Any moment now, bankers in Europe expect a wave of cross-border deals among its many universal banks. (1) But no such wave has come yet, and for good reason: because of differences among Europe's national banking markets, regulations, and business cultures, banks would gain smaller synergies from cross-border mergers than from domestic ones. Conditions favoring greater cross-border synergies are beginning to emerge, but shareholders of some European banks are pressing so hard for growth that international mergers may occur before conditions are ideal.
The structure of Europe's banking industry means that one or two mergers will quickly trigger many more. Banks are at risk for getting swept into inopportune deals. Which banks would make the best partners, and what should be their postmerger strategy? To help bank leaders decide, we have imagined what the European banking system might look like in ten or so years, when competitive conditions are more uniform. Europe, we believe, will have three types of banks, all much bigger and more specialized than most of its banks are today, as well as large regulated monopolies providing the necessary infrastructure, such as payment platforms and stock exchanges. A bank that decides now what type it aspires to become will have a better chance of steering its M&A strategy through the next few turbulent years.
The pressure to consolidate
Europe's banking industry, consisting of some 15,000 institutions, remains unusually fragmented (Exhibit 1), though it has been consolidating on the domestic level for some time. Since 1996, Europe's major banks and insurers have been involved in more than 60 mergers and acquisitions, each worth more than $1 billion. Three-quarters of this activity took place within national borders, the rest mainly among players in markets with close cultural ties: Belgium, the Netherlands, and Luxembourg, for example, and the Scandinavian countries. For three reasons, most observers now expect cross-border deals among banks that don't have such links.
First, opportunities for domestic consolidation have been exhausted in several European markets. In the Benelux countries, Ireland, Spain, Sweden, and the United Kingdom, the banking market is already highly concentrated, and some leading banks have reached the maximum market share permitted by antitrust regulations: in Ireland, for instance, the two largest banks manage 80 percent of all current accounts. The less concentrated markets of France, Germany, and Italy still have room for domestic consolidation, but few banks may be available, either because their shares aren't quoted or their ownership structures favor continued independence. German savings banks, owned and operated by regional governments, aren't available, for instance, and Italy's banche popolari give all shareholders one vote each, making it difficult to create broad shareholder support for any effort to influence management in favor of moves to consolidate. Banks in these markets must look abroad to grow by acquisition.
Second, banks are under tremendous pressure to increase their profits. The share prices of Europe's 25 largest banks suggest that their shareholders expect profits to rise by almost 10 percent annually during the next four years. But we estimate that the pool of profits available is likely to grow by only 5 to 6 percent a year, thus leaving an annual gap of 4 to 5 percent, or [euro]90 billion ($82.8 billion), in all over these years. Cost-saving cross-border mergers seem to many banks a tempting way to fill that gap.
Last, financial markets appear to reward scale. The larger European financial institutions generally have higher relative valuations than do midsize institutions. But top banks must go on growing fast to stay in the top league: over the past five to six years, the market capitalization of the ten biggest players has increased, on average, by 20 to 30 percent a year. …