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(1)COPYRIGHT AND CITATION CONSIDERATIONS FOR THIS THESIS/ DISSERTATION. o Attribution — You must give appropriate credit, provide a link to the license, and indicate if changes were made. You may do so in any reasonable manner, but not in any way that suggests the licensor endorses you or your use. o NonCommercial — You may not use the material for commercial purposes.. o ShareAlike — If you remix, transform, or build upon the material, you must distribute your contributions under the same license as the original.. How to cite this thesis Surname, Initial(s). (2012) Title of the thesis or dissertation. PhD. (Chemistry)/ M.Sc. (Physics)/ M.A. (Philosophy)/M.Com. (Finance) etc. [Unpublished]: University of Johannesburg. Retrieved from: https://ujcontent.uj.ac.za/vital/access/manager/Index?site_name=Research%20Output (Accessed: Date)..

(2) The impact of bank mergers and acquisitions on bank loan pricing behaviour in South Africa By Merusha Ragavan MINOR DISSERTATION Submitted in partial fulfilment of the requirements for the degree MAGISTER COMMERCII in FINANCIAL MANAGEMENT in the FACULTY OF ECONOMIC AND FINANCIAL SCIENCES at the UNIVERSITY OF JOHANNESBURG SUPERVISOR: Marno Booysens April 2016.

(3) DECLARATION I, Mrs Merusha Ragavan, declare that this minor dissertation is my own unaided work. Any assistance that I have received has been duly acknowledged in the dissertation. It is submitted in partial fulfilment of the requirements for the degree of Master of Commerce at the University of Johannesburg. To that effect, my research report has not been submitted before for any degree or examination institution, neither at this nor at any other university thereof. ___________________ Signature. __________________ Date. ii.

(4) ACKNOWLEDGEMENTS The completion of this dissertation required a passion for the field of finance and banking as well as dedication, perseverance and commitment. These traits were enhanced by the ongoing support provided by instrumental people mentioned below.. I would like to thank my supervisor Marno Booysens for his time and support. Your guidance has assisted me immensely.. Heartfelt thanks go to my incredible husband, Neil Pillay. Thanks for your patience and support throughout these past two years.. My family has also been a pillar of strength. Mum and Dad, Mr and Mrs A. Ragavan, thanks for the encouragement and the foundation you have provided.. iii.

(5) ABSTRACT There seems to be a distinct difference in bank behaviours between a merged bank and a non-merged bank. More specifically, it is evident that South African banks that engage in merger and acquisition (M&A) pacts seem to lower the price of their loans following a merger. One of the key motivating factors for banks to engage in an M&A deal is to create value. This value creation may arise through an increase in share price which creates value for the business and the shareholders in particular. This concept of value creation is based on a managerial theory which is a theory based on maximising shareholder wealth (Mueller, 2007). This research examines the impact of South African banks’ mergers and acquisitions (M&As) on their loan pricing processes and procedures by analysing the factors affecting bank loan interest rates. The MontiKlein model of a banking firm is applied to analyse these relationships. This model utilises macroeconomic factors as well as banking financial indicators to ascertain an optimal price for loans. Research on the impact of M&As on company performance in South Africa concluded that the share price increases following an M&A deal and abnormal returns between the range of 30% to 40% are experienced by shareholders (Affleck-Graves et al., 2011; Bhana, 2009). The findings from the South African studies aforementioned were consistent with the findings from international studies that also concluded that shareholder value was created following an M&A deal. The international studies claimed that shareholders experienced abnormal gains within the range of 16% to 45% (Kohers & Kohers, 2012; Becher, 2013; Andrade, Mitchell & Stafford, 2011). The lowering of the loan price may be an indication that the bank has experienced enhanced efficiency gains as a result of the merger. The improved levels of efficiency may be as a result of the merged banks better diversifying their risk or improving lending systems, processes or technology.. Ultimately, borrowers or. customers of the merged bank gain by means of paying a reduced price for lending. The empirical studies explored in the research stated that M&As do actually create value for the shareholders and it is therefore imperative to fully understand the potential impact and influences that M&As can have on our banking industry as it may affect financial performance of the target and acquiring banks.. iv.

(6) TABLE OF CONTENTS. CONTENTS DECLARATION .......................................................................................................................ii ACKNOWLEDGEMENTS ..................................................................................................... iii ABSTRACT .............................................................................................................................. iv CONTENTS ............................................................................................................................... v LIST OF TABLES ...................................................................................................................vii LIST OF FIGURES .................................................................................................................vii LIST OF ACRONYMS: ........................................................................................................ viii CHAPTER 1: INTRODUCTION .............................................................................................. 9 1.1 Background .................................................................................................................... 9 1.2 Research problem ...................................................................................................... 15 1.3 Research Question ..................................................................................................... 16 1.4 Research Design ........................................................................................................ 16 1.5 Data Analysis ............................................................................................................... 17 1.6 Significance of Research ........................................................................................... 20 1.7 Overview of Thesis ..................................................................................................... 20 1.8 Conclusion ................................................................................................................... 21 CHAPTER 2: LITERATURE REVIEW ................................................................................. 22 2.1 Introduction .................................................................................................................. 22 2.2 Bank Lending Behaviour............................................................................................ 22 2.3 Effect of M&As on Loan Pricing Behaviour ............................................................. 30 2.3.1 Price of Loans....................................................................................................... 31 2.3.2. Loan spreads ....................................................................................................... 33 2.3.3. Credit availability ................................................................................................. 33 2.3.4. Risk Exposure ..................................................................................................... 35 2.4 Conclusion ................................................................................................................... 38 CHAPTER 3: MERGERS AND AQCUISITIONS IN SOUTH AFRICA ............................. 39 3.1 Introduction .................................................................................................................. 39 3.2 M&As by Industry and Value ..................................................................................... 39 3.3 Regulation of M&As in South Africa ......................................................................... 41 3.4 M&As in the SA Banking Industry ............................................................................ 41 v.

(7) 3.5 Factors Influencing M&As in SA ............................................................................... 43 3.6 Impact of M&As on SA bank performance.............................................................. 44 3.7 Conclusion ................................................................................................................... 45 4.1 Introduction .................................................................................................................. 46 4.2 Monti-Klein Model of the Banking Firm ................................................................... 46 4.2 The Monti-Klein Model and Competition ................................................................. 50 4.4 Risks and Flaws of the Monti-Klein Model .............................................................. 53 CHAPTER 5: METHODOLOGY ........................................................................................... 57 5.1 Introduction .................................................................................................................. 57 5.2 Panel Regression........................................................................................................ 57 5.2.1 Fixed Effects Model ............................................................................................. 58 5.2.2 Least Square Dummy Variable H ...................................................................... 58 5.2.3 Time-Fixed Effects Models ................................................................................. 59 5.2.4 Random Effects Model ........................................................................................ 60 5.2.5 Fixed vs Random Models ................................................................................... 60 5.2.6 Redundant Fixed Effects Test ........................................................................... 60 5.2.7 Hausman Test for correlated Random Effects ................................................ 61 5.3 Panel Regression Model ............................................................................................ 61 5.4 Conclusion ................................................................................................................... 67 CHAPTER 6: DATA ANALYSIS ......................................................................................... 68 6.1 Introduction .................................................................................................................. 68 6.3 Descriptive Statistics .................................................................................................. 68 6.4 Multicollinearity ............................................................................................................ 70 6.5 Conclusion ................................................................................................................... 71 CHAPTER 7: EMPIRICAL RESULTS .................................................................................. 73 7.1 Introduction .................................................................................................................. 73 7.2 Hausman Specification Test Outputs ...................................................................... 74 7.3 Breusch Pagan Lagrangian Random Effects Test ................................................ 75 7.4 The Regression Random Effects Model’s Outputs ............................................... 75 7.5 Conclusion ................................................................................................................... 80 CHAPTER 8: CONCLUSION ................................................................................................ 81 8.1 Reflecting on the Research Phenomena ................................................................ 81 8.2 Annotating the Monti-Klein Model’s Utilisation and Outputs in Banks’ M&As ... 81 8.3 Distinct Differences in Bank Behaviours between Merged and Unmerged Banks ................................................................................................................................... 81 8.3.1 South African Merged Banks and Lowered Loan Prices ............................... 81. vi.

