Big Banks Grow Bigger and Smaller Banks Disappear, As Mergers Return to Crisis-Hit Eurozone

A fresh wave of bank failures and mergers are set to trigger a new round of consolidation of the Eurozone’s banking system.

The ECB has a dream: to unleash a whirlwind of consolidation across the Eurozone’s banking system, out of which will arise a new breed of giant trans-European bank. The operations of these new mega-lenders will straddle the continent, thus helping to finally convert the Eurozone into a genuine single financial market. Their gargantuan size will allow them to finally compete with their mega-bank rivals from the U.S. and China. At least that’s the theory. As an added bonus, these mega-bank deals can serve as handy cover for stealth recapitalisations of failed or failing banks. 

This dream is not new, of course. One of the crowning goals of Europe’s half-baked Banking Union, initiated in 2014, was to enhance dramatically the concentration and consolidation of the banking sector. The number of banks in Europe has been falling steadily since the Global Financial Crisis. Many small and mid-sized lenders have fallen by the wayside, victims of their own bad lending practices, excessive regulatory burdens and/or the EU’s zero and negative interest rates, which have obliterated banks’ interest margins. By 2018, there were 5,698 banks in the EU, 30% fewer than in 2008.

Thinning the Herd

The ECB could sharply accelerate this trend if it proceeds with its proposal to introduce a central bank digital currency (CBDC) at some undefined moment in the future. Some economists, including the authors of a new report published by the Federal Reserve Bank of Philadelphia, have warned that CBDCs could end up significantly reducing or even eliminating the raison d’être of commercial banks, as the central bank “arises as a deposit monopolist, attracting all deposits away from the commercial banking sector.” 

Before that happens, the massive tsunami of defaulting loans and cascading losses that is fast approaching as debt holidays come to an end could provide an opportunity in the interim to thin the herd. A fresh round of bank failures and mergers will once again serve as a launchpad for further consolidation. As the ultimate decider of which struggling banks get to live or die and which lucky competitor gets to pick up the sanitised pieces afterwards, the ECB’s Supervisory Board will be in an ideal position to drive this type of consolidation forward.

European Central Bank supervisor Andrea Enria said the coronavirus crisis would create room for mergers and acquisitions, both domestically and cross-border, as it pummels banks’ profitability. To get the ball rolling, the central bank has already lowered the bar for mergers, in the hope of encouraging banks to buy up rivals. As Reuters reported in July, merged entities won’t necessarily have to raise extra capital and will be allowed to use their own accounting models as well as any “badwill” — a paper profit that occurs when an asset is bought below its book value.

Mergers Have Already Begun in Italy and Spain 

In September, Intesa Sao Paolo bought out UBI Banca in a hostile takeover to create Italy’s largest bank by assets and the eurozone’s second-biggest by market capitalization. That wasn’t enough to earn Intesa a place on the Financial Stability Board’s hallowed list of “Global Systemically Important Banks” (G-SIBs). In total, there are 30 G-SIBs, of which four are French (BNP Paribas, Groupe BPCE, Groupe Crédit Agricole and Société Générale), two are British (HSBC and Barclays) and two are Swiss (Credit Suisse and UBS). Germany (Deutsche Bank), the Netherlands (ING), Spain (Santander) and Italy (Unicredit) each have one G-SIB a piece.

Unicredit is also likely to grow in size in the near future, once it is offered enough taxpayer-funded inducements, including generous fiscal credits, to make it worth its while to absorb the perennially troubled state-owned lender Monte dei Paschi di Siena (MPS). Given that MPS is still under-capitalized and its books are still crammed full with toxic assets at varying stages of decomposition, no other bank wants it.

Spain’s third-largest lender, Caixabank, recently tied the knot with majority state-owned Bankia, itself the product of a merger of seven failing savings banks, to spawn a new domestic market leader that will account for between 25% and 30% of the Spanish domestic market’s loans, deposits and mutual funds. The operation is yet to receive the blessing of the two banks’ shareholders, but that should be a formality. The shareholders include Spanish taxpayers, who have recouped a measly €3 billion of the €24 billion of the public funds used to bail out Bankia.

