The most obvious trend in the Nigerian banking industry today is the consolidation drive. The Central Bank of Nigeria (CBN) imposes a N25 billion minimum capital base in order to increase asset portfolios of banks, partly in response to the spate of insolvencies that has characterised the sector in recent times.
Recognising the difficulties that may face most banks in meeting the minimum capital base, the CBN actively supports consolidation of the industry through mergers and acquisitions (M&A's). To this end, the CBN provides a number of incentives for banks which consolidates to meet the new capital base within the stipulated time.
Some complementary factors also favour the consolidation process. Merged banks tend to achieve cost-savings in their operations. Also, technological advancements (eg. e-banking) will provide relative ease with which bank transactions can be effected and offer a large variety of products to a more diverse group of customers. Inter-branch information sharing that span a wide range of geographic regions will be enhanced as well.
Moreover, the market for corporate control will change. The market now sorts out potential acquiring banks and banks that are likely to be targets of M&A's. This provides a scope for assessing management and past performance of banks. For instance, acquiring banks considering mergers have incentive to facilitate shareholder value by expansion through acquisition in new markets. On the other hand, target banks can maximise shareholder value by finding an acquiring bank willing to offer a bid commensurate with the present value of their future earnings.
The consolidation drive receives wide support in the media and among few academics through various seminar presentations designed to facilitate timely implementation. However, while there are high hopes that all would be well for the industry; it is equally important to recognise that M&A's raise some public policy issues. A key public policy issue that may arise relates to the emerging competitive structure of the industry and the associated implications for consumer welfare.
Conventional economic analysis indicates that mergers can be pro-competitive if a merger leads to more-equalled size firms, since they are likely to behave more competitively than unequalled firms. However, the Nigerian banking industry is imperfectly competitive; consisting of a few relatively larger dominant banks with a number of smaller ones on the competitive fringe.
M&A's in an imperfectly competitive sector has two main impacts; greater market power and possible cost efficiency effects. Greater market power results from declining competition associated with increasing market concentration. Cost efficiency results from cost savings from operations, especially where scale economies are present. Whether the welfare reducing effect of greater market power is greater or less than the cost efficiency effect depends on the emerging competitive structure of the industry.
As a result of consolidation, the assets of rival banks come together under the control of a single bank. This implies that the strategic behaviour of the merged banks can be coordinated. It can be presumed that mergers, by reducing the intensity of competition, will be anticompetitive, by generating higher product prices, thus lowering consumer welfare. The merged bank will also have less incentive to increase capacity when output of rivals is constrained.
It should be noted that incentive to merge is related, but different from desirability of a merger. There is incentive to merge given the past performance of the banks and the need to meet the minimum capital base. Desirability of a merger follows from the perspective of potential effects on consumer welfare. The nature of the merged entity is critical to desirability of mergers.
For example, if two small banks merge to become a large dominant bank, the cost structure of the merged entity will improve, but this will also facilitate market power and collusion. Merger policy within a broader competition policy requires an assessment of the likely competitive structure of the market and associated future conduct of the banks.
A key public policy issue therefore, is how to balance the potential cost efficiency gains against the potential welfare losses resulting from increase in market power. Generally, there is no consensus on how to handle the trade-off between the efficiency gains and welfare losses arising from mergers.
A central problem that will face any competition agency is an information problem relating to assessing the desirability of a particular merger. Banks have privileged information about their motives for a merger, separate from meeting the required capital base. These can be presumed in terms of the efficiency gains, market power, and the potential for collusion, which are not completely known to the competition agency.
Obtaining the required information may be difficult in the Nigerian context. The merged entities would want their merger proposal approved, based on meeting the required capital base. However, the competition agency must ensure that merger takes place without increasing the risk of abusive behaviour. The information constraint is also compounded by the lack of expertise in relation to competition and regulation policy in Nigeria. Qualified personnel levels are extremely low.
Despite the comprehensive nature of the Nigerian reforms program involving various sectors of the economy, the Federal Competition Bill, drawn by an American consulting firm, has remained a mere draft since 2002. Given the type of information required to assess merger cases, the CBN may have to resort to using undertakings.
Undertakings serve as a signalling device and a kind of guarantee that the information provided by proposed merged entity is reliable. Where there is a concern that a merger might results in loss of social welfare, an undertaking by the merged entity will reveal information about their intentions. Nonetheless, a judgement will still be required over what undertaking is to be established and to what extent the merged entity is willing to offer an undertaking rather than forgoing the merger. Breaching an undertaking will require a penalty. But the ability to enforce a penalty depends partly on how well the undertaking is specified. The caveat here is that, the use of undertakings may provide incentive for regulatory capture if they are poorly specified and lack enforcement.
In conclusion, as the Nigerian banking sector consolidates, new products and services will develop, the competitive structure of the market will change. However, while these changes are potentially beneficial to the banking industry and the economy at large, they will also raise antitrust issues. It is important that independent regulatory institutions accompany the consolidation process with functions separate from the present focus on mere facilitating M&As.
*Dr. Olajide is a Senior Fellow of the Institute of Public Policy Analysis and teaches Economics at Monash University Clayton Melbourne Victoria, Australia.