• The London Finance Journal

An era of consolidation for Eurozone banks

By Yogen Mudgal, BSc Accounting and Finance Student at Warwick Business School

Europe’s Financial Sector is a Pandora’s box. The bloated, inefficient banks on the continent are a living embodiment of the permanent damage the one-two punch of the financial and sovereign debt crises did to Europe. According to the Banker, a trade publication, European lenders have a 6.7% return on capital on average [1], the lowest of any region and less than half of the 14.4% their American counterparts deliver. Several exogenous factors can be blamed for their underperformance ranging from low interest rates to weaker growth. At the heart of the problem, however, is the fact that there are just too many lenders in the Eurozone, each too small and weak [2] to thrive in a low-growth environment on their own.

Even after more than a decade of lay-offs, cost-cuts, divestments, branch closures and killing their risky trading floors, investors keep fleeing European lenders in droves. The largest bank in the Eurozone, BNP Paribas, has a value of $54 billion, merely a sixth of America’s JP Morgan and Chase, valued at $300 billion. It is probably safe to assume that banks have run out of firepower to keep cutting costs and if the European Central Bank won’t let them fail, the only realistic way for them to exit the market is through a series of large mergers. However, European bank mergers fell to their lowest in 2019 thanks to the decade long expansion that kept dragging them along. These ‘zombie’ banks neither have the capacity to invest in new technologies and data capabilities, nor the resilience to deliver the financial stability and strength that businesses across the Eurozone crave.

The tide for consolidation may have turned in 2020, thanks in part to non-performing loans and huge losses from Covid-19 that have piled on many of these lenders. A change in accounting techniques to using ‘badwill’ to offset restructuring charges, the issuance of common debt by the EU and a little nudge from the ECB have also helped. The nearly $5 billion takeover of UBI Banca by Intesa [3] to create the largest domestic bank in Italy was the biggest in Europe since the financial crisis. Another major merger came recently when Spain’s state controlled Bankia merged into its larger rival CaixaBank, yet again creating the country’s largest bank valued at nearly $20 billion and giving taxpayers a stake in a stronger lender. The mega-mergers point to a resurgence in the mood for consolidating the fragmented financial industry in Europe.

The M&A activity thus far seems to be concentrated in the weaker economies of Southern Europe that took a bigger hit from both the financial crisis and the Covid-19 pandemic. While loan losses and rising unemployment could both be important, the major reason for this trend has to do with excessively low valuations. The Financial Times points to balance sheet oddities [4] that have arisen from record low valuations for some European lenders like Italy’s UniCredit, which has surplus capital that exceeds its market value implying that, in theory, the bank could be bought for free. Even a preliminary examination of price-to-book value [5] will reveal that Italian and Spanish banks are most likely to be targets of acquisitions.

While banks across the Mediterranean are in a more dire need for consolidation to bolster their finances, Western and Northern European lenders need to participate in any wave of mergers that sweep the continent or risk being left behind. Germany Commerzbank or ‘Comedy Bank’ as City of London Bankers call it, France’s Société Générale and Netherlands’s ABN AMRO, all fall into that category after delivering abysmal results this year. Average return on capital among Eurozone lenders [4] in 2020 is expected to fall to 2%, only recovering to 5% next year and far lower than 20% before 2008. Activist investor Cerberus tried to engineer a merger of Commerzbank with Deutsche [6] in the past but without success. It might well be time to try again.

While European policymakers and bankers alike might cheer large domestic mergers in the short-term, the ECB has stated in no uncertain terms that it would seek more cross-border transactions. There are clear benefits to having a bank with business diversified across different countries and for policymakers, it might allow a push for further European banking integration. However, its downsides are just as apparent [7]. A large cross-border push doesn’t necessarily help banks achieve greater cost-cutting measures that they clearly need. Moreover, it creates ambiguity if the bank needs a bailout since a common European deposit-insurance scheme doesn’t yet exist to facilitate such a move. Above all, banks need to be optimistic about their future when planning such a transaction; optimism tends to be in short supply in the middle of a recession.

For the first time in living memory, European FIG is in play again. It is unlikely that the Eurozone will ever deliver blockbuster returns like the 2000s, but a less fragmented financial industry would be better suited to keep pace with technological advancements and provide stronger and more stable returns. Consolidated lenders will be better suited to fighting off the current recession and reducing the systematic risk attached with Europe. They still have a long way to go before catching up with their American counterparts, but investors are already beginning to take notice and cautiously walking back into this unloved, underperforming segment of the market.


[1] https://www.economist.com/finance-and-economics/2020/09/10/why-are-european-banks-merging

[2] https://www.ft.com/content/657f198e-cb51-3309-a34b-419c7fcb918a

[3] https://www.reuters.com/article/us-ubi-m-a-intesa-sanpaolo/intesa-secures-full-control-in-takeover-battle-for-ubi-idUSKCN24T0PI

[4] https://www.ft.com/content/266ee6ff-ade1-4934-b97e-c8e8c82b365d

[5] https://www.datawrapper.de/_/0zI9u/

[6] https://www.ft.com/content/ed320081-db1b-4b08-8df7-f3604e5ec419

[7] https://www.bloomberg.com/opinion/articles/2020-09-16/the-eu-needs-banks-to-merge-across-borders?srnd=opinion

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