(8) 8.3.2 Relative Impact of Merged Banks’ Market Structures on Consumer Benefits ............................................................................................................................ 82 8.4 Limitation of the Study................................................................................................ 82 8.5 Area of Future Research ........................................................................................... 83 8.6 Final Conclusion.......................................................................................................... 83 REFERENCE LIST ................................................................................................................. 84. LIST OF TABLES Table 1.1: M&A Waves Over Time ........................................................................... 11 Table 1.2: Thesis Overview ...................................................................................... 20 Table 5.1: Variables Definition ................................................................................. 67 Table 6.1: Descriptive Statistics ............................................................................... 69 Table 6.2: Correlation Matrix .................................................................................... 71 Table 7.1: Correlated Random Effects - Hausman Test ........................................... 74 Table 7.2: Breusch Pagan Lagrangian Random Effects Test .................................. 75 Table 7.3: Pooled Regression (EGLS-Period Random Effects) ............................... 76. LIST OF FIGURES Figure 1.1: The Six Merger Waves ........................................................................... 11 Figure 1.2: Quarterly Global M&A Activity (2006 – 2011) ......................................... 13 Figure 3.1: M&A Industry Split .................................................................................. 40 Figure 3.2: M&A Transaction Value in SA (R billions) .............................................. 40. vii.

(9) LIST OF ACRONYMS: A&Ms. Acquisition and Mergers. ABSA. Amalgamated Bank of South Africa. BEE. Black Economic Empowerment. BSM. Bain-Sylos-Labini-Modigliani. B&AMs. Bank and Acquisition Mergers. CCSA. Competition Commission of South Africa. GDP. Gross Domestic Product. ESP. Efficient Structure Performance. ICBC. Industrial and Commercial bank of China. JSE. Johannesburg Stock Exchange. LSDV. Least Square Dummy Variable. M&As. Mergers and Acquisitions. NPL. Non Performing Loans. SA. South Africa. SCP. Structure Conduct Performance Hypothesis/Method. SME. Small to Medium-sized Enterprise. TBTF. Too Big to Fail. UK. United Kingdom. US. United States. viii.

(10) CHAPTER 1: INTRODUCTION. 1.1 Background Mergers and acquisitions occur when two or more companies combine with the ultimate aim of benefiting from one another in some way. These benefits could include but are not limited to cost reduction, increase in market share and increase in operational efficiencies. Companies may also have other motives such as to capitalise on certain tax laws or other monopoly regulations (Ross, Westerfield & Jordan, 2012:797). With the recent increase in the presence of multinational companies’ operatives in South Africa, it is often thought that mergers and acquisitions (M&As) are a fairly new phenomenon that allows companies to enter new markets quicker and at an optimised level. Firms’ multinationality can be measured by the number of countries in which firms have foreign subsidiaries in a given year based on information collected from the sample firms’ annual reports and publicly available documents (Zyglidopoulos, Williamson & Symeou 2016:388). Some of the initial M&As which took place and created reputable multinationals include Daimler-Chrysler which was the merger between the German-based Daimler and the American-based Chrysler. Another prominent multinational was the merger between Sparbanken and Foreningsbanken to form the largest Swedish bank.. Although the creation of multinationals may seem new, it is in fact an old phenomenon. The initial occurrence of M&As was in the late 19th century (Zarotiadis & Pazarskis, 2013). Series of merger waves were experienced in many of the more established economies. The waves which hit the US and the UK were perhaps the most influential and possibly had the largest impact on the global economy (Weston, Kwang & Susan, 2010).. The start of the initial M&A wave occurred in 1895, once the great depression had come to end. The wave developed during this period and seemed to be fuelled by the increased levels of capital and economic activity (Bruner, 2011:72). The M&A deals took place in the manufacturing sector and were mainly horizontal in nature. A horizontal merger is defined as an M&A activity type which occurs when one company purchases another company in the same industry (Gaughan, 2011). Other companies 9.

(11) decide to merge horizontally to create monopolies which enable them to gain on economies of scale and monopolistic rent (Gaughan, 2011:36; Bruner, 2011:72).. Coincidentally, the second wave developed together with the rise of the stock market which occurred after the 1923 recession. The soaring stock market was short lived and saw its crash in 1929 (Bruner, 2011:74). This wave consisted of vertical M&A deals among various industries. The merging of several industries was sought after since these industries wanted to take advantage of an oligopolistic structure (Gaughan, 2007:36).. The third wave took place in the 1950s, which was a period characterised by a strong economy and prominent bull market (Bruner, 2011:74). This wave saw the acquisition of larger companies by smaller ones. These types of mergers were conglomerates and the main motive for these types of mergers was to benefit from gains arising as a result of diversification (Gaughan, 2011:40).. The next wave was dominated by medium to small sized companies and commenced at the end of 1970. This wave also occurred in a period when stock prices were on a rise and the economic situation was such that low interest rates were on offer (Bruner, 2011:74). Hostile takeovers were common during this wave which made this wave unique and different from the previous waves (Gaughan, 2011:53).. The fifth wave also occurred during a period of high stock prices and low interest rates and occurred between the years 1985 and 1989. Many of the crucial financial indices were also at their highs (Bruner, 2011:7; Gaughan, 2011:59).. In 1993, the next wave developed. This period also saw the rise of globalisation. During this wave, there seemed to be an overwhelming drive for established companies and corporates to merge, form large multinationals and engage in private equity deals (Matthews, 2011:1). Table 1.1 summarises the key points of the different M&A deals.. 10.

(12) Table 1.1: M&A waves over time Wave Period Stage 1st wave 1880-1904 2nd wave. 1916-1929 1940s-1950s. 3rd wave. 1965-1969 1970s. 4th wave 1981 1985-1989 5th wave 1993 2000 onwards. Background Horizontal takeovers. Monopoly rents realised. Vertical M&As. Control was gained over the entire value chain Small increase in value and volumes of M&A deals. Economic downturn led to consolidation across different industries. Decrease in the volume of M&A announcements. Increase in Carve outs and Divestures Leveraged buy outs brought about speculative gains for buyers. Increase in globalisation encouraged cross border M&A deals. Technology and new economy drive M&A deals.. (Source: Gaughan, 2011). There has been much debate about whether a possible sixth merger wave has developed. DePamphilis (2008:48) believed that there has been an unidentified merger wave which began in 2003 as depicted by the dotted line in Figure 1.1.. Figure 1.1: The Six Merger Waves (Source: Gaughan (2011) Martynova and Renneboog (2008:214) agreed with DePamphilis’s (2008:48) theory that there is a sign of a sixth merger wave having emerged. They affirm that the. 11.

