European Cross-Border Bank Mergers: Less Compelling After The Pandemic Than Before

Euro area growth: neither very fast nor particularly slowEA cross-border bank M&A could not be the grand idea many were reckoning it was

EU agreement on a EUR €750 Bn pandemic fund boosted market and regulators’ wishes to move towards cross-border consolidation among European banks, especially within the euro area EA). As EU governments come together to help economies during the pandemic, the idea is that transformational cross-border bank M&A will naturally follow. Scenarios have started to be built again about who should be merging with whom to boost efficiency, unlock pockets of untapped profitability and build unassailable market dominance.

But unity around the EU pandemic fund is not about banks. On the contrary, unlike the previous crisis, public funds are being made available directly to economic agents rather than to fund banks. Not least because this time banks don’t need rescuing.

Not surprisingly, no CEOs of large banks are clamouring for their groups to merge with cross-border counterparts within the EA. At least not from a position of strength, and who wants to show weakness if not forced to? Despite the ECB’s encouragement to do just that and despite “nearly here” narratives from bankers, traders, sell-side analysts, consultants and media.

Six months ago, before the pandemic spread across Europe, Scope ratings suggested that EA cross-border bank M&A is not the grand idea many were reckoning it was.In the pandemic age, this should be even more obvious. Bank M&A transactions should be judged bottom-up on their own economic and ESG merits, rather than top-down as a stepping stone to transformational re-landscaping.

In general, the very significant management time and resources spent on questionable cross-border M&As could be used far more efficiently for an accelerated digital re-focus and for ESG retrofitting.

Three essential questions can be asked about the wisdom of cross-border bank M&A:

  1. Is the pandemic strengthening or weakening the argument for cross-border bank consolidation, give the new socio-economic and behavioural dynamics that are emerging?

2. Overall, will cross-border mergers of ‘legacy’ banks still make sense withfast-advancing mobile technologyand capacity, open banking, interlinked platforms, growing reliance on APIs(encouraged by new regulations such as PSD2), and changing customer habits in accessing and using financial products and services?

3. If a cross-border group gets into serious trouble, would the national government of the financially healthier member of the group not prevent it from transferring capital or liquidity to the weaker member in another country; BRRD and Single Resolution Mechanism (SRM) notwithstanding?

Why are EA supervisors encouraging cross-border M&A Banks supervisors have historically been less at ease with large banking groups, especially those with complex structures. When the last crisis broke out, a common criticism from supervisors was that larger groups were most likely to trigger systemic risk. But the post-crisis years have seen theopposite: further systemic concentration through the emergence of larger groups, mostly through domestic consolidation. In Spain, Benelux, UK, Ireland, Portugal, among Germany’s Landesbanken, and elsewhere.

Regulatory thinking has adjusted to the new reality, and now rightly encourages further domestic consolidation, especially among second-tier banks.

On a pan-EA scale, a key point on the regulatory agenda is to strengthen the single market. An effective way to strengthen pan-EA supervision and avoid excessivenational-government interference in large banks is to multiply cross-border groups with interlinked business lines.

The argument that large pan-EA champions are more efficient and profitable than national members on their own is less compelling. Especially when the expectation is that through cross-border M&A banks could boost their returns to match and then exceed their cost of capital. Efficiency gains through cost-cutting as a result of a cross-border merger may have more ominousside effects due to inevitable ‘foreigners are slicing us up’ implications. It is no surprise that there is less harmony and shared business logic in the larger world than within EU and EA institutional bodies.

Cross-border M&A may not be a compelling proposition at this time

For incumbent banks,by far the main competitive challenge but also a compelling opportunitylies in the digital sphere. The digital leap has been driving–and in turn is being driven–by changes in customer behaviour. Rather than buying or merging with the distribution and back-office infrastructure of another legacy bank in a different country –thereby significantly limiting any synergies afforded by in-market M&A (a current example is the Intesa-UBI transaction) –banks would be better off investing in digital capacity; buying fintechs, creating theirown, or parterning with BigTech.

Through the implementation of PSD2 (the EU’s Revised Payment Services Directive), accessing new customers and segments can be achieved more cheaply and quickly through open APIs and other digital platforms. Also, products and services can be replicated through technologmore easily than in the past without merging with or buying another factory. Through commoditisation, the unassailable advantage of developing and marketing a financial product of wide usage is very much a thing of the past.

Post-pandemic dynamics

If anything, this trend is even more compelling in the new world shaped by Covid-19.Banks’ reliance on digital has increased markedly and the clock will not turn back. Most employees are working remotely using banks’digital infrastructures.Once the virus is undercontrol, there will be a re-balancingtowards more office-based work but not to the same extent as pre-pandemic. Many bank employees have discovered the advantages of working from home andwant to keep it that way.

This suggests that the shape of work will partially changeand that the old back/middle/front-office realities are up for a structural shake-up. This is a massive challenge for banksand entering into a transformational legacy M&A in the middle of it is unnecessarily risky.

Equally important: even after the end of lockdowns bank customers will rely increasingly on digital channels and platforms.Unless these channels turn out to be unreliable and/orslow (less likely as digital capacity and speedevolve) digital customers aren’t about to start walking back to branches. In general, physical bank outlets have been used in larger numbers by middle-aged and elderly customers, many of whom have had the time during lockdown to familiarise themselves with digital channelsand who would be eager to avoid spending too much time in enclosed public spaces like bank branches.

This trend also suggests that more than ever banks need to re-think and reduce their branch networks. While in-market consolidation can be an effective avenue to achieve this, cross-border M&A is likely to be much less so.Again, it may be difficult politically to justify any serious cost-cutting involving staff reductionsas the result of the merger with a potentially more efficient foreign bank.

Investment vs retail banking

It is generally accepted that European banks engaged in investment banking (IB) need to build more muscle to compete against the five US giants. But the major European IB firms –Barclays, HSBC, Credit Suisse, UBS, BNP Paribas, Societe Generale, Credit Agricole, and to a lesser extent Deutsche Bank –also run and generate substantial earnings from large domestic and in some cases foreign retail and commercial banking operations: A cross-border merger between any of these groups, as implausible as it is, might make their IB activities more efficient (though not necessarily less risky), but would add few synergies to their retail and commercial banking networks. Unlike IB, retail and commercial banking has remained largely a national affair, and there is little evidence from the activities of the existing cross-border groups that this will radically change. To reach critical scale in IB, it is more advisable that large European players start considering partnerships and joint ventures rather than the unlikely and undesirable scenario of merging among themselves. With the opportunities and needs in the post-pandemic world, this could be a winning strategy for some, as so much willneed to be restored and rebuilt.But the mind of top managementis not there yet. Non-financial risks trickier in cross-border M&A Prudential and financial metrics are relatively transparent and can be assessed with some confidence by parties to a merger(and by external analysts).However, growing areas of non-financial risk, such as money laundering/misconduct, cyber risk, or climate-change, are relatively opaque and more difficult to gauge. A cautious bank should hesitate before walking into a mega-transaction without reasonable comfort about these risks vis-à-vis the merger party. This should be a growing reason to derail future cross-border combinations.