Corso di Laurea magistrale (ordinamento ex
D.M. 270/2004)
in Amministrazione, Finanza e Controllo
Tesi di Laurea
Concentration in the Italian
banking industry: future
prospects.
Relatore
Prof.ssa Francesca Checchinato
Laureando
Jacopo Maria Parise
Matricola 816090
Anno Accademico
2012 / 2013
C O N C E N T R A T I O N I N T H E I T A L I A N B A N K I N G
I N D U S T R Y : F U T U R E P R O S P E C T S
WRITTEN BY Jacopo Maria Parise
RELATOR
Prof. Alain Chevalier
English Version :
During the last 3 decades, the aggregation process among different financial intermediaries has represented the most clear evolving feature of all the major financial markets. Even the credit market of the European countries, initially fragmented and characterized - especially in some countries - by structures and conditions often underdeveloped has been interested by deep changes, heading towards a progressive integration, although incomplete. Under the lens of the concentration process undertaken since the beginning of the 80’s of the previous century, this paper aims to analyse and deepen the concentration process in the Italian banking industry, in order to produce an univocal judgment over its state of health after the financial crisis and its strategic perspectives for the future. The following analysis is directed to underline modality and effects of these changes, with particular attention to their relevance in terms of competition and efficiency in the national credit market; integration in the European market and, through it, in the global one.
Keywords: Concentration in Banking, European Union, M&As in banking, Italy. JEL Classification: G34, L22, N20.
Version Française:
Au cours des trente dernières années, le processus d'agrégation de différents intermédiaires financiers représente le point d'évolution majeur dans les marchés financiers. Bien qu'initialement fragmenté et caractérise par une structuration ancienne, le marché du crédit européen également a subit un profond changement amenant à une intégration progressive, bien que partiellement incomplète. En considérant le processus de concentration mis en œuvre à partir des années quatre-vingt, le but de notre recherche sera d' analyser la concentration du secteur bancaire en Italie afin de mieux en comprendre l'état actuel après la crise financière de 2007 et d'élaborer ses prospectives stratégiques futures. Ainsi, nous soulignerons les modalités et les effets d'une telle mutation, en se penchant plus particulièrement sur le concept de concurrence et efficience du marché national du crédit, ainsi que sur le concept d'intégration au niveau du marché européen et, plus généralement, au niveau global.
Mots-clés: Concentration dans le secteur bancaire, Union Européenne, M&As bancaires, Italie. Classification JEL: G34, L22, N20.
Durante gli ultimi trent'anni, il processo di aggregazione tra intermediari finanziari di diversa natura ha rappresentato il tratto evolutivo più evidente in tutti i maggiori mercati finanziari. Anche il mercato creditizio europeo, inizialmente frammentato e caratterizzato - specialmente per alcuni Stati - da strutture e condizioni arretrate, è stato interessato da un profondo cambiamento, portando ad una progressiva integrazione, sebbene incompleta. Sotto la lente del processo di concentrazione intrapreso dagli inizi degli anni Ottanta del secolo scorso, la presente ricerca intende analizzare e approfondire la concentrazione del settore bancario in Italia, in modo da giungere ad un giudizio univoco sul suo stato di salute dopo la Crisi Finanziaria del 2007 e le sue prospettive strategiche future. La seguente analisi sarà rivolta a sottolineare modalità ed effetti di questi cambiamenti, in particolare in relazione ai concetti di concorrenza e efficienza del mercato creditizio nazionale; dell'integrazione nel Mercato Europeo e, attraverso questo, in quello globale.
Parole chiave: Concentrazione bancaria, Unione Europea, M&As tra banche, Italia. Classificazione JEL: G34, L22, N20.