(13) decrease in interest rates could have been a major contributing factor to this wave as credit was cheap to acquire hence allowing companies to participate in M&A deals.. There was also an observed 50% increase in M&A activity in Europe between the years 2004 and 2005 (“Europe's nascent merger boom; mergers and acquisition”, 2005). This trend in M&A activity has been the highest in Europe since the fifth merger wave (the bursting of the internet bubble) in the early 2000s.. Researchers claim that this merger wave only lasted three years until 2008 when the stock markets dropped drastically as a result of the sub-prime mortgage crisis and M&A activity substantially decreased (Thomson Financial Proprietary Research, 2008). There was much uncertainty as a result of this 2008 credit crunch and approximately 1,307 M&A deals with a value of $911 billion were abandoned (DePamphilis, 2008:52).. Affordable interest rates, increased costs, falling stock market, a global credit withdrawal and a possible economic recession are some of the exogenous factors that researchers claim ended the sixth wave in 2008 (Martynova & Renneboog, 2008).. After briefly describing the historical formation of merger waves and the early rise of M&A deals, the focus is now directed to recent M&A activity. Figure 1.2 displays how the global M&A activity has decreased over the years with the major dip beginning in 2007. The 2010 decline in M&A volumes and values marks the end of the sixth M&A wave.. 12.

(14) 90 000. 6 000 000. 80 000 5 000 000 70 000 60 000. 4 000 000. No. of Deals. 3 000 000. Average Deal Value (million USD). 50 000 40 000 30 000. 2 000 000. 20 000 1 000 000 10 000 0. 0. 1. 2. 3. 4. 5. 6. Figure 1.2: Quarterly Global M&A Activity (2006 – 2011) (Source: Elliot, 2010:17). The graph represented in Figure 1.2 illustrates that in recent years, there has been a widespread occurrence of bank mergers and acquisitions. Elliot (2010:17) stated that approximately 60 000 M&A deals occurred per annum between the period 2006 and 2011.. 13.

(15) There has not been much merger and acquisition activity in the South African banking industry. A major transaction took place in 2005 when UK based Barclays acquired a controlling stake in ABSA. Subsequently, there have been a couple of international transactions in South Africa which included the 2007 transaction between Standard Bank and China’s biggest bank, the Industrial and Commercial Bank of China, as well as the acquisition of Scandia by Old Mutual. The transaction between ABSA and Barclays and Standard Bank and the Industrial and Commercial Bank of China has resulted in both ABSA and Standard Bank gaining a large share of the South African banking market (Okeahalam, 2011).. Research has shown that bank consolidations or merger and acquisition activity can result in dynamic changes in a banking industry with regard to the acquired banks increasing their market share and in turn increasing their performance.. A study conducted by Short (1979:210), cited in Okeahalam (2011:4), displayed a high correlation between a bank’s concentration in the market and a bank’s profit rates. Previous studies have also stated that bank mergers and acquisitions result in improved performance in the long term and not in the short term (Correa, 2009; Wu, 2008). These results claim that M&A transactions do in fact have an impact on the banking industry.. Merger and acquisition transactions which cause changes in the banking industry should be investigated as one of the main duties of a bank is to transfer funds from one sector with excess funds to another sector which has insufficient funds or simply put, is in need of credit. Therefore, banks play a crucial role in determining the value and distribution of credit in the economy. Banks can change their lending objectives based on changes in the structure of the banking industry which further reaffirms that banks’ merger and acquisition activities may have an impact on a bank’s lending behaviour (Demirguc-Kunt & Huizinga, 1998). Studies have concluded that M&As in the banking sector can either positively or negatively affect the price of loans (Berger, Rosen & Udell, 2007:29), the supply of loans (Akhavein, Berger & Humphery, 2011:5) as well as other lending objectives (Avery & Samolyk, 2014). It is vital that banks be aware of these changes in lending as the change in these lending variables and. 14.

(16) objectives can affect banks’ risk exposure and ultimately affect their financial performance.. 1.2 Research problem Many international studies have discussed the impact of M&A activity on banks’ performance. However, limited research on the effect of M&A activity on a bank’s loan pricing behaviour is available. A study by Sapienza (2012:360) claimed that the interest rate of loans to small business tends to fall following a merger which supports the real world problem of decreased profits realised following a bank merger or acquisition. Similarly, this research aimed to assess the impact on banks’ lending by focusing on analysing the impact on the price of loans.. Another study conducted by Petersen and Raghuram (2012:407) compared the price of loans between merged banks and non-merged banks and found that merged banks tend to charge lower interest rates on loans and as a result, profits of the merged banks are reduced. Drucker (2005:142) analysed investment banks’ mergers and the impact of this activity on the pricing of loans. This is more in line with the aim of this research. Additionally, the South African M&As context focuses on the factors that affect M&As and other foreign investment into the South African economy. These studies have stated that factors such as a stable political environment (Fedderke & Romm, 2014:738-760) and well-developed financial markets are attractive features for foreign investors (Moolman, Roos, Le Roux & Du Toit, 2010). These studies considered the factors influencing the overall economy and not specifically the banking sector.. Other South African studies have assessed the effect of M&As on the share price and concluded that the share price does increase following an M&A transaction resulting in abnormal gains earned by shareholders (Bhana, 2009; Affleck-Graves, Burt & Cleasby, 2011; Van Den Honert, Affleck-Graves & Smales, 2011). Although these results may possibly be applicable to banks, the aforementioned South African studies analysed the impact of M&As on entire industries and not specifically on the banking sector. 15.

(17) In summary, international literature on the impact of M&A activity on banks’ performance does exist. However, there is limited in-depth research on specific objectives; namely, the impact of banks’ mergers or acquisitions on banks’ lending objectives and the cost of loans. Furthermore, although there are studies in a South African context on assessing the factors influencing M&As and analysing the impact of M&As on a company’s share price, there is no research on the effect of banks’ M&As on their loan pricing behaviour. 1.3 Research Question Because the effect of mergers and acquisitions on a South African retail bank’s performance or rather on a bank’s lending behaviour is unknown, the research question follows: Do mergers and acquisitions affect South Africa’s retail banks’ price of loans? The terms ‘mergers’ and ‘acquisitions’ in the research question refer to a transaction in which either the four big retail banks of South Africa attain a stake in another international or domestic bank or some international bank gains a stake in a South African bank. The phrase ‘loan price’ is the price received from the respective bank for a loan. The price of the loan is the interest rate the consumer pays and is therefore a cost for the customer (Bhana, 2009; Affleck-Graves, Burt & Cleasby, 2011).. The desired state is that the price of loans in the post-merger or acquisition phase will increase resulting in favourable lending behaviour for the merged bank. This favourable behaviour may lead to increased profits.. 1.4 Research Design A research design is a set of logical processes that a research undertakes in establishing empirical evidence and the validation processes therein in ensuring that the process is scientifically acceptable (Saunders & Schumacher, 2000). This study employed a quantitative research philosophy as its empirical data utilised accountingbased data for the regression models and followed the quasi-experimental design of research. The numeric and quantifiable approach enabled exact determinants pre-. 16.

