Why has the discussion about the need for bank mergers suddenly reignited? Beyond the emergence of talks between some large European banks, many factors are driving this debate.
Firstly, banking is a sector with increasing returns to scale: an increase in balance sheet size generally allows for improved profitability. Secondly, the profitability of the European banking sector remains insufficient, measured in terms of both ROE and ROA, and falls below market expectations (the cost of capital). Furthermore, the persistence of a low-interest-rate environment—with negative short-term rates and a flat yield curve—confirmed by recent ECB announcements, means that the core of traditional banking business—the capture of cheap liabilities such as transactional deposits and maturity transformation—holds no value, thus hindering profitability improvement.
A third element is increasingly demanding regulation: the new normal for capital is approaching 14% (double the Basel III minimum), and the resolution capital requirement, MREL, stands at around 26%. Increased size facilitates compliance, especially regarding MREL, as it is cheaper and simpler for larger entities to issue the additional resolution capital, the non-preferred senior debt.
In addition to these factors, certain changes in the environment are increasing the advantage of scale. For example, digital transformation has fixed cost elements, meaning that the larger the number of customers, the lower the unit cost required for that digital transformation. The possibility of cloud computing partially mitigates this scale effect, but probably does not eliminate it. Another element that makes scale relevant is sustainable finance: meeting these objectives will require massive investment in information and monitoring systems, which will again constitute a fixed cost, similar to that of digital transformation.
Finally, there is a perception of overcapacity in the European banking sector; that is, there are too many banks in Europe. Regulatory and supervisory authorities frequently remind us of this. Evidently, the situation differs between countries: in Spain, where we have gone from 43 entities to 13, the crisis has been used to rationalize the market, giving us a certain advantage over our European competitors.
Due to all these factors, it is not surprising that the topic of potential mergers emerges every few months, like the Guadiana River. But it is important to understand that not all mergers have the same potential. The truly significant ones, because they would indicate that the Banking Union is functioning, would be cross-border mergers, i.e., those that would lead to pan-European banks. However, the fact that this Banking Union is incomplete—the third pillar, the EDIS or European Deposit Insurance Scheme, is still missing—is a major impediment to these cross-border mergers becoming a reality.
This leaves us with national mergers as the only option in the short term. And here, their rationality is what matters. The Spanish example illustrates the convenience of these national processes as a step to rationalize the banking market. But, as is also our case, not all merger processes are successfully completed. Therefore, we should neither rule out this possibility nor think that a merger is the panacea that will end all the ills of the European banking sector. In other words, mergers must make economic and financial sense; that is, the resulting entity must be better than the two previously existing ones, and those best qualified to assess this are the boards of the affected banks and the market itself, without whose acquiescence no merger is possible. Any intervention by supervisors or governments can prove not only inadequate but reckless. The concept of a national champion, behind which many failures in different sectors are hidden, is especially dangerous.
José María Roldán, Chairman of the Spanish Banking Association
