Lack of a fully fungible capital and liquidity regime may limit large-scale mergers between eurozone countries.
Fitch Ratings anticipates significant obstacles to the European Central Bank’s (ECB) aim to encourage cross-border consolidation in the eurozone banking sector to boost resilience.
“We believe the lack of a fully fungible capital and liquidity regime and a single deposit insurance scheme across the eurozone continue to limit the attractiveness of large-scale mergers,” the rating agency said in a note.
Fitch cited a poll taken at its recent credit outlook conference where only 5% of respondents anticipated cross-border mergers or regional expansion drives to be a key feature of European banking consolidation in 2021.
The ECB recently published a guide to its supervisory approach to consolidation in the eurozone banking sector, following speeches from members of its leadership calling for more pan-eurozone banks.
The central bank argues that consolidation will make the sector more diversified, resilient and profitable because of economies of scale.
Different national markets
Another rating agency, Scope Ratings also expressed doubts about any large-scale mergers happening soon because of the vast differences in national markets.
Scope argues consolidation within eurozone member states is more likely and so far most consolidations have been domestic. Spain has seen a flurry of merger activity over the past year. In December, Spanish banks Unicaja and Liberbank announced plans to create an institution holding €110bn in assets, creating the country’s fifth-largest lender.
Eurozone banks have weaker profitability and returns on equity than most global peers
This move follows the merger last year of state-owned Bankia and CaixaBank to create Spain’s largest bank in terms of customer numbers.
Despite these domestic Spanish tie-ups, there remain deep-seated problems with eurozone banks.
On average, eurozone lenders have weaker profitability and returns on equity than most global peers, an issue made worse by the recent pandemic-induced economic shock.
European Banking Authority data shows that the average return on equity of EU banks was just 0.5% in the first half of 2020, down from about 7% the same time a year before. By contrast, the numbers for US banks stood at 3% and 12% respectively, according to the Federal Reserve Bank of Saint Louis.
Supervisory approach
The ECB consulted on its supervisory approach to bank mergers and acquisitions in July 2020. The ECB is prepared to recognise verified accounting ‘badwill’ to contribute towards post-merger common equity Tier 1 (CET1) capital.
“As many listed western-European banking groups trade below book value, potential badwill creation through low purchase prices would support post-acquisition CET1 ratios,” Fitch Ratings said, adding that the ECB nonetheless expects banks to deduct additional provisioning for non-performing loans as well as transaction or integration costs from the badwill. It also asks for the associated capital gain not to be distributed until integration of the businesses is firmly established.
If the ECB anticipates that a cross-border eurozone bank merger will lead to greater resilience or a reduced risk profile, it is willing to show some temporary flexibility on Pillar 2 guidance around its supervisory review covering areas such as operational risk and liquidity, for example.
It will even allow newly-merged banks to temporarily use existing internal models to calculate capital requirements for newly acquired assets, or assets transferred to a different legal entity. Normally, the ECB’s approval to use internal models is not transferable to another legal entity.
A version of this article first appeared in The Banker's sister publication Global Risk Regulator.
