of existing loans, so a negative effect of credit risk is expected. Moreover, Rasidah et al. (2008) claimed that a high provisioning policy requires banks to set aside a large amount of funds as loan loss reserve and this contributes to bringing down ROE of the banks. Their findings indicate that banks were equally risk-adverse during the pre- and post- merger periods and are reflected by their conservative loan loss reserve policies. This assumption is in line with the evidence in Hughes and Mester (1998) who attribute the banks' choice of financial capital (above the cost-minimising level) to risk aversion. Risk-averse banks can improve their protection against financial risks by merging with other banks. Through mergers, banks can achieve a larger scale, increase their geographical scope, and offer a more diverse mix of financial services.

Cost Efficiency

Azofra, Olalla, and Olmo (2008) studies on the consequence of technological progress and financial deregulation, the operational synergy derived from greater and the improvement of acquired institution's management. From their results, they stated that if the cost efficiency is positive and significant, it indicates that the institutions are less efficient. In the case of the institutions involved in mergers, the effect of the variable ROE is significant and negative and the cost efficiency is not significant. Hence, the firms undertake mergers in order to reorganise themselves and to increase their performance.

Studies reviewed by Beccalli and Frantz (2009), found that mergers are associated with a pronounced enhancement in banks' cost efficiency but simultaneously with a deterioration in profit efficiency, return on equity and cash flow. This evidence is supported as well by Rasidah et al. (2008), as level of inefficiency of management increases, the ROE of banks deteriorates due to the relatively high expenses incurred by the banks and caused negative impact on overall profitability. So, a bank with high efficiency ratio is considered as less efficient. Therefore, a negative association between inefficiency and profitability is expected since more efficient banks are likely to have larger scope for generating extra income.

Interest Earning Ratio

Interest earning ratio is defined as the net interest income of the banks divided by the total revenue. As net interest income can be more or less sensitive to the changes in interest rate, so when interest rate increase, interest earning ratio of banks will increase and thus it might caused the return on equity or profitability of the bank to drop. This may be due to the decrease in their revenue. The studies by Rasidah et al. (2008) supported the statement that as interest earnings ratio of the banks increase, their ROEs decrease. From the results on the post-merger performance, they concluded that banks are becoming more focused on their intermediation activities to generate high net interest income; however, the activities may still have a negative impact on their overall income and the ROE.

Moreover, the implication from Banal-Estanol and Ottaviani (2006) stated that the increase in the expected interest rate has the same consequences as an upward shift in the demand for deposits and an upward shift in the marginal cost of loans. As a result, fewer loans will be offered and more deposits will be collected.

Loan-Deposit Ratio

Loan-to-deposit ratio (LDR) is a traditional measure of bank's liquidity, indicates the extent to which deposits are used to meet loan request (Viverita, 2008). LDR also has important role for the banks which is as an indicator for banks as an intermediary institution to connect the excess funding holders and the users in their economic activities. Therefore, the optimum level should be maintained, so that the necessary liquidity needed and their function as an intermediary should be fulfilled.

Rasidah et al. (2008) suggested that as liquidity position of the banks becomes more risky, the ROE of banks become higher. Such risky position for banks could be caused by either an increasing loans portfolio or a decreasing deposits base. They did also found out that during the post-merger period, banks are cautious and watchful in their lending activities as an aggressive lending activities will increase the profitability, yet, only if the loans issued by the banks are of good quality. Examples for good quality loans are government bonds and T-bills. Furthermore, liquidity risk, generally arising from the possible inability of a bank to accommodate decreases in liabilities or to fund increases on the assets' side of the balance sheet, is considered an important determinant of bank profitability. The loans market, especially credit to households and firms, is risky and The data will be divided into pre- and post-merger according to individual bank's completed merger date for the descriptive equality test analysis, which is based on the method used by Rasidah, Fauzias, Low and Aisyah (2008). If a merger was completed before the middle of the year, that year is considered as the post-merger period analysis. On the other hand, if a merger was completed after the middle of the year, then that year is considered as pre-merger period. The analysis will be performed based on the pre-merger performance data for two years period prior to merger and two years period for the post-merger performance. The time range is supported by Altunbas et al.'s (2004) suggestion that two years are sufficient to avoid alteration and inaccuracy of results as longer time spans may negatively affect accuracy and results from the effects of other external economic factors. Thus, the data will be collected spread from 2000 to 2008, covering a period of nine years. Besides, the initial sample includes the nine anchor-banks that are listed on the Bursa Malaysia and have undergone mergers and acquisitions. Table 3.1 provides the list of acquirers and targets as well as the year of completion for mergers and acquisitions in Malaysia.

