The trouble with UniCredit’s interest in Commerzbank

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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

The writer is a founding partner of Veritum Partners

The US and Europe are two of the largest financial blocs in the world enjoying broadly similar levels of GDP. So why is it that the top 50 banks in Europe only have the same combined stock market valuation as the top five in the US? And is the fact that profitability is higher for US banks proof that those in Europe need to merge to become more like their rivals across the pond?

If you asked Onur Genç, chief executive of BBVA, or Andrea Orcel, chief executive of UniCredit, then the answer would likely be yes. Both banks are currently attempting takeovers of rivals, Sabadell and Commerzbank, respectively. The former is a more traditional, domestic affair, whereas the UniCredit-Commerzbank tussle feels much closer to a hostile cross-border transaction. While German government officials have described it as “unwise”, if it goes ahead, it would be the largest such transaction since the calamitous hostile takeover of ABN Amro by Royal Bank of Scotland (RBS) in 2007, a move which contributed to the latter’s collapse.

So should we be worried? The drivers of recent banking transactions are many of those that have shaped the European banking industry for the past 15 years: sluggish revenue outlook as the sugar rush of higher interest rates fades and rising costs as the promise of IT-driven efficiency is continually offset by higher investment spend, set against a backdrop of fragmented market shares, “market” referring to the eurozone.

It is therefore hardly a surprise that investment bankers are reaching for their pitch books and that mergers and acquisitions are back on the agenda, despite decades of studies suggesting that half or more of deals destroy shareholder value.

But are larger banks a good idea? One of the most important lessons of the financial crisis of the late 2000s was, as then Bank of England governor Mervyn King put it, that “most large complex financial institutions are global — at least in life if not in death”. The cost of the 2008 bailout of the globally active RBS fell entirely on the shoulders of UK taxpayers; those in the US didn’t have to pay a dollar, despite the fact that RBS was a top 10 US bank whose failure would have had clear repercussions for the American economy. 

In reality, the theory that large banks are ‘too big to fail’ seems to still hold true

And while new rules today mean that the cost of rescuing a bank falls theoretically on shareholders and debtholders rather than taxpayers, in practice it is clear that a large bank facing imminent collapse would not simply be allowed to fail once other providers of capital are fully wiped out. Does anyone believe the Swiss government would have simply allowed Credit Suisse to fail if it hadn’t managed to strong arm UBS into rescuing it? 

In reality, the theory that large banks are “too big to fail” seems to still hold true. The bigger banks are, the more problematic issues become. While today’s economic and financial conditions, combined with significant balance sheet strengthening, means that we are a long way from having to worry about bank failure, banking remains a highly cyclical, fantastically leveraged business with lurking dangers.

Some might argue that the formation of a European banking union means that a potential UniCredit-Commerzbank merger doesn’t change the risks: with both Germany and Italy using the euro, any failure would in turn be the responsibility of the eurozone. But that too is a chimera. There is no eurozone-wide deposit guarantee scheme, which in practice means that, were UniCredit to risk failure in the future, it would remain a problem for the Italian government and taxpayer to resolve.

For many banks in Europe looking enviously at their US peers, getting bigger may feel like an attractive option to address the challenges of today and regain their seat at the mega cap table. This is, however, not the case. Such transactions are rarely good for shareholders and, more importantly, for Europe’s taxpayers and governments, who remain the lenders of last resort.