European bank mergers are back on the agenda. Barclays is looking at a domestic merger or acquisition, possibly of Standard Chartered. UniCredit and Société Générale are reported to explore a cross-border merger.
There are two trends behind a prospective wave of bank consolidation in Europe, which was predicted with the move to the Banking Union.
- The first is cyclical: the European economy is in recovery mode and bank balance sheets in most EU countries have been cleaned up, so bankers are starting to plan for the future.
- The second is structural: there is an overreliance on banking in Europe (Langfield and Pagano, 2016). The shift from banking to capital markets has already set in. Figure 1 shows the share of banks and institutional investors (investment funds, insurers and pension funds) in the euro area . The share of institutional investors, which operate in capital markets, in total euro area financial intermediation has already increased from 30% to 40%.
Figure 1 Share of banks and institutional investors in the euro area financial system
Source: Authors calculations based on ECB Structural Financial Indicators 2018
Banks are thus consolidating to reduce overcapacity. Mergers and acquisitions are the main mechanism for bank consolidation, as exit is near impossible in the regulated and protected banking sector. The big question is whether the prospective merger wave will be domestic or cross-border. While cross-border consolidation was predicted at the time of previous integration events, such as the Single Market in 1993 and the EMU in 1999, the major mergers were domestic (Schoenmaker 2015). Examples are the merger of ABN and AMRO in 1991 and the creation of the BNP Paribas Group from the merger of BNP and Paribas in 1999. By contrast, the lifting of the ban on cross-state mergers in the 1990s led to major cross-state consolidation in the US (Stiroh and Strahan 2003).
The European banking market
Before reviewing the main drivers of cross-border and domestic bank mergers, we examine the European banking market. Table 1 indicates that the largest banks are headquartered in the UK, France, Germany, and Spain. It also shows that the largest European banks have already substantial cross-border business. On average, the domestic business amounts to 56%, with 22% of their business in the rest of Europe and another 22% in the rest of the world. There are some very international banks, like HSBC, Credit Suisse and Standard Chartered, and some more domestic banks, like Crédit Agricole and Lloyds Bank.
While many bank combinations can be imagined, supervisory authorities have become wary of large banks that are too big to fail (TBTF). This implies that supervisors are reluctant to allow mergers that create mega-banks with over €2.5 trillion to €3 trillion in assets. So, a merger among the top eight banks in Table 1 is likely to be blocked. Nevertheless, one of the larger banks may take over a relatively smaller bank.
Table 1 Biggest 30 banks in Europe in 2017
Source: Updated from Duijm and Schoenmaker (2017).
Note: The geographical spread measures the share of assets in the home country, rest of the EU and rest of the world.
What are the arguments in favour of cross-border mergers? A major synergy of cross-border mergersis credit risk diversification. In a recent paper, we find that cross-border mergers do not lead to higher returns, but reduce credit risk (Duijm and Schoenmaker 2017). Our findings show that a bank that is active in two countries and expands its business to a third country experiences a reduction in default risk by around 1.3%. The diversification effect is caused by limited synchronisation of business cycles across the EU.
Another synergy is the scaling up of technological innovation. Major players, such as ING Bank, Santander and BNP Paribas, invest heavily in new technology (both developed within the bank and acquired by buying fintechs). These banks can subsequently roll out their new technology across their domestic and international business. Examples are the acquisition of Abbey National in the UK by Santander and the acquisition of the German Direktbank by ING (renamed to ING DiBa). Santander and ING have used these foreign acquisitions to introduce their superiority in technology in these markets. In this way, they create a strong competitive edge and realise a higher return on their technology investment through economies of scale.
A final argument for cross-border mergers is client driven. The client pull hypothesis (Grosse and Goldberg 1991) states that a bank’s international clientele, notably large corporates, provide an incentive for internationalisation by a bank. The financial system of the foreign country might lack a level of sophistication that these corporates desire. Moreover, corporates want to concentrate their international business with only a few banks to streamline payments and to benefit from cash-pooling.