Using this sample, pre- and post- mergers and acquisitions performance of acquirer banks will be measured using return on common equity (ROE) as a dependent variable. This study use the ROE to measure the performance of banks involved in mergers and acquisitions exercise because of the availability of accounting data for pre- and post-merger, and able to obtain accurate results as compared to the stock market which do not offer a fair indicator of performance or market value due to the excessive fluctuations.


Performance Measurement based on Accounting Studies

For the comparison on the pre- and post-merger performance of the merging banks, this paper introduces the accounting-based studies which utilise the accounting data. Accounting-based studies have used numerous financial ratios as a tool to evaluate whether the mergers and acquisitions have benefited the acquirers. The financial ratios are widely used for modelling purposes both by practitioners and researchers, as their analysis is one of the most valuable tools for the decision-making of many interests' parties, for instance, owners, management, personnel, competitors, and academics as well as for comparisons between inter-company and intra-company (Pazarskis, Vogiatzogloy, Christodoulou, and Drogalas, 2006). A number of researchers have used the similar accounting approach to investigate the post-merger performance of banks, for instance, Mylonidis and Kelnikola (2005), Harjito et al. (2006), Jeon and Miller (2006), and Resti and Siciliano (2000).

This study will further explore on the effects of a number of potential correlates of bank performance by using the financial ratios and bank-specific variables. Lim et al. (2004) claimed that financial ratios have been generally accepted as good indicators of corporate performance when analysed across time and against industry norms, as they reveal crucial information about the effectiveness of operations and management abilities. Specifically for banks, financial ratios analysis can disclose important bank performance dimensions such as profitability and efficiency (Lim et al., 2004).

Table 3.2 provides the lists of the financial ratios selected to measure the improvement in the performance of the banks after the merger and acquisition programme is completed.


In order to measure the change in performance (measured by ROE) before and after merger and acquisition, there are some methods to apply in the test. This study will use the descriptive statistics of mean and standard deviation for each of the variables identified in this study to determine whether there are significant differences in the average values before and after merger. After getting these descriptive statistics, the parametric t-test for each of these variables will be computed and all t-values will be tested based on 1, 5, and 10 percents level of significance by using the SPSS software. Finally, multiple regressions will be employed to see whether there is relationship between two variables and yet a regression of one on the other variables often shows a significant relationship.

Descriptive Statistics

Descriptive statistics are defined as the mathematical methods such as mean, median, standard deviation that aim to quantitatively summarise and interpret a set of data (sample), rather than being used to support inferential statements about the population that the data are thought to represent (Wikipedia, 2009).

Multiple Regression Analysis

Multiple linear regression analysis is a technique for modeling the linear relationship between two or more variables. It is one of the most widely used of all statistical methods. In banking and finance, regression analysis is a very common method used to find the determinants of bank performance (Nor Mazlina and Izah, 2009). The regression model used in this study is based on the panel data fixed effect model (FEM) by pooling the data to perform a panel regression for the pre- and post-merger periods. A fixed effects model is a statistical model that represents the observed quantities in terms of explanatory variables (independent variables) that are all treated as if those quantities were non-random (Wikipedia, 2009).

In order to examine the dependent variable (ROE), the multiple regression equation is presented below:

    yit=x1+x2+x3+x4 + x5 + x6 (1)


    yit= Bank's performance indicator in year t, namely ,ROE

    x1= Capital buffer ratio(CBR)

    x2= Loan Growth (LG)

    x3= Loan Loss Reserve Ratio (LLRR)

    x4= Cost Efficiency CE

    x5= Interest Earning Ratio (IER)

    x6= Loan Deposit Ratio (LDR)


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