(18) determined for assertion to be quantifiable with a high degree of validity (Trochim, 2008). The accounting data used to build the regression model assisted in analysing the effects of the M&A deal pre and post the actual deal. Basically, an accurate effect of the M&A deal on banks’ price of loans should be provided if the accounting data pre and post the deal is incorporated into the regression (Bruner, 2011:34; Pautler, 2001:8).. Quantitative research is predominantly used in financial banking research efforts as it is most suitable to interpret quantifiable data that is associated with such phenomena (Bruner, 2011). This research design method has also been used by other researchers such as Kumar and Rajib (2007) and Cornett and Tehranian (2013). They also used economic and accounting data to assess the performance of their selected companies, pre and post their engagement in an M&A deal.. 1.5 Data Analysis The data analysis of this study was quantitative in nature. The data reviewed spanned a period of years, between 2002 and 2010. This is particularly significant in that the major transactions of ABSA/Barclays and Standard Bank/ Industrial and Commercial Bank of China took place in 2005 and 2007 respectively. The findings from these transactions can be quantified and analysed for this study. A panel data analysis was adopted in order to analyse the regression models of the South African ‘big four” banks. The advantage of utilising panel data over cross-section data was that with panel data, it was easier to model behaviour across the companies or in this case, banks (Greene, 2010). The outputs of the regression were compared among the major banks in South Africa’s financial sector; namely, ABSA, Barclays Bank, First National Bank and Nedbank. The emphasis of this study was on determining the effect of bank M&As on banks’ loan pricing behaviour. The proxies for banks’ cost of lending were represented using accounting-based data. The M&As included all merger and acquisition transactions in which foreign banks were able to gain a controlling stake. The two major bank M&A 17.

(19) transactions in South Africa were the ABSA/Barclays transaction and the Standard Bank, and Industrial and Commercial bank of China.. The regression included the periods pre and post the actual M&A deal. The period for analysis pre and post the M&A was not chosen randomly. Many studies have used a two-year period to analyse the effect of an M&A on banks’ lending behaviour (Calomiris & Pomrojnangkool, 2005; Berger, Saunders & Schumacher, 2000; Focarelli, Panetta & Salleo 2002).. The Federal Reserve Bank official also interviewed banking staff who were involved in bank M&As and they stated that banks engaging in M&A anticipated cost savings and these would be realised at least two years after the actual transaction (Rhoades, 1998:285). Ayadi and Pujals (2005:4-55) and Panetta, Schivardi and Shum (2009:673-709) also analysed the effect of bank mergers on the Italian and European banking markets respectively. They too stated that a two-year lag period was utilised mainly because complete profits and losses should only be realised in the second year following the bank M&A.. A few studies did select a period of analysis pre and post the M&A transaction quite randomly and without any solid evidence. Ashton and Pham (2007:1-32) examined the impact on prices of mergers which are horizontal in nature among retail banks in the UK and used a dummy variable which was set at one for two years preceding the M&A transaction and for six years after the transaction. Similarly, Montoriol-Garriga (2008:4-53) investigated the impact Spanish bank mergers had on the average interest rate offered to small business owners and they also used a dummy variable which was set at one for all years following the merger event and zero for all other years used in the analysis.. The panel data analysis utilised in this study has also been adopted in studies conducted by Sapienza (2012:370) and Erel (2010:2-52) who assessed the impact of banks’ mergers on loan contracts and loan spreads respectively. These studies constructed regression models with the price of the loan which is the interest rate as a dependent variable. The independent variables included bank specific factors such as the bank’s cost to income ratio, deposit interest rate and liquidity ratios. Their model 18.

(20) also included macroeconomic factors such as GDP growth rate and a market rate. Finally, a dummy variable was used to indicate M&A activity, for example, ‘1’ if the bank engaged in M&A activity in that period or ‘0’ otherwise. These studies then assessed the correlations between the dependent variable which is the price of the loan and the independent variables (Bikker, Shaffer & Spierdijk, 2012). The significance of the coefficients of the explanatory variables were also analysed in order to ascertain whether a significant relationship exists between the dependent and independent variables. Their data was sourced from the respective banks’ financial statements.. The panel regression model which was constructed in this paper analysed the relationship between the price of a loan which is the loan’s interest rate and the independent variables which include key financial ratios, microeconomic as well as macroeconomic factors. The data was sourced from the banks’ published financial statements which were retrieved from various websites such as Bankscope and I-net Bridge.. The coefficient of the dummy variable can be either positive or negative, as the sign depends on whether the increased market power is higher than the gains realised from operating efficiency. If the merging banks were to increase the market power of the merged entity by means of geographical overlap in the operating markets, the interest rate offered to borrowers would increase (Bikker, Shaffer & Spierdijk, 2012). When M&As result in increasing efficiencies either through synergy gains or through risk diversification, and other variables are held constant, the benefits arising from economies of scale can be passed on to borrowers as they may be offered a decreased interest rate after a merger.. In order for the study to be reliable and valid, other researchers should be able to replicate the method and attain the same results. The exact method will now be explained. The data was first tested for unit roots and stationarity and the Augmented Dickey Fuller test was conducted. If the presence of a unit root is apparent, the data will be differenced in order to make the data stationary. The Hausman test was then conducted to determine whether the fixed effects or random effects model should be used in the panel data analysis. 19.

(21) The relationships among the variables must be investigated as this assists in answering the research question posed aforementioned. The coefficient inspection, correlation analysis and t test for significance were carried out in order to examine relationships between the dependent and explanatory variables in the regression equations. A strong correlation or a high coefficient indicates that one variable is highly impacted by the other and the sign of the correlation or coefficient indicates whether there is a positive or negative impact between these variables.. 1.6 Significance of Research If the real world problem of a potential reduction in profits following a merger is considered, it is crucial that retail banks be made aware of this impact (Focarelli et al., 2002). The results of this study should appeal to the South African major banks as they have the power to decide whether to engage in cross border mergers and acquisitions with foreign banks.. The shareholders and management of these retail banks may also have a vested interest in the results of this study especially as a bank’s involvement in M&A activity can potentially affect profits which can be translated into higher or lower returns earned. The results of this study may also appeal to the South African Reserve Bank as it often regulates cross border bank M&A transactions and ensures that the welfare of all relevant parties is considered and accounted for. Although the borrowers or consumers have limited power, they may be interested to find out how M&A activity affects the price of their credit products. 1.7 Overview of Thesis Table 1.2: Thesis Overview CHAPTER. CONTENT. Chapter 1:. Introduction The first chapter introduces the study by presenting the orientation and the motivation for the research. The background for the study is discussed which leads to the research problem and question.. Chapter 2:. Literature Review Chapter 2 provides an in-depth analysis of the current literature which exists and which pertains specifically to the research problem presented in Chapter 1.. 20.