The driving force of domestic consolidation is cost savings through economies of scale. As mentioned before, during the previous integration episodes bank mergers were primarily domestic, as also indicated by the ratio of domestic to cross-border bank mergers being five to one over the years 1990-2001 (Campa and Hernando 2006). Before the Global Crisis, multiple domestic bank mergers took place within the EU and, as a consequence, the majority of the countries experienced an increase in banking concentration over the years 1999-2007. Using the concentration ratio of the five largest banks (CR-5), Table 2 indicates that over this period the average CR-5 increased by 9.0 percentage points to 44.5% in 2007. When the crisis kicked in and the economy started stagnating, the merger activities automatically shrunk and actually, on average the concentration ratios slightly decreased in the post-crisis period from 2010 to 2017.
In light of the economic situation and the transformation to digital banking (internet-driven payment technologies), banks have mainly focused on closing branches and reducing the labour force to save costs after the Global Crisis. Over the period 2010-2017, almost all EU countries show a significant decrease in the number of branches and employees per thousand of inhabitants. Hence, while before the Global Crisis the focus was on domestic bank mergers for efficiency gains, after that the focus has been on merging local branches within banks and on laying-off the staff in the merged branches. Table 2 shows that over the period 2010-2017, the number of branches and employees per thousand inhabitants decreased remarkably from 0.44 and 7.8, respectively, in 2010 to 0.35 and 6.7 in 2017. There are however differences among countries. Countries, like the Netherlands, Finland, and Estonia are below the current averages. By contrast, Austria, Germany, and also France are well above these average efficiency indicators, with multiple branches and still large workforces.
Now that the European economy has reached the state of recovery, domestic bank mergers may reappear as a means of saving costs (effectively closing every second branch of the combined bank in the high street). There is however an important policy constraint. Domestic mergers will not be allowed in concentrated markets for competitive reasons. And as indicated by the CR-5 ratio before, there are some countries that are already very concentrated with CR-5 ratios above 75%. These countries include small countries as well as Greece and the Netherlands.
Table 2 Efficiency and concentration indicators, end-2017
Source: Authors calculations based on ECB Structural Financial Indicators 2018.
Note: The number of branches and employees are calculated per thousand inhabitants. CR-5 measures the share of assets of the five largest banks. “Euro area’ shows the weighted average for the euro area, where total banking assets per country are used as weights.
There are forces for cross-border mergers in the form of credit risk diversification and scaling-up IT investments. Moreover, European policymakers prefer cross-border mergers, as they deepen financial integration (e.g. Nouy 2017).
But it remains to be seen whether these cross-border synergies will be exploited, as earlier consolidation episodes were primarily domestic. Banking policies are not yet fully attuned to the new Banking Union setting. National supervisors still have some, albeit waning, influence. Moreover, deposit insurance is still national, which is important for consumers. Cultural barriers and different tax and legal systems may also hamper cross-border consolidation.
Finally, some of the larger banking markets in Europe, such as Germany, France and Austria, are still relatively inefficient and not (yet) concentrated. There is thus much scope for domestic consolidation.
Authors’ note: The views and opinions expressed in this column are those of the authors, and this article is prepared in their personal capacity.
Campa, J M and I Hernando (2006), “M&As performance in the European financial industry”. Journal of Banking & Finance 30(12): 3367-3392.
Duijm, P and D Schoenmaker (2017), “European Banks Straddling Borders: Risky or Rewarding?”, CEPR Discussion Paper DP12159.
Grosse, R and L G Goldberg (1991), “Foreign bank activity in the United States: An analysis by country of origin”, Journal of Banking & Finance 15(6): 1092-1112.
Langfield, S and M Pagano (2016), “Bank bias in Europe: effects on systemic risk and growth”, Economic Policy 31(85): 51-106.
Nouy, D (2017), “Too much of a good thing? The need for consolidation in the European banking sector”, Speech at the VIII Financial Forum, Madrid, 27 September.
Schoenmaker, D (2015), “The new Banking Union Landscape in Europe: Consolidation Ahead?”, Journal of Financial Perspectives 3(2): 189-201.
Stiroh, K and P Strahan (2003), “Competitive dynamics of deregulation: evidence from U.S. banking”, Journal of Money, Credit, and Banking 35(5): 801–828.