The aftermath of the recent merger breakdown between Dresdner and Deutsche banks and other, successful acquisitions and get-togethers, will drastically change Europe’s banking landscape.

An event-filled few months in the European playground of banking mergers and acquisitions – as banks find new playmates and fall out with others – marks a change from the 1990s’ theory that bigger must be better to compete effectively.

“We are sceptical about the revenue enhancement from cross-border mergers because we don’t see it at the bottom line,’’ says Sheila Garrard, bank analyst at Lehman Brothers. Investors are also wary, marking HSBC’s shares lower when it bought Crédit Commercial de France.

Although happy with the bank’s strategy of lessening its Asian dependence, the high price paid will mean dilution for shareholders. As for shares in Deutsche Bank and Dresdner Bank – arguably not an in-market merger because the goal was global and their share of the domestic retail market small – both fell almost 20 per cent in a month.

This is not to say that the need for size in an integrating market, as well as increased earnings, is no longer a defining strategy in continental Europe. But full mergers are no longer the Holy Grail. With misgivings about them so pronounced, banks are looking for other ways of achieving those aims. As a result, a slowdown in European bank mergers is on the cards. The reasons are manifold.

First, there is investor scepticism. Stuart Graham, European banking analyst at JP Morgan, says: “Bank managements have assumed the stockmarket would respond well to mega-mergers with cost-cutting potential. Now the stockmarket responds with indifference or negativity.” After the collapse of the German merger, Deutsche Bank’s Rolf Breuer said shareholders should be reassured the bank did not go for deals that would not create value in their favour (see page 18).

Even if this gloss on management failure sounds unconvincing, it at least implies an awareness on the part of the German behemoth that investors will have to be taken into account in future deals. This is underlined by a recent Andersen Consulting report, which doubts the value of global expansion, noting that only 14 of the world’s top 31 financial institutions achieved above market returns over the past decade. Secondly, there are less targets. Take France: after HSBC’s purchase of Crédit Commercial de France (see page 19) there is a dearth of prospects, especially as French regulators are not well inclined towards foreign mergers.

The same can be said in Italy, where regulators are stopping even in-market mergers (see page 16). Thirdly, analysts are calling into question how easy mergers are to implement. They take up a great deal of management time and energy which might be better employed. This is especially true of combinations of investment and commercial banks, where the culture clash can be the kiss of death, or at least of a lingering illness, such as in Deutsche Bank’s 1989 acquisition of Morgan Grenfell, which led to years of underperformance from what had been a star UK investment bank.

Even worse is the current style of deeming all partners equal. This was part of the problem for Dresdner Bank, which presumed the merger with Deutsche Bank was a merger of equals, while Deutsche Bank had very different ideas. But a merger will be drawn out and divisive unless one bank’s working methods and culture are the dominant ones. “Merging a bank is very difficult, more difficult than an acquisition,’’ says Josef Ackerman, head of investment banking at Deutsche Bank, in a classic understatement following the debacle.

The alliance between Spain’s Banco Bilbao Vizcaya Argentaria and Italy’s UniCredito, for example, made sense only if it lead to a full merger, say analysts. It collapsed because the Italians did not want to be the junior partner, and BBVA’s capitalisation would have made this inevitable. “Banks have to rely on a co-operative approach so it suggests the process will be slow and gradual,’’ says Christopher Williams, head of banking analysis at Donaldson Lufkin Jenrette. Benelux and Scandinavia are the only regions where cross-border mergers seem to have worked, due to a combination of history, culture and, perhaps, the awareness that in such small markets, size is crucial.

And then the Internet changes the whole picture. “The jury is out because of the Internet. Do you need to carry on making acquisitions?’’ says Lehman’s Ms Garrard. ABN Amro, for example, is looking to grow its 3 million customer base in Holland to 10 million in the rest of Europe through the Internet, rather than a merger. Whether this is achievable, as every other bank appears to be trying to do the same, is another question. The recent announcement of a merger between Uno-e, the online bank created by Spain’s BBVA and Terra Networks, and first-e group, a subsidiary of Enba, shows that mergers in the online world may not be subject to the same restrictions.

Gerhard Huber, chief executive of the merged unofirst group, says it took Citibank 25 years to establish a global network, while unofirst will do this in a fraction of the time. And the joint venture between HSBC and Merrill Lynch – online banking and broking for the reasonably wealthy – is yet another new model (see page 106). With cross-border mergers losing credibility, the European alliance option touted by Emilio Botín of Banco Santander Central Hispano might gain ground.

He says that “fusing with other European groups is a cock-and-bull story”, but has yet to prove how much more productive alliances are. As with a number of mergers, there seems to be little effect on the bottom line. Take BSCH’s long-standing co-operation with Royal Bank of Scotland. The only material returns come from the appreciation of RBS’s share price, which increases the Spanish bank’s profits because of its shareholding in the Scottish bank. However, more alliances are to be expected, say analysts, because banks fear being left as wallflowers at the dance, and because it is perceived as an easier option than merging.

Also, banks are hopeful that the alliance model can be developed further, to the point of bringing in decent profits. “There is scope for further co-operation agreements, away from purely cost savings, towards establishing a model where there is some kind of sustained comparative advantage,’’ says Bryan Crossley, European banking analyst at ABN Amro. But some large mergers will still take place in Europe, and such obstacles – be they regulators, implementation and shareholders – will be dealt with. Dresdner is an obvious candidate. As it restructures its investment bank, responsible for about half its profits, it still has the problem of too small a share of the German retail market.

The Deutsche merger was aimed at getting rid of that segment; now, it may find itself merging with a rival German bank such Commerzbank or HypoVereinsbank and leaving aside its international ambitions. If nothing else, shareholder Allianz has made it clear its 21.7 per cent stake is up for sale. After all, it was the German insurer that forced Dresdner and Deutsche back to the drawing board after unsuccessful talks between the two banks last August. There are, however, other banks to watch for merger activity.

Crédit Lyonnais is looking for a partner openly, while Lloyds TSB of the UK is considering a bid, probably in Spain or Benelux. Dutch bank ING could be a candidate, after its failed attempt earlier this year to take over CCF. Analysts say there could be a fit between Lloyds and ING because they are both bancassurance groups.

Lloyds’ shareholders, however, may not appreciate a merger with a foreign institution that cannot match the UK bank’s 33 per cent after-tax return. ABN Amro is also said to be a candidate for a merger, despite insisting its Internet strategy is a fine substitute, as is Benelux group Fortis, a high-quality bancassurance institution.

The past few months have injected a much-needed note of realism into bank mergers in Europe. The urge to merge is cooling. Whichever banks merge, they will be a lot less gung ho than a few months ago, while many others will take the alliance option.

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