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Mergers and Acquisitions: Analysis of Banking Sector of Pakistan

Article  in  Journal of Computational and Theoretical Nanoscience · September 2017

DOI: 10.1166/asl.2017.10001

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 RESEARCH ARTICLE
Copyright © 2017 American Scientific Publishers Advanced Science Letters
All rights reserved Vol. y, xxxx-xxxx, 2017
Printed in United States of America

Mergers and Acquisitions: Analysis of Banking

Sector of Pakistan
Muhammad Faizan Malika*, Suresh Ramakrishnanb, Shahzad Khanc
a,b,c Faculty of Management, Universiti Teknologi Malaysia, 81310, Skudai, Johor, Malaysia

The present study initiated to find out the effect of M&A’s on the financial performance of banks.
The study was conducted on the banking sector of Pakistan. Five (5) events were taken as a sample
of the study. The data of every sample event was collected 3 years before and 3 years after the year
of M&A’s. The study was based on CRAMEL model. As per the results, capital adequacy, resource
allocation, management capabilities and liquidity have insignificant effects on bank’s performance
after M&A’s while assets quality and earning quality has significant effects on the bank performance
after M&A’s. According to paired sample t-test, capital adequacy, management capabilities, earning
quality and liquidity does not show significant difference after M&A’s while assets quality showed
significant difference after M&A’s.

Keywords: Merger & Acquisition, CRAMEL Model, Banks, Performance

1. INTRODUCTION dramatic increase in the number and size of bank M&A’s. In

An entrepreneur may expand business either by interior
extension or by exterior extension. Interior extension is the one
where a firm grows steadily in the typical course of business,
through buy of new resources, targeting new markets and
business and the creation of new lines of products 1. While
exterior extension refers to the expansion whereby a firm
merged/acquired with a running business and becomes
prosperous overnight2. These mixes and combinations are in
the form of mergers, acquisitions, amalgamations, takeovers
and have now turn out to be essential features of corporate
restructuring. Merger and acquisitions (hereafter referred to as
M&A’s)have been playing a vital role in the growth of firms
due to superior competition, zero trade barriers, easy and
speedy flow of capital across countries and globalization of
businesses3.
The significance of M&A’s in the financial sector further
increases because financial sector plays a significant role in the
success and economic growth of every country 4. A healthy and
sound banking system is very crucial for the economic
stability. Banks by intermediating between surplus and deficit
savings units within financial system of a country activates and
facilitates well-organized distribution of national savings.
Thus, increasing the quantum of investments and hence
national output 5. Banks through financial intermediation
facilitate capital formation (investment) and encourage
monetary development. Banks all over the world have been
extensively undergoing a process of consolidation and
restructuring. Factors such as globalization and competition
have compelled banks to improve their effectiveness in
providing financial services to meet the increasing demands for
quality products and services 6. In the last decade, the financial
sector around the globe has experienced a major structural
change from the wave of M&A’s activity 7. The interest in this
topic has developed from the fact that globally there has been a
*faizanmalik@awkum.edu.pk
1995-96, the values of the M&A’s transactions in banking
sector were 450 billion pounds consisting of 1527 deals which
rose to 580 billion pounds consisting of 1814 deals in 2009-
2010 (http://www.imaa-institute.org/recources/statistics).
In case of Pakistan, the banking sector showed drastic trend of
corporate restructuring from the last 10 years and the number
of M&A’s deals has been recorded particularly in banking
sector. It happened when State Bank of Pakistan (central bank)
made amendments in rules and regulations and introduces
certain reforms for banks. The banks in order to comply with
the statutory requirements set by State Bank of Pakistan need
to raise their paid-up capital. The large and sound banks raised
their paid capital as required by central bank and hence
survived in the market but small and low profit oriented banks
left with no option except to quit from market or else merged
with or acquired by sound/good financial firms. The banking
sector thus is the only sector in Pakistan where most of the
M&A’s transactions have occurred8. The present study tries to
analyze the performance of banks that are involved in the
process of M&A’s by looking at the results of pre and post-
merger period (3 years before and 3 years after the deal of
M&A).
2. LITERATURE REVIEW
The maximum of the research studies have discussed the
empirical validation on M&A’s for many decades. Different
researchers have tested the impact of M&A’s by their pre and
post-performance analysis and almost every study has
proposed different methods and tools to assess the performance
of M&A’s.
Sufian 9 researched on the small and medium size banks in
Malaysia and concludes that the banks obtained their goals due
to M&A’s. The results proved that after M&A’s, the overall
efficiency in the period which was taken as a sample was
increased by 95.9%. As a result, it was concluded that