I N D E X
I N T R O D U C T I O N
A. Content of the research and analysis objective . . . 1
B. Methodology of the research . . . .4
C. Literature Review . . . 9
C H A P T E R I - B A N K I N G C O N C E N T R A T I O N P R O C E S S 1.1 Environment evolution and competitive pressures: evidences from U.S.. . . .13
1.2 Main determinants of banking concentration.. . . .21
1.3 Effects on the structure of credit systems. . . .25
1.4 Effects on the stock performance of the banks involved. . . .29
1.5 Concluding remarks. . . 32
C H A P T E R II - T H E E U R O P E A N B A N K I N G I N D U S T R Y 2.1 Concentration of the banking sector in Europe: general evolution . . . .35
2.2 Cross – border M&As in Europe before the financial crisis . . . .45
2.3 The 2007 financial crisis and consequences in Europe. . . .52
2.4 Concentration among companies and European regulation. . . .61
3.1 Evolutionary profiles of the concentration process in Italy. . . .69
3.2 Characteristics of concentration in Italy . . . .81
3.3 Focus: Unicredit Group. . . .88
3.4 The 2007 financial crisis and the sovereign debt crisis. . . .92
3.5 Concluding remarks . . . .100
C H A P T E R IV - C O N C L U D I N G R E M A R K S 4.1 Final considerations and main implications . . . .105
4.2 Suggestions for future research. . . .113
R E F E R E N C E S D. Books . . . .i
E. Report and Researches. . . .ii
F. Websites. . . viii
T A B L E O F P I C T U R E S G. Charts . . . .ix
I N T R O D U C T I O N
A. Content of the research and analysis objective
“I believe that banking institutions are more dangerous to our liberties than standing armies” – Thomas Jefferson, 1809.1
By this famous sentence, the third President of United States intended to underline the milestone role that banks – and more in general credit market – have had for the development of any country. Connecting people with deficits and surpluses of capitals, allowing the first to finance their activities and second to save their money, has been considered the basis of modern economies. Nevertheless, the crucial importance taken on by these intermediaries often has crashed into opportunistic behaviours that have led to tremendous consequences, bringing policy makers to change regulations in order to prevent such situations and increase financial stability.
History of the economic capitalistic systems has been often characterized by a continuous tension between regulation and free market, within a process that have led policy makers in front of a trade – off between financial stability and economic growth.
“Disorder breeds socialism. […] The controls of socialism do well when times are bad, but they inhibit progress when times are good. Order therefore breeds capitalism2”.
In periods where the ideology of regulation prevailed, the grater relevance given to stability justified a pervading intervention of the State in the economy while, at the opposite, when economic growth became a priority, free market paved the way to financial
1 “Debate Over the Recharter of the Bank Bill”, (1809)
innovation, deregulation and globalization. Even if the real challenge is represented by a stable equilibrium in the trade-off, in the course of time we have assisted to a regular turnover between these opposed positions.
“It [trade-off] emerged in a so clear way to draw economic and political cycles starting the day after an epochal crisis and finishing with the burst of further3”.
Even if different cycles exist, one pattern has remained constant in the last 40 years: the concentration process undertaken among intermediaries operating in different fields of financial markets. Again, banks have played a fundamental role, having been not only vanguards but even the key-players in the markets.
Despite the concept of bank was developed in Europe at least 600 years ago, market structure of the European banking industries has been for long time highly fragmented and closed within national boundaries, with the existence of different sub-markets where few players used their oligopolistic power in order to maximize profits. A turning point has been represented by the growing integration that has taken place after the II World War, when European countries started to experience – initially within their boundaries and then among them – the aggregation of many industrial companies and financial institutions thanks to the progressive creation of a single market, an unified currency and common rules.
The aim of this research paper is to study and better deepen the concentration process in the banking industry both in a theoretical way, by analysing the main literature produced, and in an applied way, by looking at concrete experiences. In particular, the focus of the research will be represented by the analysis of changes occurred in the Italian banking sector thanks to the presence of features that will help readers to better understand the impact of concentration process over an entire economy.
3D’Apice V., (2013), p. 2
The objective of the analysis is, thus, to demonstrate that creation of the European single market – and the increased level of competition reached – have determined a shove to concentrate in order to face the grown need of stability and efficiency, to increase market share and to reach the appropriate size for competing in a renovate and international environment.
B. Literature Review
Much has been written to explore the theory and the cases of concentration in industrial and financial sectors, often presenting controversial results. This paper takes into consideration different author’s perspectives with the aim of finding, to the extent possible, common points of view above the topic.
In the last decades researchers have decided to deepen the perspectives through which analyze banks, allowing economists and practitioners to have a broader view about the concentration process in the banking industry, its determinants and implications not only for credit market, but more in general for the entire economy. As of the early 1990s, empirical researches on the effects of banking concentration and competition were mainly interested in understanding whether the traditional structure-conduct-performance (SCP) model could be applied to the banking industry. Researches were aimed to investigate if bank concentration or normative impediments to competition could create a “dangerous” environment for banks, with implications in terms of performance and stability of the entire system. These studies were characterized by testing the assumptions through the application of simple measures of concentration – such as the Herfindahl-Hirschman Index (HHI) or non-firm concentration ratio (CRn) – by focusing on the examination of the United States market thanks to the definition of Metropolitan Statistical Areas (MSAs) and by considering all sizes and types of banks equal. Typical empirical studies of bank concentration and competition of this period fund that U.S. banks in more concentrated local markets charged higher interest rate on SME loans and pay lower interest rates on retail deposits (Berger and Hannan, 1989; Hannan 1991) and that their deposit rates were slow to respond to changes in open – market interest rates (Hannan and Berger, 1991; Neumark and Sharpe, 1992).
