Too small to succeed

European banking market may see megamergers soon

frankfurt banks skyline, bank consolidation mergers
Ready, set, merge. Source: DPA

Big banks across Europe, particularly in the overbanked markets of Germany and Austria, are likely to start consolidating in the near future, according to new research by UBS.

Many banks need to merge because they are too weak to succeed on their own, especially if the European Central Bank doesn’t start tightening its ultra-easy monetary policy soon, the report said. “We expect a significant increase in merger activity,” UBS analyst Jason Napier and his colleagues wrote in the new study that looks ahead 12 months.

They warned that the banks’ average returns on tangible equity could slump by 25 percent in the coming years unless the ECB starts raising interest rates soon. Added to that, banks face mounting competition in their core lending business, are having to ramp up their IT investments and will likely be saddled with a further tightening of capital requirements.

UBS said the German and Austrian banking markets were overcrowded: Germany has some 1,600 independent banks, compared to 400 each in France and Britain. Even though banks have been stuffing their capital cushions since the financial crisis, some could quickly slide into trouble if market turmoil returns.

UBS said that was particularly true of Deutsche Bank and Commerzbank. The analysts calculated that if the two banks were forced to write down just 2 percent of their assets, they would need to raise capital equal to their entire market cap to replenish their reserves.

UBS has created an index showing where banking consolidation would be most attractive. The index is based on criteria such as how many bank branches a country has relative to the population, what proportion of the sector’s entire assets is owned by the five biggest banks, and the return on equity. They found that Germany and Austria topped the index by a wide margin.

Candidates for consolidation

The ECB has made clear it would welcome consolidation because it would breathe life into the euro zone’s banking union, the plan launched in 2012 to reduce financial risks through common supervision, a privately funded winding-down mechanism for ailing banks and a common bank deposit insurance scheme.

Merger rumors aren’t new. German giants Deutsche Bank and Commerzbank are seen as possible partners, and some believe British banks Barclays and Standard Chartered would make a good fit, as might Italy’s Unicredit and Société Générale of France.

Scores of analysts have checked out the advantages of a merger between Deutsche and Commerzbank. Many have concluded that while a partnership would make sense in the long term because they could save costs and strengthen their market position, they’re still too weak to take such a step right now and the savings wouldn’t counterbalance the weaknesses.

Mergers were somewhat taboo in the aftermath of the financial crisis because regulators and governments feared that creating even bigger banks would merely heighten the bailout risk to taxpayers in the event of a new crisis. But that view is gradually changing. The UBS analysts said regulators have become more supportive of consolidation, thinking that mergers could strengthen the financial system by making banks more profitable.

Michael Maisch is a senior financial correspondent for Handelsblatt in Frankfurt. To contact the author: maisch@handelsblatt.com

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