1 Adv.Sci. Lett. y, xxxx-xxxx, 2017 xxxx-xxxx-/2017/x/xxxx/xxx doi: xx.xxxx/asl.2017.xxxx

Adv.Sci. Lett. y, xxxx-xxxx, 2017
M&A’sis successful strategy for Malaysian banks. Similarly,
Pillania, Kumar 10 examined the impact of M&A’s on
corporate performance in India. The financial data with
different ratios were used to make analysis. The results of the
study concluded that after M&A’s, most of the firms got
momentum and their performance in the post-merger period
has improved in the form of increased cash flow, larger
business advantage, and diversification. Likewise, Obaid,
Sabeeh 11explored the Pakistani banking sector to find out post-
merger performance of Al-Faysal Investment Bank Ltd and
Atlas Investment Bank Ltd in Pakistan. The study selected
three measures (profitability, capital adequacy and solvency)
which were compared for 4-years pre and post-merger from the
financial statements of the sampled banks. The results of the
study revealed that the Al-Faysal Investment Bank Ltd
recorded an average improvement in the post-merger period.
Contrary to it, Kouser and Saba 12 studied financial market of
Pakistan by conducting different ratios analysis in the pre and
post-merger period and found decrease in almost every ratio
after M&A’s. The study recorded that M&A’s experienced
negative results in post-merger period could possibly be due to
some various other components. These components could be
the economic downturn, political situation, changes occurred
due to industry fluctuations, and some other global components
which can be the reason in failure of bank performance in the
post-merger period. Liu and Tripe 13 investigated the efficiency
of six bank mergers from 1989 to 1998 in New Zealand. Their
study originated that the bidder banks were commonly larger
than their targets, even though they appeared to be less
efficient. The results of the study recommend that 4 out of six
banks showed clear efficiency gains in the post-merger period.
Though, they failed to clearly conclude on likely benefits of
M&A’s on public benefits.
2.1. PROBLEM STATEMENT
The present study aimed to conclude and assess the impact of
M&A’s on the performance of banking sector of Pakistan by
taking into account the Capital Adequacy, Resources
allocation, Asset Quality, Management Quality, Earnings
Quality, and Liquidity. The core objective of the present
research study is to empirically identify that either M&A’s
deals increases or decreases the performance of the banks
involved.
2.2. HYPOTHESIS
H1:Capital adequacy ratio has positive effect on the bank’s
performance after M&A’s.
H2: Resource Allocation has significant effect on the bank’s
performance after M&A’s.
H3:Assets Quality ratio has positive effect on the bank’s
performance after M&A’s.
H4:Management Capabilities has improved the bank’s
performance after M&A’s.
H5: Earning Quality has positive effect on the bank’s
performance after M&A’s.
H6: Liquidity has improved the bank’s performance after
M&A’s.
3. METHODOLOGY
The current study assumed only five (05) deals of M&A’s as a
sample of the study due non availability of data. The data has
two windows i.e. before the deal of M&A’s and after the deal
of M&A’s. The data of every sample event was collected 3
years before and 3 years after the M&A’s year. The present
study adopted CRAMEL model (Capital Adequacy, Resources
allocation, Asset Quality, Management Quality, Earnings
RESEARCH ARTICLE
Quality, and Liquidity) to assess and gauge the performance of
banks involved in M&A’s transactions.
The present study calculated the variables of the CRAMEL
model before and after the announcement of M&A to record
any differences in the performance of sample banks. The
multiple regression model and Paired sample T-test was
employed to see any relationship among the variables and
changes in Mean, T-value and P-value of the variables.
4. ANALYSIS AND DISCUSSION
The Table 2 shows the results of net change in the CRAMEL
model variables i.e. capital adequacy (CA), resource allocation
(RA), assets quality (AQ), management capabilities (MC),
earning quality (EA) and liquidity (LQ). Five sample events
were selected and their CRAMEL analysis was made. The
results of capital adequacy ratio showed that 4 out of 5 events
had positive change or increasing trend after the M&A’s. Royal
Bank of Scotland (RBS) merged to Faysal Bank (FB) showed
32 percent increase in their CA ratio. The values in the RA
column are not so much attracting, as the highest change of 5.4
percent can be seen in a merger between the First Dawood
bank and Atlas Bank. This means that their cost became lower
as compared to their total assets after M&A’s. The assets
quality column showed significant changes after M&A’s.
Highest increase of 40 percent can be seen in a merger between
Union Bank and Standard Chartered Bank. It means that their
loans to deposits were increased by 40 percent. It is significant
because loans are the primary source of income generation for
every financial institution. The management capabilities
column showed drastic changes i.e. higher and lower values.
The decrease can be seen in the values of Union Bank merged
into Standard Chartered Bank i.e. 65 percent. This means that
total advances to deposits were decrease after the merger
announcement and significant increase of 31 percent can be
seen in the merger deal between First Dawood bank and Atlas
Bank. Earning quality can be seen in the next column in which
