What will happen to Europe’s weakest banks?

In answer to yesterday’s question about How many banks are driving blind?, it’s about 20 percent.

This is because, as mentioned earlier, I’ve been involved in a great deal of debate this week about liquidity and leverage ratios and the quality of data, the divide between Europe’s regulators and the banking system and the challenges of conflicting and opposing regulations overall.

One of the things that rumbles in the background of all of this is the European stress tests of the mainstream banks. 

In case you haven’t heard, the European Central Bank is going to be reviewing the complete balance sheet structures of the largest 118 European banks.  Some banks have been exempted from the analysis as they have restructuring plans taking place already, but most will be ripped apart to see the quality of their loan book.

In reality, when we talk about transparency, it means that banks’ will be flying naked after the autumn review is released.  The quality of their assets, balance sheets, investment portfolio, risk appetite, leverage and liquidity will be laid bare for all to see.  Or that is the concern of many.

The concern is that, if this is the case, there will be two immediate impacts:

1)      A spate of mergers and acquisitions across Europe as banks see easy pickings to gain pan-European coverage by swallowing up the smaller and weaker domestic players in countries where they have minimal or no presence; and

2)      A flight to safety as corporate and high net worth clients of the smaller and weaker domestic and regional players see exposures that they have not seen before, and hence raise concerns about their banks’ stability.

These may be false concerns, as there has been little to no cross-border mergers amongst Europe’s banks over the past decades.  Sure, we have seen a Spanish Bank – Santander – enter the UK market but, apart from this lone example, I cannot cite many others.  Even the RBS takeover of ABN left most of ABN’s retail operations in the Netherlands in the hands of the Dutch.

When there have been attempts at cross-border integration it often has resulted in dispute or blockage.  Take HVB’s takeover of Unicredit by way of example.  The deal would have given the German bank a strong footprint in Poland, where Unicredit had a significant retail presence, so the deal was only completed when HVB agreed to sell-off half of Unicredit’s branches.

Or take HSBC’s entry into France.  After the takeover of Crédit Commercial de France (CCF) in 2000, HSBC has struggled for years with integration as French customers want to deal with French banks, and so rebranding the bank as anything other than French would sign the death-knell for this business.

In fact, most cross—border M&A would create havoc amongst the member state affiliations of the EU.  I always remember Jyske Bank in Denmark using the threat of a takeover by an arrogant Norwegian bank as a way to spur their staff into thinking outside the box in order to avoid such a fate.  “This would be a disaster”, as many would say.

This is why the only really strong  pan-European bank activity we’ve seen is in the Baltics, Central and Eastern Europe, where the creation of banking after the collapse of the Berlin Wall meant that strong balance sheet banks from Austria such as Erste and Raffiessen could rapidly gain a foothold in most of the former Eastern bloc economies.

So I don’t’ see the M&A opportunity arising as rapidly as some may think due to the key blocks of culture and integration.  Most banks do not want to be acquired and, even if they are, most banks’ customers do not want to deal with foreign owners (note: Icesave in the UK).

If the M&A threat does not emerge, what does this mean for the other side of the equation: the flight to safety?

Unfortunately for the weak balance sheet and undercapitalised European banks, it means that they will end up being subsumed.

Banks will disappear.

There are over 9,000 banks in Europe, and that’s far too many for 27 (or 31 if you want to include the EEA and Switzerland) countries or states if you prefer.

In the United States of Europe, about 3,000 banks would be more than enough, and some might even say 300 would do.

If that’s the case, expect the gorillas in each country to get bigger as they are forced to swallow the weaker players by their national regulators.

Yes, you heard me.

For all this talk of EU and European harmonisation and a banking union, most countries want to see their banks run by domestic operators for the reasons given in the first half of this blog.

Economic controls, cultural requirements and national identity will naturally create barriers to German banks running Spain and Italy.  Just look at what happened to Greece and Cyprus if you’re not sure about that one.

So the Spanish giants of BBVA and Santander will be gifted the good parts of the weaker domestic players, as will Intesa in Italy.

These are the countries that have the weakest balance sheets, although France will also see Société General and BNP Paribas grow as their mid-tier competition disappear.

This will prove to be an interesting decade for the European master plan, and the banking review will definitely sort out the wheat from the chaff.

The core question is: what will happen to the chaff?