The strategy of European banks ever since the Global Financial Crisis has been to focus on profitability1. How do you achieve a higher return on equity? There are two commonly followed options. Either you cut costs, e.g. by merging banks in the same geography and closing down the redundant branches. Or you sell the business, especially when you’re an also-ran outside of your home market.
I especially liked his discussion of “front book, back book“. Banks and insurers accumulate a long-term book of assets. These generate a predictable stream of income (interest and premiums). Unfortunately, this “back book” exposes them to unexpected losses. As a result, financial firms need a lot of capital.
The business model of Software-as-a-Service (SaaS) companies is also based on a back book. However, unlike banks, their portfolio of subscribers does not require a lot of capital.
In the same newletter, Rubinstein discusses the possibility of bank M&A funded by badwill, as I suggested earlier.
Sean Pawley talks about banking in East Africa on the Palladium Podcast (discussion about banks between 6:50 and 22:15). Multiple issues with banking in Rwanda and other countries in the region: economy runs on cash payments -> banks lack reliable data on borrowers -> high default rates -> unstable banks, high interest rates and fees, preference of cash over bank deposits. His solution: a narrow bank that eliminates credit risk. Provide a cellphone-based payment solution. Collect payment data. Based on the data, start making loans.
The founders of the European Payments Initiative (EPI) include all major French, German and Spanish banks.
I’m curious why Intesa Sanpaolo1 and the Austrian and Nordic banks haven’t joined.
A pan-European payment solution is long overdue. Payment providers like Visa, Mastercard and PayPal have profit margins that European banks can only dream of. Increased competition and lower prices would be great for sellers and consumers.
Italian banks in particular would benefit from a consolidation of their fragmented domestic market1. In February, Intesa Sanpaololaunched a bid for UBI Banca. UniCredit should consider a similar deal with Banco BPM, Banca Monte dei Paschi di Siena or BPER Banca. Also, French BNP Paribas could merge its subsidiary BNL with one of those banks.
Spanish banking is already quite concentrated. Santander took overBanco Popular in 2017. The integration was completed in 2019. Santander and BBVA could acquire Bankinter, Bankia, or Banco de Sabadell. Of course, further domestic growth of the majors depends on regulatory approval. The two global Spanish banks definitely have the expertise to execute such an operation.
Figure 1 shows the number of bank branches relative to population for Spain, Italy and the Netherlands. It’s clear that Italy and Spain have a lot of potential for cost cutting.
Portugal, Poland and the Netherlands
In neighbouring Portugal, Banco Comercial Português seems a good match for Santander. Especially since both Iberian banks are active in Poland. Speaking of Poland, Santander and ING might be interested in mBank. mBank is owned by Commerzbank, a bank that desperately needs to focus its strategy.
A foreign group could shake up the uncompetitive Dutch market by buying ABN AMRO. However, as most of ABN AMRO is still state owned, this will be complicated.
Many listed insurers like Aegon, NN Group (NL), Ageas (BE), Baloise, Swiss Life (CH) or UnipolSai (IT) trade at a significant discount to their book value. This could be an opportunity for big insurance companies AXA, Allianz and Zurich Insurance Group.
Consortiums of buyers could also divide the operations of their targets (although there is a bad precedent for this scenario).
Update 23 July 2020: Marc Rubinstein at Net Interest came to the same conclusion: “Coming out of Covid, when banks realise they don’t need such a large physical presence, further consolidation is likely. What’s more, if equity valuations don’t recover, banks may be able to use negative goodwill to cover restructuring charges.”