small changes occurred. EQ were measured by return on assets.
Only Union Bank merged into Standard Chartered Bank shows
8 percent increase in their earning quality after merger. The
values of liquidity showed that highest increase of 4 percent
can be seen in the event of First Dawood bank merged to Atlas
Bank.
4.1 REGRESSION
The above table shows the results of regression of CRAMEL
model variables on the bank’s financial performance. The
financial performance of the sample banks was proxied through
profitability which was measured by ROA. The values showed
that CRAMEL factors and financial performance are almost 80
correlated to each other. These factors have 63 percent effects
on the financial performance of the sampled bank. The f-ratio
is 6.392 which mean that the model is statistically significant.
The beta value shows that if CA is changed by 1 unit then
financial performance will be decrease by .183 units. If RA,
AQ, EQ and LQ change by 1 unit, financial performance will
be increased by .089, .587, .428 and .149 units respectively.
However, if the MC is changed by 1 unit, the financial
performance will decrease by .176 units. The t-values showed
that CA, RA, MC and LQ has insignificant effects on the
financial performance of the bank after M&A’s and AQ and
EQ have significant effects on the financial performance of the
bank after M&A’s.
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RESEARCH ARTICLE Adv.Sci. Lett. y, xxxx-xxxx, 2017
4.2 PAIRED SAMPLE T-TEST: results of the current study, it can be extracted that M&A’s in
The above table is the results of paired sample t-test of the banking sector of Pakistan is not a fruitful strategy to adopt
CRAMEL model. The test was used as the study consists of for expansion of business. Banks may focus on internal
two pairs i.e. before merger and after merger. As per the t- expansion to achieve their objectives. The current study can be
values of CRAMEL factors; helpful for the scholars and academicians as it fills the gap in
Hypothesis 1: The t-value of CA is -.268, which shows the literature of M&A’s on Pakistan market. The study can be
insignificant difference before and after M&A’s. So, there more elaborated by increasing the number of sample events.
exists little evidence to reject null hypothesis. The current study was conducted on the financial sector, so
Hypothesis 2: The t-value of RA is -2.371, which shows there future research can be conducted in the non-financial sector.
is a significant difference between the values before and after
the M&A’s. So, alternate hypothesis is accepted. References and Notes
Hypothesis 3: The t-value of AQ is -2.746, which shows there 1. Malik M. F., Anuar M. A., Khan S., Khan F.,
is a significant difference between the values before and after International Journal of Accounting and Financial
the M&A’sin the assets quality ratio of the sampled events. So, Reporting. 4(2), 520 (2014).
alternate hypothesis is accepted. 2. Farrell J., Shapiro C., The American Economic
Hypothesis 4: The t-value of MC is .101, which shows there is Review. 107-26 (1990).
insignificant difference between the values before and after the 3. Fauli‐Oller R., Journal of Economics & Management
M&A’sin the management capabilities ratio of the sampled Strategy. 9(2), 189-210 (2000).
events. So, there exists little evidence to reject null hypothesis. 4. Dilshad M. N., Business and economic research.
Hypothesis 5: The t-value of EQ is 1.148, which shows there 3(1), 89-125 (2013).
is an insignificant difference between the values before and 5. Afolabi J., NDIC organized Workshop for FICAN
after the M&A’sin the earning quality ratio of the sampled Enugu.(2004).
events. So, there exists little evidence to reject null hypothesis. 6. Amihud Y., Miller G. P. Bank mergers & acquisitions:
Hypothesis 6: The t-value of LQ is .421, which shows there is Springer, (1998).
an insignificant difference between the values before and after 7. Rasiah D., Ming T. T., Hamid A. H. B. A.,
the M&A’s in the liquidity ratio of the sampled events. So, International Journal of Economics and Finance.
there exists little evidence to reject null hypothesis. 6(8), 289 (2014).
8. Ishrat K., Islahi, A. 07-035 (2005).
5. CONCLUSION AND RECOMMENDATIONS 9. Sufian F., International Journal of Applied
The study was conducted to find out the effect of M&A’s on Econometrics and Quantitative Studies. 1(4), 53-74
the banks performance. The study was conducted in the (2004).
banking sector of Pakistan. 5 events were taken as a sample of 10. Pillania R. K., Kumar S., Bansal L. K., Management
the study. As per the results of regression model; capital Decision. 46(10), 1531-43 (2008).
adequacy, resource allocation, management capabilities and 11. Obaid U., Sabeeh U., Abid U., International
liquidity have insignificant effects on banks performance after Research Journal of Finance and Economics. 66,
M&A’s while assets quality and earning quality has significant 169-74 (2010).
effects on the bank performance. According to paired sample t- 12. Kouser R., Saba I., Australian Journal of Business
test; capital adequacy, management capabilities, earning and Management Research. 1(8), 54 (2011).
quality and liquidity does not show significant different after 13. Liu B., Tripe D., Journal of Asia-Pacific Business.
merger and resource allocation and assets quality shows 4(4), 61-81 (2003).
significant different before and after M&A’s. Based on the