(22) Chapter 4:. M&As in South Africa This chapter analyses the status of M&A activity in South Africa by discussing the regulation, M&As in the banking industry and factors influencing M&As. Monti Klein Model This chapter unpacks the Monti Klein model. This empirical model is a tried and tested analysis and forms the basis of the regression model presented later in the study.. Chapter 5:. Methodology. Chapter 3:. Chapter 6:. Chapter 7:. Chapter 8:. This chapter assesses the data quality of the data utilised in the regression model. The descriptive statistics and the correlation among the variables are analysed. Data Analysis This chapter aims to analyse the empirical results which are derived from the developed panel regression model. Results and Findings The outcome of the regression model is then presented in this chapter. The results and findings are presented and discussed. Conclusion Based on the results and findings of this study, conclusions are drawn. Limitations and recommendations are also provided. 1.8 Conclusion The chapter introduced the aim of the study which is the effect of mergers and acquisitions (M&As) on banks’ loan pricing in South Africa. The chapter also touched on the background to the problem, the research design, data analysis, the research questions as well as the overview of the thesis. The research which does exist on M&As mainly investigates the impact these transactions have on the participating organisations’ profits. Few studies investigate the effect M&As have on their lending behaviour, more specifically, the price of their lending products. It was also found that although mergers and acquisitions are quite prevalent in an international context, very few transactions have occurred in South Africa. The chapter concluded by pointing out the significance of the study.. Chapter 2 comprises the literature review and the objectives of this study are explored in detail.. 21.

(23) CHAPTER 2: LITERATURE REVIEW 2.1 Introduction The literature review aims to discuss the existing research related to M&As. The studies presented in this chapter explore international M&A deals. The effects arising from companies engaging in M&A deals are assessed in detail. 2.2 Bank Lending Behaviour This section is subdivided into two main parts. First, the conventional literature on banks’ lending behaviour is presented. The second part consists of empirical evidence which focuses on the impact that bank mergers have on the participating banks’ lending behaviour.. As alluded to earlier, not all banking M&A transactions were analysed in this research. This analysis is confined to South African banks only and is further limited to the M&A deals in which the bidding or acquiring bank gained enough share capital to influence the decision making procedures of the target bank. Over the last decade, there have been only two M&A deals which fit this criteria in the South African banking Industry; namely, the ABSA Barclay transaction and the Standard Bank and Industrial and Commercial Bank of China transaction. Following the involvement of these cross border transactions, ABSA and Standard Bank were able to increase their presence in the market as these two banks hold the highest market share in the banking sector (Okeahalam, 2011). This increase in market presence following the merger involvement abides by the market power theory.. In theory, market power can be defined as the ability to fix prices to the extent that the company is able to gain a dominant place in a particular market (Ayadi & Arnaboldi, 2009). The dominance a company has in a particular market can be determined by the size of the particular institute which directly influences its superior offerings’ value propositions (Okeahalam, 2011). M&As may result in an increased size as two companies are ultimately becoming one. Therefore, increased market power can be gained via an M&A if market share increases post the M&A deal.. 22.

(24) In this case, and based on the market power theory, banks can then directly impact supply and demand prices. If the size increases following a merger and the bank gains market share, this dominance allows the banks either to increase or decrease prices. These banks then decrease prices to eradicate competition or new entrants into the market (Koetter, 2008). The dominant banks may feel that they have the liberty to increase prices because of the lack of competition in the market.. A clear conclusion on this theoretical perspective can be drawn from the study conducted by Cornet, McNutt and Tehranian (2013:1014) in which they used the net interest margin as proxy for market power and claimed that a significant increase in this margin was reported after a merger. Bauer, Miles and Nishikawa (2009:2260) further concluded that banks participating in M&As may offer decreased interest rates to bank depositors. Therefore, it can be concluded that banks engaging in M&As tend either to increase the interest rates offered to debtors or decrease the interest rates applicable to depositors, or both. In accordance with the above studies, a direct answer to the research question presented in this study could be that the price of lending products may increase, decrease or remain stable following an M&A transaction. These studies also contributed to the research problem stated in that currently there are no specific studies addressing banks’ M&As and the impact on the price on loans.. Although the increased market power gives the involved M&A banks the chance to change interest income, the banks can also use their power to improve interest expense line items. Davidson, Frank and Ismail (2009:346) also tested this theory by examining the interest expense ratios and stated that improved interest expense ratios can arise following the occurrence of an M&A. Koetter (2008:259) reported a slight improvement in the cost efficiency indicator that also includes interest expenditures. These findings concluded that banks can use their increased market power to reduce the price of lending.. The findings of the empirical studies aforementioned confirmed that the increased market power which can arise following an M&A can allow the participating banks either to increase or decrease prices and improve costs depending on their objectives and the state of the market. Researchers have studied the market power theory quite 23.

(25) intensely mainly owing to its influence on market structure. Grossman and Miller (2008:617) defined market structure as a collection of buyers and sellers in a market who compete on setting prices of homogenous goods.. The structure of the banking market was considered as a vital determinant of the price of lending offered by banks. This relationship between the bank market structure and the price of lending may be grouped into two separate market power hypotheses. The first hypothesis is the Structure Conduct Performance Hypothesis (SCP) which states that banks will merge and use their larger position to earn higher prices. The second one is the Efficient Structure Performance (ESP) which rests on the premise that banks participating in mergers can use their larger concentration to improve the general efficiency of the banking sector. Therefore, this hypothesis states that if M&As improve the efficiency levels of banks, the participating banks can offer more competitive prices for their services.. 24.

(26) Various studies have discussed how bank loan yields are affected specifically by market structure. These studies produced a range of differing results. Aspinwall (1970:376-384), cited in Valverde and Fernandez (2007:2043-2063), conducted a study which investigated the effect changes in a banking market structure have on the bank’s loan interest rates in the US banking market. He found significant relationships between the bank’s interest rates, the concentration ratio and the number of lending institutions in the market. His study concluded that the interest rate tends to be low as the number of institutions in the market increases and the lending rate tends to be higher with a high concentration ratio.. An international European study conducted by Saunders and Schumacher (2000:821) found that although market structure is an important variable which can be used to explain the banks’ loan price setting behaviour, this effect varies across countries. In other words, the more fragmented a banking market is in a particular country, the more reign the banks have to charge a higher price for loans. Valverde and Fernandez (2007:2057) stated that an increase in market power can in turn lead to a decrease in the price of loans. They stated that as banks’ market power increases, they are more inclined to diversify away from more traditional banking activities and the gains which may be realised from the newfound activities may enable these banks to charge a lower price for the lending products. Along with market structure, market concentration of banks and its effect on banks’ loan prices have also been widely investigated. Corvoisier and Gropp (2010:4-47) researched this correlation and confirmed a positive relationship between market concentration and bank interest rate margin. A more recent study conducted by Perara, Skully and Wickramanayake (2010:23-37) aimed to assess the effects of market concentration on the price of bank loans in the South Asian banking market. They found that there seemed to be no relationship between these two variables. In the European banking market, it was further found that in a case where the banking market was not highly concentrated and not highly competitive, the bank loan prices tended to be lower (Maudos & Fernandez De Guevara, 2004).. 25.

