By Joseph Moss, International Banker
On July 1, 2020, the European Central Bank (ECB) published a guide covering how it would handle banking-sector consolidation in the eurozone from a supervisory perspective to encourage more M&A (mergers and acquisitions) activity throughout the region. Its release strongly suggests that while most European banks may handle the impact of the COVID-19 pandemic satisfactorily, deeper long-term systemic problems remain.
Over the last decade or so, Europe’s banking industry has changed into one that is a far cry from the one that operated before the 2008 global financial crisis (GFC). Since then, regulators have required banks to strengthen their balance sheets significantly, particularly regarding liquidity, quality and amount of capital, and funding choices. But in more recent times, banks have increasingly been unable to meet their capital costs, which has led to growing concerns over their long-term sustainability. Greater competition from the fintech (financial technology) sector and, in some cases, overcapacity has eroded banking-sector profitability, with ultra-low interest rates stemming from the COVID-19 pandemic’s economic fallout only compounding matters more recently. Indeed, the end of the first half of 2020 saw European Union (EU) banks report an average return on assets of just 0.03 percent, with more than half of eurozone banks registering a return on assets of 0.1 percent or less. And looking forward, it seems conditions are unlikely to improve, with Citigroup’s market strategists recently warning that the return on tangible equity (ROTE) for banks in the EU will reach only seven next year, which falls below the cost of capital.
As such, the ECB seems to be showing more openness towards consolidation as a solution for the banking sector’s woes, with many pointing to M&A as a way to control costs, realise more economies of scale and ultimately achieve higher profitability and more robust earnings. And while weak capital, poor equity valuations and a string of governance issues have meant that consolidation has been rather subdued to date, the ECB’s guidance gives renewed hope that more consolidation may well be pushed through from a regulatory standpoint. Indeed, the central bank has acknowledged that consolidation, if well structured and suitably executed, can alleviate the profitability challenges and overcapacity issues that have plagued the sector for many years.
Specifically, the guide outlines how the ECB treats three main aspects of banking consolidation: setting capital requirements and guidance, dealing with “bad will” and using internal models by newly consolidated entities. It also highlights how the restructuring of banking activities can bring benefits, although they will have to be weighed against potential risks. “Indeed, when well designed and executed, business combinations can contribute to the overall financial soundness of the banking system and help preserve the diversity of different business models,” the guide notes. It also emphasises that consolidation can address such longstanding issues as low profitability and overcapacity.
“I hope the ECB guide will pave the way for an accelerated process towards a long-awaited European banking consolidation,” Anthony Kruizinga, banking and capital markets specialist at PricewaterhouseCoopers (PwC), stated in October. “This is necessary in order to create stronger and more sustainable banks that will be able to compete with large US and Asian banks for the battle of the continental European market. Banks also need to achieve economies of scale and have adequate tools to address other new challenges, such as the digitalisation of the banking sector.” Citigroup has also stated that consolidation could be a way for European banks to improve their profitability and be better positioned against the potential challenges from COVID-19.
Thankfully, this consolidation drive has already commenced, with Europe having experienced a marked uptick in important M&A deals during 2020. According to Bloomberg, the region’s banking industry’s M&A volumes were up 27 percent year-on-year to $37 billion between the start of July and mid-December. Spain’s banking sector has been among the most active, with CaixaBank SA announcing its €4.3-billion acquisition of Bankia SA in September to create the country’s biggest lender with more than €650 billion in assets and a total market capitalization of more than €170 billion, as well as Banco Bilbao Vizcaya Argentaria SA selling its US assets to PNC Financial Services Group for $11.6 billion.
And it would seem that this is just the beginning, and more is to come in 2021. “Before 2022 we expect four to six large deals in the space,” Giorgio Cocini, co-head of the financial institutions group for Europe, the Middle East and Africa at Bank of America, told Bloomberg in December, adding that there will also hopefully be “a pan-European one”. Notable consolidation activity could materialise for some of the region’s biggest lenders, including possible mergers between Swiss banking giants Credit Suisse Group and UBS Group and France’s BNP Paribas and Société Générale S.A. And in Italy, the Finance Ministry has stepped up its efforts to unload its 64-percent stake in Banca Monte dei Paschi di Siena, with UniCredit among the likeliest buyers. Citigroup expects Spain, Italy and the United Kingdom to experience particularly pronounced consolidation activity over the coming months. And perhaps somewhat surprisingly, traditional lenders are not the only ones that look set to experience a wave of consolidation—after a disappointing 2020, there is a growing likelihood that Europe’s digital lenders will also succumb to a flurry of M&A activity.
Consolidation is also supported more vociferously by politicians and regulatory authorities that frequently champion the need for healthy European banking leaders to emerge to boost the eurozone economy. In Germany, with Deutsche Bank showing some clear signs of a recovery in recent months, its chief executive officer, Christian Sewing, believes the lender is now in a position to play a crucial role in banking-sector consolidation within Europe. “We continue to do better and therefore meet the criteria to sit at the table when it comes to a possible consolidation of the European banks—and not just as a junior partner,” Sewing told Welt am Sonntag. Sewing aims to effect a comprehensive transformation in the bank’s fortunes during the coming year after several years of underwhelming earnings performance and poor profitability. And although a potential merger with Germany’s number-two lender Commerzbank AG collapsed in 2019 after the two entities failed to agree on integrating their IT (information technology) and bank offices, Deutsche Bank, nonetheless, remains open to a potential acquisition.
Cross-border deals, meanwhile, may well be more difficult to come by, with ING recently suggesting that they are more likely to involve large banks targeting new markets and pursuing greater size, particularly as they face tougher competition from the tech sector. “A bank could acquire an existing player with a strong enough market position in a given country to increase economies of scale and geographical diversification, among other things,” the Dutch bank stated. “Or perhaps banks with matching geographical profiles could merge to increase their combined market share, find synergies and improve efficiency.” Other drivers of cross-border merger activity, according to ING, include acquiring better digital capabilities, extending customer bases, improving product diversification and enhancing asset and liability matches.
If anything does eventually come of the aforementioned consolidation targets, however, one is likely to observe expedited closures of bank branches across the region as the pandemic continues to push customers more decisively towards the digital route. Deutsche Bank expects to shutter 100 branches across Germany, while Commerzbank will permanently close 200 of around 1,000 branches shut “temporarily” during the pandemic. In August, Credit Suisse also announced the end of 37 branches by the end of 2020, bringing its number of branches in Switzerland down from 146 to 109. A report by Kearney, meanwhile, projects a closure rate of 25 percent of bank branches—equivalent to 40,000 in total—across Europe over the next three years, with the consulting firm also expecting around 70 percent of all account openings, deposits, and consumer loan applications to take place digitally during this period.