The mergers of Islamic banks in Malaysia and globally are much needed as the market is getting overcrowded where many small Islamic banks are fighting for their survival. Mergers among Islamic banks to create a mega Islamic bank will create synergy with an objective of achieving a more effective and competitive Islamic banking landscape. In this context, ‘Big is Better’ as size is important mainly because it will permit a mega Islamic bank to have greater access to funds as well as to expand its asset book and create value in the Islamic banking space where margins are restricted due to the tighter operational environment. This special report is to identify the potential benefits and challenges of merger amongst Islamic Banks in Malaysia.

1. 21©
11th
October 2017
SPECIAL
REPORT
Dr Nafis Alam
is an associate
professor of
finance at
Henley
Business School, University of
Reading Malaysia and Lokesh
Gupta is attached to RM
Applications as the head of
consulting. They can be contacted at
n.alam@henley.edu.my and lokesh@
rma.com.my respectively.
The mergers of Islamic banks in
Malaysia and globally are much needed
as the market is getting overcrowded
where many small Islamic banks are
fighting for their survival. For instance,
Malaysia is home to 17 Islamic banks
which include three fully-fledged
banks, Bank Islam, Bank Muamalat
and most recently, Agrobank. Eight
more are subsidiaries of their parent
conventional banks, while the
remaining are foreign banks.
The key question is why mergers
are key to the survival of the Islamic
banking industry. Banks are not only
providing key banking services such as
deposit-taking and financing but have
ventured into investment banking, asset
management and ancillary services. In
order to provide the long list of financial
services, banks need capital as well as
a large customer base which is missing
from the Islamic banking industry. In
order to understand how Islamic banks
fare with respect to their national and
international conventional counterparts,
a snapshot of the largest conventional
and Islamic banks is presented in Table 1.
It can be seen from Table 1 that the assets
of the largest Islamic bank in the world,
Al Rajhi Bank, are less than 3% of the
assets of the largest conventional bank in
the world, the Industrial and Commercial
Bank of China (ICBC). In that context,
even for the largest Malaysian bank,
Maybank, its Islamic side is only a
quarter of its conventional side.
It can be also seen from Chart 1 that the
aggregated total assets of Islamic banks
worldwide in 2016 are only one-third
of the ICBC, and it can be anticipated
that mergers among Islamic banks will
provide the impetus to catch up with
their conventional counterparts. It is not
that regulators and Islamic banks are not
pushing for mergers within the Islamic
banking sector. For instance in 2014, three
of Malaysia's largest financial institutions
– CIMB Group, RHB Capital and
MBSB – were in talks to combine their
businesses and create a mega Islamic
bank that could have been potentially
one of Southeast Asia's biggest lenders
in terms of assets. The three-way merger
would have given the impetus to the
concept of a mega Islamic bank, a bank
big enough to compete with regional
banking giants. However, the plan was
scrapped and abandoned in 2015 due to
unfavorable economic conditions. More
recently, MBSB submitted an application
to Bank Negara Malaysia for its proposed
merger with Asian Finance Bank which is
struggling to survive in the competitive
Islamic banking domain. Even Indonesia
wanted to create a mega Islamic bank
in the region in 2015 by merging four
state owned banks, namely Bank Negara
Indonesia, Bank Mandiri, Bank Tabungan
Negara and Bank Rakyat Indonesia but
the proposed merger plan did not go
through due to legal and regulatory
issues as well as renewed interest from
Gulf investors to further boost their
Islamic finance business in the country.
Instead, Indonesia’s Ministry of State-
Owned Enterprises is targeting to set up
an investment holding company by 2018
which will be responsible to manage the
operation of the four banks involved in
the merger talks.
Merger initiatives are not only
concentrated in Southeast Asia as
GCC Islamic banks are also looking
to consolidate the fragmented Islamic
Big is beautiful: The survival mantra for the
Islamic banking industry
A merger is a common business phenomenon across different industries but when it comes to the Islamic banking
sector, DR NAFIS ALAM and LOKESH GUPTA write that it still looks like a new concept.