In France, rumours swirled briefly in October that BNP Paribas may buy out its struggling fellow G-SIB Société Générale, then quickly died down. Credit Agricole last week launched a bid to take over small Italian lender Credito Valtellinese SpA, which will enable the French giant to further expand its Italian operations. Meanwhile, in Switzerland there has even been talk of the two largest lenders, UBS and Credit Suisse, both of them G-SIBs, tying the knot.

What isn’t being talked about is the potential impact further consolidation of the banking sector is likely to have on the cost and quality of banking services. Reduced competition is likely to lead to higher bank fees and charges. Nor is there any discussion of the moral hazards or systemic risks these operations would store up for the future. Lest we forget, many of Europe’s worst banking collapses, from RBS to MPS, involved lenders that made big cross-border acquisitions just before the last crisis.

Also, the loss of small banks means the loss of the vital banking services they provide to small businesses and communities. More than a quarter (28%) of Europe’s banks are in Germany. They include over a thousand local savings banks, cooperative lenders and mutual associations that play a vital role in funding local communities as well as the small and medium-size firms of Germany’s Mittelstand. As the economist Richard Werner has said, none of them needed a public bailout in the last crisis. But their number is shrinking, largely due to pressure stemming from the ECB’s negative interest rates and tighter banking regulation such as Basel III.  

Limits to Consolidation

Last year, the failed merger of Germany’s two largest but troubled lenders, Deutsche Bank and Commerzbank, showed there are limits to consolidation. In the end, the banks abandoned the talks, saying the deal would have been too risky. The proposed merger also faced stiff opposition from unions and major shareholders of the two banks, amid concerns about execution risks, mass redundancies and restructuring costs.

In the meantime, the ECB’s dream of cross-border mergers giving rise to a new breed of trans-European super-bank remains elusive, in large part due to the following four impediments:

1. The sorry state of some of Europe’s biggest banks. Despite tighter capital requirements, some large European banks pose as big a risk to the financial system as they did on the eve of the last crisis, in 2008. One major difference is that now they’re hooked on the ECB’s myriad monetary welfare schemes (LTRO, TLTRO I and II…), which have managed to keep them afloat even as the ECB’s monetary policy constricts their lending margins. Since they have no idea just how serious their rival institutions’ problems are, many banks are understandably reluctant to buy or merge with them.

2. Even if they wanted to, most banks don’t have the money to splash out on cross-border acquisitions. Europe’s banking sector never really recovered from its previous two crises — the Global Financial Crisis followed by the Euro Debt Crisis. As the author, financial journalist and former investment banker Nomi Prins said in a 2015 interview with Dutch media group VPRO, “in Europe there still exist massive amounts of trades (on banks’ balance sheets) that are underwater and going wrong every day.”

Granted, since then many of those impaired assets have been bundled up into securities, some partly government backed, and sold to investors. Thanks largely to that, the EU’s non-performing loan (NPL) ratio has fallen by half since 2015, from 6% to 3%. In Italy, it’s down to 7.2%, which is still dangerously high but nonetheless a big improvement on the historic high of 17% in 2015.

But investors remain wary, especially with a new wave of NPLs expected to hit some time next year. Even after two weeks of sharp rises, on the back of vaccine-fuelled optimism, the Stoxx 600 Banks index, which covers major European banks, is still down 23% YTD and 80% from its historic peak in May 2007.

3. Industry fragmentation. The Eurozone is still very much a working progress. When it comes to banking and finance, it is extremely fragmented. It has no central treasury, no finance minister and no comprehensive banking union. Rules on banking can still differ from one country to another. There are also limits on moving money between countries and still no sign of a common deposit insurance, all of which makes cross-border deals more difficult. 

4. IT incompatibility. In the US, some bank mergers have been nixed due to IT incompatibility. In the EU, this is no less important an issue, particularly for cross-border mergers, yet it often gets overlooked in the financial press (Naked Capitalism being a rare exception). There is no better example of just how badly things can go wrong when two banks try — but fail — to link up their IT systems than Banco Sabadell’s catastrophic bungling of its UK subsidiary TSB’s online platform changeover, which created nightmares for TSB customers and has brought the Spanish lender to the brink of collapse. That will be the subject of my next article, which will be coming very shortly.

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