(27) Apart from the research on how the theory of market power and market structure are directly impacted by M&As, other studies have also assessed the changes in market interest rates and their impact on the price of banking loans. The findings in many of these studies concluded that there is a positive relationship between the market interest rate and the price of bank loans (Borio & Fritz, 2014; Donnay & Degryse, 2011; De Bondt, Mojon & Valla, 2012; Gambacorta & Lannoti, 2005; Hienemann & Schuller, 2012). The rationale behind this relationship is that once the market rate of lending increases, banks are faced with an opportunity cost for other types of financing like bonds. This results in the credit and lending instruments being more appealing which in turn increases the demand and price of loans. It was also found that the changes in market interest rate have a higher impact on the long term lending rate rather than the short term lending rate (De Bondt et al., 2012). The relationship between market interest rates and banks’ loan prices may also depend on other factors. Kashyap and Stein (1997:15), Heinemann and Schuller (2002:18) and Cecchetti (1999:20) stated that the changes in market interest rates can lead to changes in the price of bank loans. However, the banking market structure may also affect this relationship. These researchers claimed that the competition in the banking market is also crucial as banks react differently in a market with less aggressive competition compared with their counterparts who are a part of a more highly competitive market structure as gaining and perhaps maintaining market share is the ultimate aim. The structure of the banking market yet again is referred to in the context of the effect of market interest rates on price loans. This re-affirms how crucial banking market structure is in relation to the pricing of lending products.. There are also studies which advocate that market concentration may not have a bearing on how fast banks react. Adam and Dean (2005:20) concluded that the higher the competition in the banking environment, the slower the rate of reaction from banks in changing their price of loans. Lago-Gonzalez and Sala-Fumas (2005:29) examined how rigid banks are in adjusting loan interest rates in response to changes in the interest rate in the Spanish banking market between 1988 and 2003 and found that banks’ characteristics such as size and types affect the speed of adjustment of loan prices. More specifically, they realised that the rigidity of loan prices is slower and. 26.

(28) lower among commercial banks when compared with savings banks, and smaller banks are less rigid in adjusting the loan interest rate than larger banks.. De Graeve, De Jonghe and Vennet (2007:250) deduced that highly liquid and well capitalised banks are slower to react and adjust their loan prices in response to changes in the market interest rate. This research also proved that the differences in loan types are also a factor which hampers the changes in loan prices. Banks adjust the prices of corporate loans at a slower rate than prices on consumer loans.. After having explored the influence of changes in the market interest rates and banking market structure on the price of bank loans, this writer realised that many other studies have found other significant factors influencing the price of bank loans. Wagner, Garrett and Wheelock (2011:575-595) and Kroszner and Strahan (2009:1438) analysed the branch banking deregulation policies and how these policies impacted the US banks’ loan prices. They concluded that the price of US bank loans lowered after the branch deregulation policies were enforced. Another non-financial factor which was studied by Petersen and Raghuram (2014:2538) was how the distance between borrowers and lenders impacts the price of loans. It was found that borrowers who were further from their selected bank paid a lower price than borrowers who were located closer to their respective banks.. Another study done by Gambarcota (2004:2-31) investigated the price setting behaviour in the Italian banking market. He realised that banks which have a large portion of their lending portfolio skewed towards long term lending tend to adjust their price of loans at a slower rate and over a longer period of time. Gambarcota (2004:231) also analysed the impact of government policies on the price of bank lending. Economic factors such as income and inflation have a positive influence on the short term lending interest rate. It was also found that this short term lending interest rate of well-established banks does not adjust when there are shocks to the government monetary policies. Kashyap et al. (1993:80) concluded similarly that the prices of bank loans were positively related to inflation rates and GDP. Adding to the findings on the impact of economic factors on the price of loans, Slovin and Sushka (1984:1583-1596) also examined the correlation between risks and loan prices. They found that the US banks’ price of loans was positively impacted by cyclical changes. 27.

(29) Many researchers have studied whether the type of ownership of a merged bank has any impact on a bank’s loan price behaviour. Sapienza (2012:356) established that there seems to be a clear difference between interest rates charged by state owned banks and privately owned banks. This study used a selection of banks in the Italian banking market from 1991 to 1995. Even though there was a difference between the price setting behaviours of these differently owned banks, Sapienza (2012:380) further argued that the lower price charged by state owned banks does not indicate that these banks are more efficient in lowering costs. She also found that the state owned banks have a bigger market for larger borrowers and through economies of scale are able to lend to them at a lower interest rate.. Fungacova and Poghosyan (2009:3-23) researched the factors of the bank loan prices in the context of the Russian banking market. They found, when they considered different ownership structures, that the more conventional determinants such as bank characteristics, risk factors and economic factors have different impacts on the price of loans. An example of their findings was that credit risk was particularly significant to change in the price of bank loans in the domestic banking market but was insignificant among state controlled banks.. Political influences also seem to affect how state owned banks set their loan prices. Sapienza (2014:345) found that when state owned banks were located in an area where the ruling political party was in power, the banks charged a lower price on their loans. Macroeconomic shocks also affected state owned and privately owned banks differently. Micco and Panizza (2012:252) found that state owned banks do not readily change their price of loans in response to a macroeconomic shock as fast as a privately owned bank does.. Specific factors have been researched in relation to how banks set loan prices and many of these studies arrive at conclusions and uncover findings which are in accordance with the more traditional theoretical assumptions and predictions. For example, Angbanzo (1997), cited in Williams (2007:145-165), studied the US banking market and found that the levels of management efficiency, risk of default and leverage. 28.

(30) have positive relationships with the interest rate charged in bank loans. Liquidity risk on the other hand was found to have a negative relationship with loan interest rates.. Besides the financial and macroeconomic determinants of bank interest rate margins, researchers have also taken on the task of analysing the relationship between the price of bank loans and specific costs. Nys (2013:17) found that among European banks, opportunity costs and administrative costs are positively correlated with the price of bank loans. Williams (2007:158), in his study of the Australian banking market, found that bank loan prices positively relate to the concentration of the market as well as to operating costs.. Williams (2007:158) also found a contradictory finding to that of other studies as his paper revealed a negative relationship between credit risk and the price of loans. He mentioned that in most instances, banks do not know how to incorporate credit risk into their pricing of loans accurately.. The greater cost savings which can be achieved by larger banks may be another reason why these banks can afford to price their loans at a lower price. The larger size banks are able to achieve cost saving benefits by instituting lower monitoring and credit screening costs which may allow for a better flow of information between themselves and the customers. In 2000, Brock et al. (2009:113) also found evidence that costs have a positive relationship with bank loan prices. In his analysis he also concluded that other factors such as capital and liquidity risks positively affect loan prices. In the South Asian banking market, Doliente (2005:55) found that the quality of loans, collateral backing of loans, capital, as well as costs have a significant effect on changes in the bank loans spreads.. A study by Dermirguc-Kunt and Huizinga (1998), cited in Brock et al. (2009:120), revealed that bank loan prices not only depend on more traditional factors such as bank financials and macroeconomic factors but also regulation of insurance, taxation, legal factors as well as a bank’s financial structure. Other studies claimed that economic factors have the most influential correlation with bank interest rate margins than any of the other factors. For example, Afanasieff, Lhacer and Nakane (2011:22) analysed the Brazilian banking market and found that changes in bank loan prices are 29.

