Two years after a sweeping consolidation, Malaysian banks are again at a crossroads as they seek a new round of mergers to stay competitive ahead of market liberalisation, analysts said.

The industry has emerged on a stronger footing after a major upheaval following the 1997/98 Asian financial crisis, which led 54 banks and finance houses to be merged into 10 "anchor" groups under the aegis of the government.

But a big gulf still separates the small and big banks among the 10 groups and analysts say a further overhaul to create fewer but stronger players is inevitable to cope with competition when the sector is liberalised in 2007.

The central bank, which oversaw the banking restructuring, envisages further consolidation to leave between six and eight banks.

Low valuations

However, the recent collapse of merger talks between EON Capital and AMMB Holdings to create the country's third largest banking group shows that the process is tougher than expected, analysts say.

"It is not easy to give up a banking licence without the required premium and timing is bad now because valuations are low due to the economic slowdown," said Andrew Chuah, analyst with Mercury Securities.

Malaysia has cut its economic forecast to 4.5 percent growth this year from previous estimates of 6.0-6.5 percent.

"But local banks must pull up their socks and merge to transform into more compact, fully fledged, one-stop financial institutions if they want to survive in an open market," Chuah said.

Despite the failure of the EON-AMMB talks, the government insists the second round of banking consolidation will be market-driven.

"The government will leave the mergers to the market and let the suitors talk to each other. They all know it is necessary for them to grow and get bigger to compete in the world," Second Finance Minister Jamaludin Jarjis said last week.

Commerce Asset-Holding, Malaysia's second biggest lender, is already eyeing a merger with AMMB, ranked fifth largest, to close the gap with top bank Malayan Banking, analysts said.

The Alliance Bank group is also shopping for suitable partners and has reportedly approached Malayan Banking and EON.

"The message is that banks are interested to merge but the question is how to cut the deals. At the end of the day, its about pricing and whether they fit each other," said a research chief at a foreign house.

Crucial gov't role

Analysts warn local banks may sit out for better premiums and control over the merged entity - the key stumbling blocks to the EON-AMMB deal - without the government's whip.

"The first round of forced mergers was a necessary evil although it left a sour taste. The government's role will still be crucial in the second round," said Nizam Idris, regional economist with Singapore-based IDEAglobal.

Looking at Singapore, which has merged its eight banks into three over the years and is seeking to further trim it down to two, Nizam said three to four big banks would be ideal for Malaysia.

"Ten banks are too many in a liberalised market and they will all be vulnerable to foreign acquisition if they don't consolidate," he warned.

At the same time, size alone will be meaningless if Malaysian banks do not improve their asset quality, profitability and capitalization, other analysts said.

The industry must adopt stringent risk management processes, boost efficiency in its liability and cost management, develop new services amd products, and improve transparency and internal controls.

"Malaysian banks stand at a crossroads. They can build on their achievements or slip back into past excesses that affected them so deeply during the crisis," said a foreign banking analyst. - AFP