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The ECB’s newly published guide on its supervisory approach to consolidation in the eurozone banking sector indicates its openness to large-scale cross-border mergers and acquisitions, Fitch Ratings says, but significant obstacles to pan-European consolidation remain.
“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 results of an audience poll at Fitch’s recent Credit Outlook conference were in line with this view, with only 5% of respondents expecting cross-border mergers or regional expansion to be the predominant type of European banking sector consolidation this year.
The ECB’s guide aims to provide greater transparency on its supervisory approach to bank mergers and acquisitions, and also confirms important aspects disclosed at the launch of its public consultation in July 2020.
For example, the ECB will recognise verified accounting badwill to contribute to 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.
However, the ECB 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.
The ECB guides banks envisaging a merger to contact it as early as possible for a preliminary assessment, including the impact on ex-post Pillar 2 capital requirement (P2R) and Pillar 2 guidance (P2G) buffers.
Although the base case for determining each of these is the weighted average level before the consolidation, P2R and P2G can be set lower if the merger improves the resilience of the business model or the risk profile of the combined entity. This could be the case if the merger provides credit portfolio or sovereign exposure diversification or improves cost efficiency. The advised P2R and P2G communicated during the formal notification process will remain stable for at least a year, subject to unexpected material negative developments.
The ECB invites existing groups or groups envisaging consolidation to apply for liquidity requirement waivers for all or some of their subsidiaries, as permitted by EU capital requirements regulation. The ECB and local regulators will reach a joint decision on liquidity waiver requests within six months.
The ECB confirmed that it is in favour of capital waivers for subsidiaries in the eurozone, but this has yet to be considered by European legislators. Both waivers would enable banks to manage their liquidity and capital resources more efficiently, and improve the outlook for pan-European bank consolidation.
The ECB will allow combined entities to temporarily use existing internal models to calculate capital requirements for newly acquired assets, or assets transferred to a different legal entity. As a general rule, the ECB’s approval to use internal models is not transferable to another legal entity.
Eurozone banking groups have weaker profitability and returns on equity than most global peers. The economic fallout from the coronavirus crisis has exacerbated the weakness. The average return on equity of EU banks was 0.5% in 1H20, down from about 7% in 1H19, based on European Banking Authority data.
Corresponding figures for US banks are 3% and 12%, according to calculations of the Federal Reserve Bank of Saint Louis. While the ECB is not seeking a target for bank consolidation, it does want to see a more sustainable and profitable eurozone banking sector in the medium term.
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