Table 1: Largest banks by assets (US$ billion) as of 2016
Top global banks Top US banks Top Arab banks
(conventional)
Top Arab banks
(Islamic)
Top Malaysian
banks
(Conventional)
Top Malaysian
banks (Islamic)
Name Assets Name Assets Name Assets Name Assets Name Assets Name Assets
Industrial and
Commercial Bank
of China
3,470 JPMorgan
Chase & Co
2,550 Qatar National
Bank
190.2 Al Rajhi
Bank
88.4 Maybank 170 Maybank
Islamic
42.1
China
Construction Bank
3,020 Bank of
America Corp
2,250 National
Commercial
Bank
120.8 Kuwait
Finance
House
56.45 Public
Bank
93 Bank
Rakyat
23.02
Agricultural Bank
of China
2,820 Wells Fargo
& Co
1,950 Emirates NBD 116 Bank
Mellat
53.1 CIMB 70 CIMB
Islamic
15.5
Bank of China 2,600 Citigroup 1,820 National Bank
of Abu Dhabi
114.2 Bank
Melli
52.9 RHB 55 Bank
Islam
12.95
Mitsubishi UFJ
Financial
2,590 Goldman
Sachs Group
894 Al Rajhi Bank 88.4 Dubai
Islamic
Bank
46.85 Hong
Leong
Bank
44.2 Public
Islamic
Bank
11.53
Source: The Banker

2. 22©
11th
October 2017
SPECIAL
REPORT
banking sector. A proposed merger
between three Qatari banks, Masraf Al
Rayan, Barwa Bank and International
Bank of Qatar is on the cards and if the
merger is successful, the combined entity
would be the largest Islamic bank in
Qatar and the fourth-largest Islamic bank
in the GCC with total assets amounting
to around US$48 billion having a 14%
market share. There is also speculation
about merger talks between Abu Dhabi
Commercial Bank, Union National Bank,
Abu Dhabi Islamic Bank and Al Hilal
Bank, but none of the institutions have
publicly confirmed their interest in the
consolidation.
Consolidation of the Islamic banking
sector is not only necessary to create
mega Islamic banks in line with big
conventional banks but also to provide
endurance to the declining Islamic
banking sector. Islamic banks in the
GCC are expecting a tough 2018 due
to geopolitical risk and the rift among
the GCC nations. Islamic banks’ asset
growth in the GCC declined to 5.3% in
2016 from 10.7% in 2014 and profitability
also declined due to the rising cost of
funding and the tightening of banks’
intermediation margins. In addition,
the intense competition has slowed the
average growth rate of Islamic banks
in Malaysia from 15-20% about 10 to 15
years ago to only 5% in the past five years,
reported The Sun quoting the then group
CEO of BIMB Holdings, Zukri Samat.
It is expected that banking mergers will
improve operational efficiency through
the rationalization of overlapping
branches and the merging of duplicate
infrastructure will bring economy of
scale. It has been observed that the
enhanced scale of operations and the
rationalization of common costs will
result in reducing the cost to income
ratio. Mergers strengthen the financial
aid and liquidity requirement in terms
of capital, thus complying with the
regulatory requirements. A merged
entity, with a bigger balance sheet,
makes it a stronger bank and helps it
to command better valuation and raise
capital from the market easily with its
new strengths. A low cost of funding will
help in lower financing rates and in turn
will improve profitability. The merger
will also enable the filling of product or
technology gaps and create a stronger
digital footprint where the entities can
leverage on each other’s technology
platform. The bigger the bank, the
better is the diversification of its assets
portfolio and this reduces the chance
of failure of a bank within the banking
ecosystem. Economies of scale and
rationalization are the key advantages of
a bank merger, provided merging entities
have competitive advantages and are
profitable and well-capitalized.
Although mergers bring a lot of benefits
but they also have their unique set
of challenges. The key challenges are
merging banks with fairly different
cultures, orientations, IT systems
and geographic operating regions.
A merger is always seen as a threat
to human resources of the merging
entities and there is a fear of losing
their jobs, changes in current positions,
integration of roles and salary structure
and so on. The concerns of human
resources can possibly be addressed
by thorough communication with the
resources during the merging process
and establishing measures to ensure
employees are adapting to the change.
The impact on customers and their
perception of the merger process should
be attended to by establishing regular
and careful communication at every
stage of the merger to build customers’
confidence in the newly merged entity.
Bank mergers are complex strategic
moves with the possibility of an
extraordinary payoff and irrespective
of the difficulties they pose, the benefits
far outweigh the challenges. The Islamic
banking industry will be no different
to the aforementioned challenges and
opportunities.
If we focus on Malaysia, which as
of now has 17 Islamic banks and 27
commercial banks, it can be said that the
market is overcrowded and there is a
need to have mergers to boost growth.
Mergers among Islamic banks to create
a mega Islamic bank will create synergy
with an objective of achieving a more
effective and competitive Islamic banking
landscape. In this context, ‘Big is Better’
as size is important mainly because it
will permit a mega Islamic bank to have
greater access to funds as well as to
expand its asset book and create value
in the Islamic banking space where
margins are restricted due to the tighter
operational environment.
Mega Islamic banks in terms of a larger
asset size, a wider branch network and
customer base and sophisticated
channels are always needed to cater to
the needs of a growing economy and the
demand for Islamic banking. This will
also be in line with the government’s
ambition of making Malaysia a global
hub for Islamic banking and enable
Islamic banks to offer large financings
and go head-to-head with bigger
conventional banks. Mergers among
Islamic banks in today’s economic
climate make sense from a competitive
point of view and will make the Islamic
banking landscape in Malaysia more
‘future ready’ and easier to regulate with
a larger asset base.
Continued
Chart 1: Aggregated total assets of stand-alone Shariah compliant banks (US$ billion)
1,200
1,000
800
600
400
200
0
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source: The Banker
Bank mergers
are complex
strategic moves with
the possibility of an
extraordinary payoff
and irrespective of
the dif iculties they
pose, the bene its far
outweigh the
challenges