MERGERS, ACQUISITIONS AND ... TOO BIG TO FAIL? A POSSIBLE FUTURE FOR THE ANGOLAN BANKING SECTOR

THE TOO BIG TO FAIL RISK

Due to BNA Notice No. 02/18 on the adequacy of minimum social capital and regulatory capital of banks, which requires their increase, there has been much speculation about the possibility of a wave of mergers and acquisitions (mainly mergers) in the near future of the angolan banking subsector. However, little or nothing has been mentioned about the risk of it resulting in potentially large Banks that could represent massive systemic risks: the Too Big to Fail.

A Too Big to Fail bank, is a banking institution whose size and influence on the economic system, would be so significant that if it became insolvent, the economy would suffer severely. Bank size, complexity and interconnection with other banks may inhibit the Government's ability to resolve the bank without significant disruption to the financial system or the economy (see the subprime crisis in 2008, where the fall of Lehman Brothers triggered the recent global financial crisis and whose consequences are still felt).

The risk of bankruptcy of a “Too Big to Fail” increases the probability of a bailout by the Government, which often means, as we have seen in other realities, times of austerity. It should be recalled that in the case of Angola, although the Deposit Guarantee Fund has recently been materialized under Presidential Decree No. 195/18 of August 22nd (which is positive), the Resolution Fund has not (at least not yet), which makes our financial system still vulnerable in case a Too Big to Fail institution needs to be "rescued".

These Too Big to Fail banks may arise amongst us if these operations are not closely monitored (and very cautiously) by the regulator. And as experiences of other realities have already demonstrated, institutions of this nature can have devastating effects on the financial system, which should preferably be avoided.

If the risk of this scenario becomes significant, the regulator may, as a preventive measure, intervene and mediate these M&A operations, in order to ensure that one or more institutions will not take on the risk of converting them into risk centers, potentially unbearable for the financial system.

Such intervention may also involve, if necessary, the creation of new regulatory instruments aimed at limiting the ability of banking financial institutions to concentrate their risk; impose new capital requirements (again) which may even be progressive in nature; the creation of a category of "systemically relevant financial institutions"; the establishment of specific and more stringent continuous monitoring mechanisms; oblige banking institutions to develop mechanisms that enable them to quickly liquidate assets in the event of insolvency; the development of a complex structure of settlement and deposit-guarantee mechanisms so that, in the event of  insolvency (whether it is a Too Big to Fail or not), it serves as a buffer against the impact on the financial system; and the creation of communication channels that facilitate a direct consultation with the regulator, in what concerns to matters that can influence the systemic risk that these institutions represent.

In this approach, the fundamental concern will be the definition of frameworks that guarantee the economic-financial equilibrium of institutions, preventing (or controlling) their involvement in other entities whose eventual collapse could  have a negative repercussion on the participants themselves and, in a more comprehensive plan, in the national economy, through the so-called domino effect.

As we can see, the intervention of the regulator is necessary to ensure the stability of the financial system during and after the completion of these merger and acquisition operations that may (and most likely will) reconfigure our financial system and, in particular, the banking subsector.

 THE SUBPRIME CRISIS

In conclusion, it is worth recalling, very briefly, the origins of the 2008 financial crisis, which serves as a reminder of the risks of Too Big to Fail institutions.

This resulted from market failures and regulatory failures.

The market failure occurred because wealth (or capital) holders did not, in many cases, take the necessary precautions to protect their interests. Several companies established compensation structures that rewarded excessive risk.

Banks "bought mortgages", even with the knowledge that the criteria for granting housing loans were not very strict.

At the same time, several regulators (recalling that this had international proportions and occurred in a number of markets) took on "more relaxed" postures in the performance of their duties, despite the alerts by a number of experts about the risk of a crisis with the same nature of the crisis of 2008 (some date back to the 1990s). As noted, such alerts were ignored.

Originally published in 05/10/2018 on Jornal Mercado.

Elaborated by: Elvis Barros