Table 1: variables and their measurement

ExpectedSign Variables Ratios
CA Capital Adequacy Capital Adequacy Ratio
Advances to Assets Ratio
RA Resource Allocation Cost to total assets
AQ Assets Quality Loan to deposit ratio
MC Management Capabilities Total advances to deposits
EQ Earning Quality Return on equity
LQ Liquidity Current ration

Table 2: Mean change

Events Capital Resource Assets quality Management Earning Liquidity
Adequacy Allocation capabilities quality
Change Change Change Change Change Change
HBA-HBM 10% 1.3% 10% -1.8% 0.5% -0.5%
PIC-NIB 26% 0.7% 27% 33% 1.1% -2.4%
UN-STD 13% -0.2% 40% -65% 8% 1.6%
RBS-FB 32% -0.2% 2% -5% -29% 1.3%
FDB-ATB -14% 5.4% 6.8% 31% 3.2% 4%

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Adv.Sci. Lett. y, xxxx-xxxx, 2017 RESEARCH ARTICLE
Table 3: Regression results
Profitability R R2 F-value Beta t-value p-value
Constant .126 .901
CA -.183 -1.103 .282
RA .089 .543 .592
AQ .797 .635 6.392 .587 4.150 .000
MC -.176 -.954 .350
EQ .428 3.096 .005
LQ .149 1.057 .310

Table 4: changes in variables before and after M&A

Pair Mean Std Deviation t-value p-value
Before: Capital Adequacy -1.019 14.75 -.268 .793
After: Capital Adequacy
Before: Resource Allocation -.0176 .02880 -2.371 .033
After: Resource Allocation
Before: Assets quality -.13989 .1973 -2.746 .016
After: Assets quality
Before: Management Capabilities .0112 .42975 .101 .921
After: Management Capabilities
Before: Earning quality .0597 .20132 1.148 .270
After: Earning quality
Before: Liquidity .0042 .03701 .421 .680
After: Liquidity

Received: 15 December 2016. Accepted: 12 May-2017

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