Banking consolidation in Europe: What can we expect?

Fri 24 Sep 2021

The low level of banking consolidation in Europe compared to other countries is raising concerns among the supervisory community in Europe. It is a trend further reinforced after the financial crisis of 2007/2008 that produced a noticeable slowdown in consolidation operations in the EU. So what has been the impact, and what can we expect in the future?

As far as medium to large entities are concerned, out of 30 worldwide, Europe without the UK hosts eight banking groups identified as systemic by the Financial Stability Board, four of which are based in France. Hence, banks in Europe operate in a highly competitive environment, lack economies of scale and have low diversification capabilities. This, in combination with very low interest rates, has had significant profitability consequences. It has also held back the market valuations of EU banks, thus making them easy targets for potential acquirers. Today the market capitalisation of the five largest European banks together – BNPP, Credit Agricole, Santander, Societe Generale and Deutsche Bank, is smaller than that of JPMorgan Chase alone.

Supervisors have raised concerns and made it clear that they would like to see more concentration in the banking sector, particularly in cross-border operations. This would be a way to demonstrate that the banking reforms are viable and that the Banking Union is a reality.

Recently, banking regulators have been more vocal about the advantages of consolidation, and numerous times, the ECB senior management has shared its positive position in this context. However, if consolidations start materialising, the focus should be on the day-to-day management of the new groups rather than the merging operations. Hence, further harmonisation regarding EU rules and banking regulations is needed, and, above all, more trust between the different regulators and supervisors in Europe is required.

The ECB clarifies its position on consolidation

In January this year, the ECB published a guide illustrating its prudential approach to consolidation. In this document, the ECB clarifies that the new entities own funds requirements should not be increased in the first year of the operation and that the Internal Ratings-Based (IRB) model authorisation could be maintained. Moreover, it also allows bad will recognition as own funds of the acquirer, which then will be available to cover expected transactions costs.

Furthermore, both the head of the Single Supervisory Mechanism (SSM) in a speech and a member of the Supervisory Board of the ECB in a blog post explained in detail the approach likely to foster more EU and cross-border operations. 

Day-to-day management is what counts

Despite all these efforts, the possibility to manage the merged entity as a real new group is likely to make the most difference. It is essential to allow free movement of capital and liquidity within the group even when borders are crossed, which is an area where the Banking Union still falls short of its promises. Even if some restrictions can be recognised, for resolvability reasons and between different types of activities in particular, national and local supervisors are always reluctant to allow the free flow of funds, sometimes even in the same country between different entities of the same group. This reduces the potential efficiencies expected from a merger. Today, this legacy of the last financial crisis is impairing the integration of the EU financial system, banks and markets.

Another important roadblock is that, despite all the efforts deployed by the EU Commission for the Banking Union, some essential rules and regulations remain different across European countries. This makes the management of a cross-border banking group less efficient than it should be, particularly for insolvency rules, tax regimes, and everything related to consumer protection or conduct rules.

What to do next?

Improvements are needed from all parties. Supervisors should apply current regulations and try not to impose additional safeguards or, worst, ring-fencing measures. Notably, they should refrain from applying regulations at a sub-consolidated or solo level when not required by EU legislation.

Regulators should continue discussions to regain trust between countries, confirm that consolidation is at the appropriate level of supervision, and validate group support agreements that everyone can trust so that cooperation is effective in a time of crisis.

In addition, more legal harmonisation in the EU is required regarding insolvency rules, corporate and contract law, conduct rules, anti-financial crime and Anti-Money Laundering (AML) issues, and consumer protection. Plus, progress is urgently needed regarding the European Deposit Insurance Scheme (EDIS), the last pillar of the Banking Union. All of this is essential for the emergence and further development of a genuine Capital Markets Union (CMU).

Banks themselves should also improve their behaviour at different levels. First, they should provide supervisors and the market with a credible integration plan and strategy. This should be supported by a viable and attractive business model perspective that would be sustainable in the long term and a clear governance scheme.

Banks should also be very transparent regarding how they are managed, the risks they face, and their source of profitability. They should put a robust governance system in place to reassure supervisors that they would responsibly take advantage of all potential merger benefits. Finally, auditors and advisors also have an essential role in helping banks reach the required level of clarity and efficiency, acting as the trusted interface between banks and their respective supervisors.