Björn Ebert, Financial Services Leader at PwC Luxembourg, writes that in 2007, European Banks held eight of the top 10 spots worldwide in terms of total assets, were growing fast and acquiring aggressively.
A not-so-slight disturbance in financial markets the following year, involving the collapse and liquidation of major banks globally, put a swift end to this period of ascendancy. Following more than a decade of an M&A winter in Europe, there are finally signs of the frost thawing as interest in consolidation heats up.
Thus far, activity has been most prominent between European banks domestically, but to really ratchet up their scale banks will have to leave the comfort of their own home and go knocking on their neighbours doors. Although the cross-border merger of major banks is en vogue for both European political and business leaders, the realities of making it happen are less optimistic.
Invisible borders?
For the average Joe, Jean, Juan or Johann, borders do not exist in Europe in many ways. You don’t need a passport to cross them, you don’t need a visa to stay after crossing, you don’t even then need a permit to then start working and begin a whole new life. For banks on the other hand, stark borders in Europe are very much still real. Although significant strides have been made in the European banking union – such as the European Central Bank being granted direct supervisory powers via the Single Supervisory Mechanism and the establishment of the Single Resolution Board for failing banks – major gaps remain.
The lack of a shared European Deposit insurance Scheme (EDIS) is probably the greatest hurdle. Without such a scheme, deposits held by a hypothetical bank in Poland would not be protected under the same bank in the Netherlands. As a result, capital, liquidity and insurance requirements are ring-fenced at the Member State level. Thus, for the hypothetical bank to operate in the Netherlands, it must create a subsidiary which complies with minimum capital requirements in that country in its own right. This squanders much of the economies of scale that should come with a merger.
A myriad of other technical frictions complicate matters too. For instance, while there is no limit to the size of intragroup transactions within a Member State, intragroup exposure and financial transactions between different parts of the same group face limitations across borders. Indeed, cross-border intragroup transactions are limited to 25 per cent of Tier 1 Capital, unless specially exempted. This limits the ability of groups to centrally manage their liquidity and thus optimally allocate their funds.
European policymakers are not blind to these issues. Steps have been and are being taken to further complete the banking union, but competing interests at the Member State level have so far frustrated attempts. For instance, the European Commission’s proposal to waive individual Member State capital requirements for cross-border groups was rejected by Member States over fears of financial instability. The prospects of EDIS look equally bleak, as wealthy northern European states are seemingly unlikely to put their treasuries on the line for the deposits of citizens of poorer eastern and southern states.
Thinking and planning ahead
Given these hurdles and obstacles, European banks that want to go border hopping will need to optimise their strategies within the current rules. Aside from the universally applicable tenets of a good banking merger – revenue synergies, potential to eliminate duplicated tasks etc. – there are some particularities which apply to Europe. The acquiring entity having a pre-existing presence in the target country, counterintuitively to most acquisitions which seek untapped markets, can be a positive factor here. The acquiring entity will already be in compliance with capital requirements in the target country and have some exposure to their laws and regulations. Cultural and linguistic differences need to be given much greater weight in these kinds of cross-border mergers as banking relies so heavily on reputation and trust. The political landscape needs to be carefully considered, more so than with domestic mergers or mergers in other industries. Massive banks have national and strategic importance. Acquiring entities should be prepared for a hostile reaction from the host country of their acquisition target. They should also check back home that their own government does not get nervous about moving jobs and taxes abroad.
Finding the right match in a merger is never easy. Overlapping regulations, byzantine bureaucracy and political gamesmanship certainly do not make it any easier. However, if European banks want to compete globally and at scale, they need to get creative and ambitious. The major European players should be closely watching the eventual outcome of Italian UniCredit’s interest in acquiring German Commerzbank and taking notes on what they should, and shouldn’t, do in their own pan-European expansions.
