European regulators have called for more cross-border banking mergers, and the bosses of some of the continent's biggest lenders agree with them. But because rules remain unfinished and balance sheets are still fragile, there's little reason to expect a wave of consolidation anytime soon, industry observers agree.
With the eurozone economy strengthening and progress being made in creating a sweeping European banking union, regulators argue that the prospects have improved for cross-border deals, especially in the eurozone. Arguably the most influential in their ranks, ECB supervisory board chair Danièle Nouy, has been one of the strongest voices in favor of consolidation, having said that banking union has "paved the way for cross-border mergers" and that the only thing missing is "brave banks" to explore the opportunities.
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Yet European banking remains largely domestic, with little in the way of true cross-border operation. The CEOs of at least four major European banks have agreed that such consolidation would be beneficial — but not necessarily for their own institutions.
Deutsche Bank AG's John Cryan and UniCredit SpA's Jean-Pierre Mustier, for example, have repeatedly spoken in favor of more M&A, including across borders, but both say their banks are not ready yet because they have unfinished restructuring work to do. BNP Paribas SA' Jean-Laurent Bonnafé said in a recent interview that the French lender would be focusing on its own digital transformation, rather than deals such as the oft-rumored acquisition of Commerzbank AG, while Société Générale SA boss Frédéric Oudéa said recently that cross-border consolidation was likely only in the longer term and after the eurozone banking union is completed.
Factors holding back the M&A tide include limited cost synergies, high execution risk, changing business priorities and a reluctance to add complexity to bank structures. Figures compiled by S&P Global Market Intelligence lay bare the constraints on the market: There were nearly €100 billion of deals in the heart of Europe in 2007, and over €40 billion in 2008, but only once since then have annual aggregate deal values exceeded €10 billion, and 2017's five biggest takeovers in terms of acquired assets were all linked to rescues of failing banks.
Regulatory hurdles persist
"For significant cross-border expansion to happen, some of the regulatory barriers in Europe would have to be reduced," DBRS credit analysts said Feb. 12 in a note on challenges to pan-European banking. A "greater harmonization of regulatory operational requirements, such as banking regulation, deposit insurance and common rules for products and funding," is necessary to drive cross-border M&A, they added.
Uncertainty over regulatory requirements can deter M&A by stopping a prospective buyer from ascertaining the true value of a would-be takeover target, according to Vicente Vázquez Bouza, a partner at global management consulting firm Oliver Wyman.
"This has to do with nonperforming assets on the balance sheet but also with the impacts of Basel IV, IFRS 9 and MREL provisions, which are not yet finalized," he said in an interview.
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"Basel IV" refers to the final measures within the set of post-crisis reforms known as Basel III, including changes to how banks calculate the riskiness of assets. Implementation of the rules is not scheduled until 2022, with a phase-in period running until 2027.
Meanwhile, new accounting rules known as IFRS 9 took effect at the start of 2018 and demand that banks make pre-emptive provisions for bad loans. European lenders also face having to build up stockpiles of debt that can be "bailed in" if they run into trouble, under a regime known as MREL, or the minimum requirement for own funds and eligible liabilities.
Bank boards need clarity about the "deal maths," including the "regulator's ask" on capital, nonperforming loan provisions and internal model changes, UBS equity analysts said in a European banking review at the beginning of 2018. Once they can define these requirements more closely, "material sector consolidation" should follow as banks look to offset "sluggish topline" and "sticky costs," they predicted.
Yet significant work also remains before any European banking union can come to fruition. Policymakers have succeeded in setting up pan-eurozone mechanisms for supervising and resolving banks, but the third pillar, a eurozone deposit guarantee scheme, remains some way off.
Oliver Wyman said in a recent report that regulators pushing for cross-border consolidation as a route to a more integrated European market are getting things the wrong way around.
"Until the European market is truly integrated, banking is likely to continue being a country-driven industry," it wrote, adding that although cross-border deal-making could make sense in some cases, there is little indication that the number of such deals will accelerate in the coming cycle.
Internal obstacles
Apart from regulatory barriers, European banks' lack of appetite is also related to internal issues such as earnings power and future business goals.
"A lot of European banks just shored up their capital positions and currently there is an increasing room for organic growth given the improving economy and bank lending conditions. Hence, [it does not make] too much sense to chase ... more risk growth opportunities via M&A activity," said Gunter Deuber, head of economics, fixed income and foreign-exchange research at Austria's Raiffeisen Bank International.
In addition to increasing complexity and creating extra costs, M&A may also affect lenders' capital position, noted Daniel Regli, vice president of equity research at Switzerland's MainFirst.
"Takeovers above book value create significant goodwill, which is not attributable for [common equity Tier 1] capital, i.e. further deteriorates the capital situation of banks," he said.
"In terms of internal capacity, balance sheet repair remains the primary focus for many banks, and they are cautious about diverting limited internal resource towards M&A activity," said Patrick Sarch, a partner and co-head of the global financial institutions industry group at law firm White & Case.
"Banks also have limited P&L capacity for crystallizing losses, and some have opted to improve noncore assets prior to sale in the hope of improving market conditions. And with the full impact of IFRS 9 not yet clear, valuing noncore assets and selecting appropriate price adjustment mechanisms is challenging," Sarch said in an email.
He added that cross-border deals are likelier in the longer term, "once balance sheets have been further repaired and banks have embedded operational automation." He did project an uptick in domestic bank consolidation in the short term, "with financial sponsors also being increasingly active in competitive auctions."
"We are most likely to see rather small- to mid cap bank mergers, particularly where the acquiring party can buy the bank below book value ... and where there are big economies of scale or synergies," Regli added.