(31) most dependent on both microeconomic and macroeconomic factors. More specifically, growth in GDP and the national inflation factors were found to be the most significant factors affecting the bank interest rate margins.. Two traditional models are employed to analyse bank lending behaviour. The earliest banking firm model was developed by Monti (1972) and Klein (1971), cited in Cornet, McNutt and Tehranian, 2013:1020. The second model also utilised to analyse interest rate pricing is the dealership model which was created by Ho and Saunders (1981). The Monti-Klein model was developed under the premise that banks operate in a market which is imperfectly competitive. The factors which influence the interest rate in this model are market power costs and certain risks. The dealership model on the other hand considers banks to be risk adverse intermediaries that facilitate the collecting of deposits and issuing of loans among borrowers. The main factor which is considered in this model is transaction uncertainty which can arise between the demand and supply of loans and deposits.. Another pertinent factor in the dealership model is the structure of the banking market. If banks operate in a market where there is an inelastic demand for loans and deposits, they tend to take advantage of their market power and set higher prices for their products (Cornet, McNutt & Tehranian, 2013).. The studies explored thus far analysed the M&As and provided clear conclusions. However, in line with the research problem, none of these studies directly assess the impact of M&As on the price of lending products. The consumers have no indication that these M&A transactions may actually affect them by means of increased prices on banking products and in this context, retail lending products. The studies presented in this chapter are all based on an international setting and no similar studies have been carried out in the South African context.. 2.3 Effect of M&As on Loan Pricing Behaviour After the analysis of the conventional research on bank lending behaviour, this section discusses studies which analyse the impact of M&As and their effect on the price and. 30.

(32) supply of lending products. The change in the level of risk arising from the change in lending behaviour following an M&A transaction is explained.. 2.3.1 Price of Loans As mentioned in the market power theory discussion aforementioned, there seem to be two different views when it comes to how bank M&As affect lending product prices. One of the views is that banks engaging in M&A activity gain market share following an M&A transaction and can in fact reduce the price of their lending products (Davidson, Frank & Ismail, 2009). The second view states that an increased market share experienced by the merged banks can also result in an increase in the price of lending products as these banks use their stability and their presence in the market to price competitively (Cornet, McNutt & Tehranian, 2013). The reduction in prices may, on the one hand, negatively impact the banks’ revenue income but, on the other hand, positively affect the borrowers as they incur reduced costs. The inverse is true if prices are increased following an M&A.. Studies have claimed that the merged banks that gain an increased market share may be more cost efficient through economies of scale (Bikker, Shaffer & Spierdijk, 2012). This cost efficiency can be passed on to borrowers via a reduced interest rate and this may result in banks receiving decreased interest income which is unfavourable (Berger, Rosen & Udell, 2007; Akhavein, Berger & Humphery, 2011). Sapienza (2012:358) used a loan dataset to investigate the impact of market mergers between Italian banks on loan prices. She concluded that when markets overlap, and market shares of the target banks are small, the banks involved in M&A activity tend to reduce their loan prices. Her results were in line with an abundance of other studies which stated that an increased market share of the target bank following an M&A might result in a reduction in the price of loans.. In contrast to the view aforementioned where an increased market share can result in a decrease in the pricing of loans, some studies advocate that an increased market share can actually result in the participating banks increasing the price of their lending products.. 31.

(33) Kahn, Pennacchi and Sopranzetti (2011:26) found that personal loan rates tend to increase after a merger whereas automobile loan rates decrease. The difference can be explained by the differing capacity to manage costs across these two loan types.. Similarly, Garmaise and Moskowitz (2006:501) analysed the social impacts of bank M&As on prices and they found that merged or acquired banks which manage to increase their presence in the market after a merger tend to increase their loan prices. They stated that banks with a larger presence in the market have the stability and authority to claim higher prices. The higher prices are beneficial to the banks as their interest received is higher; however the borrowers incur higher costs of borrowing. In this instance, banks’ M&As positively affect their lending as the banks may potentially earn higher income. However, borrowers are negatively affected by the banks’ M&A owing to the higher cost of borrowing incurred.. As observed by the discussion aforementioned, many studies advocate that an increased market share following an M&A gives the participating banks the authority to change the prices of their lending products. This is not always true as Drucker (2005) showed that mergers among commercial banks do not result in any change in market share for the merged bank and there is also no significant change in the pricing of loans following an M&A transaction.. So after all of the empirical studies aforementioned have been studied, it can be stated that bank M&As only affect bank lending product prices if the market dominance of the bank following an M&A transaction changes. The direction of prices following a merger is still unclear as studies claim that prices can either be increased or decreased.. The studies presented do analyse the direction of prices following a merger or acquisition; however, the context of these studies differs. None of them assess the impact of mergers on the price of lending products and they are all set in an international context.. 32.

(34) 2.3.2. Loan spreads The results of some of the studies aforementioned by Berger, Rosen and Udell (2007), Akhavein et al. (2011) and Sapienza (2012indicated that an M&A transaction can potentially change loan interest rates. This revised interest rate can further impact the interest rate spread. Mujeri and Younus (2009:2) defined interest rate spread as the difference between a bank’s interest income and interest expense as a ratio to total assets. A lower spread results in borrowers being charged a low interest rate for their loans and banks potentially earning a lower interest income which may have a negative impact on their lending behaviour. Erel (2010:2-52) analysed the impact of US commercial bank M&As on loan spreads. He found that on average, loan spreads decreased after a merger. This decline in loan spreads can potentially result in decreased interest income for the merged bank.. Other studies found no significant relationship between bank M&As and interest rate spread. Calomiris and Pornrojnangkool (2005:1-25) investigated the merger between Fleet and BankBoston on small to medium sized enterprise (SME) lending rates. This study found that after a merger, there seemed to be no change in the interest rate spreads to small sized borrowers. Again, the effect of bank M&As on loan interest rates seems inconclusive because studies have produced differing results. 2.3.3. Credit availability The effect of M&As on the price of lending products also has an impact on the supply of these products as price and supply are related in economic theory. Therefore, another lending variable which needs to be explored under the presence of bank M&As is credit availability (Avery & Samolyk, 2014).. A number of studies have investigated the effect of bank M&As on credit supply or availability. However, their analyses are aimed at assessing the effect on a particular group of borrowers: small business borrowers. Mixed results have been obtained from empirical studies as the findings state that credit supply either increases, decreases or remains unchanged following an M&A transaction.. 33.

