ECB’s pledge to encourage bank mergers is falling on deaf ears

For sale: a 150-year-old German bank. Bargain price with shares trading at only a fifth of book value. Enviable market position serving hundreds of loyal Mittelstand clients. Fresh management team set to take over. Great fixer-upper potential. Yours for just over €6bn.

Investment bankers are once again speculating about how soon Commerzbank will be in merger talks with a rival. A perennial subject of takeover rumours, the German lender announced this month that its chairman and chief executive were leaving and it was now working on a drastic plan to shed some 10,000 of its 48,000 employees.

Commerzbank’s woes are symptomatic of a European banking sector suffering from bloated costs, squeezed profit margins, fierce competition and rapid digital disruption. In most other industries, this would result in only one thing: takeovers.

The European Central Bank, which oversees the biggest eurozone lenders, stepped up its efforts to encourage more consolidation this month by publishing a guide clarifying how it would go easy on capital requirements in future banking mergers.

The heads of three big eurozone banks contacted by the Financial Times welcomed the ECB’s move, arguing it should clear up doubts created by the cautious way its supervisors have handled previous deals, which may have acted as a deterrent to others.

They pointed to the extra capital the ECB called on Banca Popolare di Milano to raise after its merger with Banco Popolare in 2016 as well as the tougher risk models the supervisor pushed for when Spain’s Banco Santander bought its failing rival Banco Popular a year later.

It is easy to make the case for a shake-up of Europe’s banking sector. Return on equity at the 113 banks the ECB supervises fell last year from 6.2 per cent to 5.2 per cent — far behind most of their US and Asian rivals.

The struggles of European lenders are encapsulated by the gulf between JPMorgan Chase, the biggest US bank with a market capitalisation close to $300bn, and France’s BNP Paribas, the eurozone’s closest rival, which has a valuation almost six times smaller.

ECB officials believe this is at least partly due to Europe being overbanked. However, the number of banks in the EU fell 30 per cent in the decade after the financial crisis to reach 6,000 by 2018, according to the European Banking Federation

That means the region has fewer banks per capita than the US. So the profitability problem does not seem to be caused by the sheer number of lenders — especially as Japan has fewer than 200 and yet they have still struggled with weak profitability for decades.

A better metric of lending capacity could be the number of physical bank branches. The eurozone has 41 bank branches for every 100,000 inhabitants, against only 25 in the US. 

Despite all this, mergers between European banks have steadily dried up from a peak of 218 deals worth $123bn in 2006 to only 77 deals worth a paltry $6bn last year, according to Refinitiv.

While some takeovers — such as Intesa Sanpaolo’s bid for its Italian rival UBI Banca — are still being pursued, even that deal is struggling and most eurozone bank bosses are sceptical that deal flow will increase anytime soon, whatever the ECB promises on capital requirements. 

One of the biggest hurdles bankers face is how to work out what a rival’s lending book is worth when the eurozone is heading for a record postwar recession and the fallout from the coronavirus pandemic threatens to cause a surge in defaults.

In addition, banks now rely more than ever on taxpayer support, both from state loan guarantees and ultra cheap liquidity from central banks. This makes some executives dubious that they could cut enough costs with job losses and branch closures to make a deal work without stirring up a jarring backlash from unions and politicians.

The ECB is forcing banks to conserve capital by stopping them paying dividends or buying back shares. But this restriction is likely to be lifted later this year — at least for the strongest banks — and with share prices trading at big discounts to book value across the sector, buying back shares is likely to be a more attractive use of capital than a risky acquisition.

In any case, bank mergers have a terrible record. Most destroy value and Royal Bank of Scotland’s takeover of its Dutch rival ABN Amro in 2007, which left the British lender needing a £45bn government bailout, still casts a long shadow. 

So most bank bosses, including whoever gets the top job at Commerzbank, will be better off doing the hard work to strip out costs themselves, rather than counting on any ECB-assisted takeover to help them out.