Merger revolution sweeps banking

Date: 24/06/1999

By Bruce Barnard
Europe's banks are on a roller-coaster ride as a wave of consolidation engulfs the industry.

Even as they were buffeted by the Asian financial crisis, Russia's default and Brazil's close shave with bankruptcy last year, the continent's leading banks were simultaneously preparing for the launch of the euro and hatching mega-mergers and take-overs to keep pace with their US rivals in the race for global dominance.

These deals are only the start of a revolution in global financial services. "Unprecedented consolidations and realignments threaten to reshape the industry by the year 2003," warns US-based consultancy AT Kearney.

The market will change dramatically in the coming five years, according to Kearney. The 50 largest financial services institutions will control 40% of financial assets in Organisation for Economic Cooperation and Development countries, compared with 100 controlling 40% in 1997. The average market capitalisation of the world's top ten financial institutions will be between €150 and €200 billion, compared to €50-70 billion in 1997. The leading companies will need to achieve annual revenue growth of 20% to 25% to maintain their positions, compared to average current growth rates of 10% to 15%.

Most market-watchers reckon that European banking will be dominated by a dozen players within ten years. The British, Dutch and Swiss have booked their places at the table and are about to be joined by the Germans and French.

The consolidation of European banking gathered momentum with the €80-billion merger of Swiss Banking Corporation and its domestic rival UBS. By mid-1998, when the launch of the single currency was assured, every large bank was eyeing potential targets and seeking likely allies.

But it took the arrival of the euro to unleash a wave of mergers and acquisitions from the Nordic region to the Iberian peninsular. Some were totally unexpected, like the €10.97-billion take-over by Spain's Banco Santander of Banco Central Hispanoamericano, creating one of Europe's top ten banks and the biggest foreign operator in Latin America.

Many of the deals were knee-jerk, defensive reactions to the consolidation of the US banking system and the dominance of American investment banks in Europe. Most seem to lack a clear strategy, with size for size's sake seeming to be the overriding motive, and few appear to envisage the bank closures and job losses which have characterised the cost-cutting shake-out across the Atlantic.

Other deals, however, have much more far-reaching consequences, not just for banking but for the entire business culture.

Banque Nationale de Paris's €37-billion unwanted double-barrel bid for its two domestic rivals, Société Générale and Paribas, which were plotting their own friendly merger, marked the final surrender to Anglo-Saxon practices of a country where hostile take-overs are a rarity.

The inability of the authorities to influence events was a further reminder that there is no escape for France from globalisation. Only a few months previously, Deutsche Bank was made to understand that its interest in Crédit Lyonnais and Société Générale was not welcome. But the government can take solace in the fact that if the bid is successful, France would boast the first bank in the world with more than €970 billion - $1 trillion - in assets, toppling Deutsche Bank, UBS and Citigroup off their perches.

Deutsche Bank is still celebrating the official completion in early June of its €9.80-billion take-over of Bankers Trust, the US investment bank, which has created a universal bank with assets of €800-850 billion.

This has put pressure on its arch domestic rival, Dresdner Bank, to pull off a US deal. Talks on acquiring Paine Webber fell through last

year, shifting the focus to JP Morgan, Lehman Brothers and Donaldson, Lufkin & Jenrette.

An American scalp may be the glittering prize for banks with global ambitions, but the US market is littered with European casualties. Crédit Suisse moved into US investment banking in 1978, but it took a decade to turn CSFB into a significant player. The UK's Midland Bank, which is now part of HSBC, botched its take-over of Crocker National and offloaded it at a big loss to Wells Fargo.

Deutsche's eye-catching acquisition of Bankers Trust has only partly compensated for a chequered history in the US: its first target reportedly was J P Morgan. It is also reckoned to have spent around €3 billion building up an American investment banking presence from scratch with mixed results marked by desertions by key staff apparently alienated by its attempt to Germanise its US operations.

But Deutsche Bank must be present in the US if it is serious about being a global investment bank. Even its home market is under threat from American banks. When Daimler Benz wanted advice on its take-over of Chrysler, it turned to Goldman Sachs, not Deutsche Bank, even though the latter was its biggest shareholder with more than 21% of its stock.

European banks which avoid Wall Street have prospered in the US: the leading Dutch bank ABN-AMRO is a major player in Chicago and Michigan after a series of multi-billion-euro acquisitions.

Ironically, while Europe's big banks build global operations, they remain relatively small players at home, both in European and national markets.

Germany's 'big three' - Deutsche Bank, Dresdner Bank and Commerzbank - have only 17% of the domestic market between them, with the remainder split evenly between some 2,000 cooperative banks, public savings banks and the state-owned Landesbanken .

Even the biggest, most outward-looking banks lack pan-European clout. ABN-AMRO controls half of its domestic Dutch market, but only 2% of deposits in the 11-nation euro zone, while Deutsche Bank has just 3%.

In contrast, the domestic market share of the top five US banks soared from 12% to 22% last year following a wave of consolidation which has continued in 1999.

In Europe, which has twice as many bank branches per head as the US, fiscal, regulatory and cultural differences will stunt the development of a fully integrated banking market. Some banks are, however, pushing ahead with plans to create a pan-European network: Deutsche Bank has strategic banking stakes in Spain, Italy and Greece alongside ownership of a British investment bank, Morgan Grenfell.

Meanwhile, a yawning performance gap separates European banks.

The UK's Lloyds TSB is probably the most profitable bank in the world, sustaining an average annual 30% rate of return on equity during the past five years. This compares with an average of 18-20% in the UK as a whole, 20% in Spain and Sweden, 12% in France and under 10% in Germany, where large public banking sectors distort competition.

This means that ambitious banks must move abroad to grow.

European banks, especially those in the euro zone, appear to be less enthusiastic about consolidation as investors raise uncomfortable questions about the logic behind the recent frantic activity.

The fact that euro-zone banking shares are underperforming in the region's market and are around 15% below their level on the eve of the Russian financial crisis underlines investors' doubts.

This outbreak of nerves has already slowed the pace of mergers, even in markets such as Italy which are prime candidates for consolidation: Banca di Roma has rebuffed overtures from San-Paolo-IMI and Mediobanca blocked a planned alliance between UniCredito Italiano and Banca Commerciale Italiana.

But there is no escape for underperforming banks. The arrival of the euro has simultaneously made the entire industry's costs more transparent and threatens to wipe out a large slice of foreign exchange dealing, a key source of revenue.

"Consolidation in Europe is not only an economic necessity but, in many cases, the only chance for survival," insists AT Kearney.

Article forms part of a survey 'Financial Services'.