(35) Studies such as that conducted by Strahan and Weston (2009:830) have confirmed that small banks do in fact increase their loans offered following a merger or acquisition. They analysed the agricultural loans offered before and after a merger and found that following a small bank’s involvement in M&A activity, the merged bank increases the agricultural loans offered to small borrowers or businesses. This result of mergers and acquisitions between small banks leading to increased small business lending offerings was also found by Avery and Samolyk (2014).. Contrary to the view that small banks increase their loans after a merger, Gilbert and Belongia (2011:75) studied the mergers and concluded that M&As among smaller banks reduce their supply of loans following an M&A transaction whereas larger banks tend to increase their supply of credit. The reduction in credit supply among smaller banks was a similar result derived in a study conducted by Keeton (2011:63-75) who analysed the effect of bank M&As on the agricultural sector in the US. He discovered that local banks involved in international M&A transactions generally reduce their supply of agricultural loans to small businesses and farmers. However, the local banks not involved in acquisitions tend to increase their supply of agricultural loans within the period analysed. The studies aforementioned focused on banks’ agricultural lending to small businesses. Francis, Hasan and Wang (2008:1601), focusing on a different perspective and analysing the effect of bank M&As on new businesses, found that these merged banks also tend to reduce the credit available to new businesses.. The decrease in supply of credit offered after a bank M&A was also obtained by Sapienza (2012:357) who found that M&A activity in larger Italian banks also led to the banks decreasing their supply of credit to small borrowers. Bonaccorsi Di Patti and Gobbi (2007:687) confirmed this result as they also found a reduction in total credit extended to corporate borrowers. These corporate borrowers may terminate their relationship with the merged or acquired bank as they anticipate a decrease in credit supplied from these banks (Bonaccorsi Di Patti & Gobbi, 2007). Other research which studied the European banks’ M&As activity also stated that there seems to be a reduction in supply of credit following a bank’s involvement in an M&A transaction (Degryse,. Masschelein. &. Mitchell,. 2006;. Montoriol-Garriga,. 2008).. The. aforementioned studies found that when a bank engages in M&A activity, a significant decrease in the supply of credit following the M&A transaction is apparent. 34.

(36) However, other studies concluded that there is no significant effect of banks’ M&As on the supply of credit (Mercieca, Schaek & Wolfe, 2009; Berger et al., 2004; Erel, 2010; Berger et al., 2007).. Although the supply of credit can be affected by the presence of a bank M&A, the overall supply of credit in the market may remain unaffected. This statement was confirmed by research conducted by Berger et al. (2004:815) who investigated the effect of bank M&As on small business lending in the US and stated that even though the bank M&As tend to reduce the lending or the supply of credit, this decrease is covered by the inverse, an increase in credit which is supplied by banks not involved in any M&A activity. Craig and Hardee (2007:1255) further confirmed this finding as they too established that larger banks involved in consolidations reduce their credit available to small borrowers after the consolidations. The rest of the banks in the market make up for this decrease in credit supply. Thus there seems to be an offsetting effect on the supply of credit following a bank merger or acquisition activity as the total credit available in the market remains unaffected. 2.3.4. Risk Exposure The discussion aforementioned on the impact on banks’ credit supply following an M&A leads on to the topic of risk as the more credit products offered increase the risk exposure of banks. The participating M&A banks’ risk is either positively or negatively affected depending on whether their supply or price of credit increases or decreases following the deal.. Research which analyses M&A activity among banks and its impact on bank risk attitude or risk exposure mainly focuses on the theory of diversification. Diversification may be a vital motive for bank M&As (De Nicolo, Bartholomew, Zaman & Zaphirin, 2013). Many large banks may aim to expand into other banking markets. This business expansion may enable banks to reduce their risks as losses incurred in one market may be offset against gains earned in another banking market. This reduced risk exposure is a gain realised from banks diversifying and expanding into different markets. However, this method of diversifying and expanding into different markets may also result in increased risk exposure which can lead to increased losses incurred. De Nicolo et al. (2013:37) stated that increased risk exposure following an 35.

(37) M&A is possible especially in instances when the engaging banks have not properly researched the new banking market they enter. These banks who experience increased risk exposure after entering a new banking market have failed to consider the new geographical, political and environmental factors which may impact their business (De Nicolo et al., 2013).. Therefore, banks engaging in M&A activity may experience positive or negative effects on their risks as their risk exposure may either increase or decrease following the M&A transaction. The impact of banks’ risk levels following a bank M&A was studied by Craig and Dos Santos (1997), cited in De Nicolo et al. (2013:39) and they concluded that a bank’s risk level reduces after a merger. Lowered risk levels following banks’ M&A transactions are one of the benefits of diversification. This risk level motive can actually be a pivotal factor in a bank wanting to participate in an M&A deal (De Nicolo et al., 2013). Another study which analyses the potential reduction of risk levels as a result of mergers between bank holding companies and financial firms was carried out by Lown, Osler, Strahan and Sufi (2010). Their results stated that bankruptcy risk and financial risks were reduced following a merger. Mishra, Karels and Peterson (2013:86) discussed the changes in risks for merged or acquired banks and confirmed that overall risk was reduced after the merger transaction.. The studies aforementioned assessed bank M&A’s impact on differing risk exposures such as bankruptcy risk, credit risk and financial risk but the fundamental message is that bank M&As may potentially reduce a bank’s levels of risk. Apart from bank M&As potentially leading to the reduction in risk, there are studies which conclude the inverse. It is possible that bank M&As may lead to an increased level of risk. Boyd & Graham (2008:15) examined cross border bank mergers and stated that bank M&As negatively impacted share returns as these shares became more volatile and risky.. In an attempt to examine the correlation between banks’ M&As and banks’ risk, De Nicolo et al. (2013:39) found that large merged banks are enticed by the economic theory of moral hazard incentive and take on high levels of risk when compared with smaller non-merged banks. The economic theory of moral hazard occurs when an 36.

(38) agent undertakes greater risks in an attempt to earn a profit while in a contract with other parties (Holstrom, 1979). One of the main factors which fall under the moral hazard incentive is the concept of Too Big to Fail (TBTF) (Boyd & Graham, 2008). This concept is based on the fact that banks are protected by government and are able to take on risky ventures with little to no attention given to effective risk management policies as the safety net is provided by government. Numerous studies state that M&A banks may take on more risk using TBTF as a motive. A study by Kane (2000:680) stated that banks engaging in large mergers aim to become large and complex and they may be exempt from the government’s risk exception regulations. In this way, these banks are able to gain value from increasing their size. This gain of increased size can also result in reduced costs through the theory of economies of scale. The statement is supported by the results of a study conducted by Penas and Haluk (2004:149-179) who investigated the effect of bank M&As on bond returns. They stated that bondholders assign value to banks that achieve their TBTF status and highly support banks that are able to reach this level via high degrees of diversification. Reaching this TBTF status via diversification can also have a positive effect on a bank’s credit rating as the rating agencies may award the TBTF banks with more favourable rating bonuses (Rime, 2010).. The aforementioned studies provided a direct impact on levels of risk following a bank engaging in M&A activity. The risk exposure either increased or decreased post a bank M&A. However, a study by Amihud, DeLong and Saunders (2012:867) assessed cross border M&As and found no significant changes in bank risks or share price risk following a bank M&A. These results proved that with regard to international mergers, diversification gains may be offset by the high costs of dealing with foreign entities.. There seem to be mixed views on the effect of bank M&As on banks’ risk levels. Past researchers advocated that the banks’ level of risk may increase, decrease or remain unchanged following the banks involvement in an M&A deal. The increase or decrease of the bank’s risk levels will directly impact the banks’ lending behaviour (Amihud et al., 2012).. An increase in risk levels leads to the involved banks being more cautious regarding their lending practices and their lending practices becoming more stringent whereas 37.

Figure

Figure 1.1: The Six Merger Waves (Source: Gaughan (2011)
Figure 3.2: M&A Transaction Value in SA (R billions)
Table 6.1: Descriptive Statistics
Table 6.2: Correlation Matrix
+3

References

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