Merging Matters

The Dilemma of Europe’s Banks

European Central Bank Supervisory Chief Daniele Nouy Interview
Danièle Nouy, the euro zone's top bank supervisor, said European banks are more resilient and better prepared to deal with another crisis. Source: Bloomberg [M]

Ten years have passed since the financial crisis broke out. The banking business has changed significantly during the past decade. From capital resources to liquidity, from bonuses to dramatically stricter rules of conduct – the entire segment has been transformed. Bank overseers and politicians can slap each other on the back and say with satisfaction how much safer they have made the banks. The only problem is that safe does not mean stable.

European banks are still plagued by a long list of problems. Bad loans of nearly a €1 trillion ($1.07 trillion) are poisoning the balance sheets, operating costs are far too high and earnings way too low. As a result, profitability is feeble.

The reasons for these woes are well known – tougher regulatory control and chronically-low interest rates, while the next big structural change looms with digitalization. The key question is what therapy will put Europe’s banks back on the road to recovery? The chair of the European Central Bank’s supervisory board, Danièle Nouy, is convinced that consolidation of the hopelessly overweight European banking sector is “absolutely necessary.”  She sees mergers and acquisitions as unavoidable.

A market consolidation consists of more than just mergers.

In principle, the woman who oversees the largest financial institutions in the Eurozone is right – but only in principle. Or to quote a song by German rock band Tocotronic: “The idea is good, but the world isn’t ready yet.” This is based more on political factors than financial ones.

First, let’s look at whether mergers and acquisitions make sense as an answer to Europe’s banking woes. The idea of having even larger banks ten years after the financial crisis is definitely a source of concern. But if we take the idea of a European banking union seriously, then sooner or later there will also have to be pan-European banks whose home market is the entire monetary union. There are benefits to size. Operating costs will fall dramatically, and the enormous investment for digitalization will pay off much faster because it will be divided up among more customers.

Yet despite these good arguments, things are not quite so simple. There’s more to consolidation than just mergers. The ECB is convinced of one thing, namely that mergers of weaker banks do not make sense because “two ugly ducklings don’t make a swan,” as Nouy put it a couple of days ago in an interview with Handelsblatt.

Disruptive forces have dominated for so long now that stagnation is seen as a success.

So what will become of ailing banks? In a normal market, they would eventually disappear. But here that doesn’t work, because the banks are so closely networked and play a central distribution role for the rest of the Eurozone economy. To prevent the collapse of the entire system, the taxpayer was forced to save even mid-sized institutions during the financial crisis. And despite efforts to phase out the weaker banks, nothing fundamental has changed. This can be seen in the endless discussions about preventing the venerable Monte dei Paschi di Siena bank in Italy from slowly going under.

But the chances of merging European banks that are too large or too networked to be phased out are not good. Politics is the reason for this – or more precisely, the rise of populism and neo-nationalism. Who seriously believes that the current German government would accept the acquisition of Deutsche Bank by, for instance, a major French bank?

The situation in France is too unstable, and the danger too large that opponents to Europe could come to power, if not in this presidential election, then perhaps in the next. These kinds of considerations may well contradict the teachings of the market economy. But how quickly markets can become politicized was demonstrated during the financial crisis, when international banks left Germany very quickly to return to their home markets.

Ultimately, the financial sector is merely a sad reflection of European unification. Disruptive forces have dominated for so long now that stagnation is seen as a success. Deeper EU integration – even in Europe-friendly Germany – would likely be extremely unpopular and is hardly feasible on a political level. And the same goes for the financial markets. “It’s the economy, stupid.” With this motto, Bill Clinton campaigned against George W.H. Bush in the 1992 presidential campaign. Now, 25 years later, we have to turn this around – it’s political risks that are currently ruling the economy.

 

To contact the author: maisch@handelsblatt.com

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