With the progress of time, literature went beyond the SCP hypothesis and tested a number of different models of competition with alternative measures of competitiveness, including indicators of market structure that took into consideration the possibility that
different sizes and types of commercial banks could affect competitive conditions differently. Analyses, thus, have expanded to include indicators of efficiency, service quality, risk of the banks and consequences for the economy as a whole.
Since the early 1990s, progresses have been made on a high number of fronts. Researchers have recognized the problems with SCP model and tried other methods. For example, some studies tested the relation between X – efficiency or scale efficiency and concentration and market share in local U.S. banking markets, achieving evidences that support the effect of both market power and efficiency on profitability (Berger, 1995; Frame and Kamerschen, 1997). Other studies broadened analysis of concentration in banking industry including also indicators for entry restrictions, regulation and other legal impediments to bank competition. These researches have shown that financial regulation, creditor and shareholder rights, banking and openness trade and entry have an important effects on competition among banks and between banks and financial markets, with significant consequences for economic growth (La Porta et al., 1997, 1998).
More recent studies stopped to consider credit market as a uniform environment composed by an unique typology of players, theorizing that different sizes of banks may affect competitive conditions differently. Small banks are often considered to be “community banks” with different competitive advantages than large banks. Relative to large banks, small banks in developed nations tend to serve smaller, more local customers and to provide more retail-oriented rather than wholesale-oriented financial services (De Young, Hunter and Udell; 2004). Following researches, having considered previous findings as a point of departure, investigated whether banks of different size could deliver their services using different technologies. Banking groups may have a comparative advantages in lending technologies such as credit scoring that are based on “hard” quantitative data. Small banks, on the contrary, could have comparative advantage in technologies based on “soft” information, that is those information more difficult to quantify and transmit through the communication channels typical of large banking organization (Stein, 2002; Berger and Udell, 2002). In accord with these arguments, banking groups have been found to lend
proportionately less of their assets to SMEs (Kashyap, Berger and Scalise; 1995), to lend to larger, older and more financially secure SMEs (Haynes, Ou and Berney; 1999), to have shorter and less exclusive relationships (Berger et al.; 2002) and to lend more on an impersonal basis and at longer distances (Berger et al. 2002). These new papers generally have an international orientation that includes developing nations, a significant change from the vast majority of the studies in the precedent literature.
A further step in the analysis of the credit markets, financial markets and, more in general, the banking environment, became established when other studies started distinguishing between concentration and broader measure of competition, such as entry restrictions and legal impediments to bank activities. Investigators have, thus, expanded their research field to include analysis on the effect that competition and consolidation in the banking industry produce on economic growth, credit availability to SMEs and performance of non – financial industries. The empirical researches brought to mixed findings. Some studies, in fact, have found unfavorable effects from high concentration and other restrictions to competition, including less new firms concentration, expansion and employment, less economic growth and slower exit of mature companies (Black and Strahan, 2002; Cetorelli and Strahan, 2002; Cetorelli, 2003). Other studies, instead, have found favorable effects of bank concentration, such as greater access to credit by new firms and other SMEs and higher growth rates (Cetorelli and Gambera, 2001; Bonaccorsi di Patti and Gobbi, 2001; Zarutskie, 2003). In particular, some authors (Boyd and Runkle, 1993; Mishkin, 1999) have claimed that concentration is a destabilizing element (concentration-fragility view) due to the likelihood that these larger intermediaries could take more risks due to the implicit “too big to fail” policies. Some studies have deepened the effect of a bank concentration on the stability of a national financial market, claiming that concentration leads to stability (concentration-stability view) because few large banks should be more profitable, easier to monitor and more diversified, allowing them to better resist in front of a shock (Allen and Gale, 2000).
A certain number of papers have examined the different competitive effects of foreign – owned and state – owned banks. Some researchers have suggested that foreign – owned banks could compete in different ways from domestic institutions. Foreign – owned banks are, in fact, part of large banking groups and so they might have many competitive advantages and disadvantages over domestic operators in serving multinational customers, access to capital, use of technology and so on. However these institutions may also have disadvantages depending on distance, the existence of different economic environments and so on. Evidences on efficiency and profitability, however, have permitted to claim that advantages of foreign – owned banks outweigh the disadvantages in developed nations (Classens, Demirgüç-Kunt and Huizinga; 2001). Building on this work, other studies (Levine, 2003) found that regulatory restrictions on the entry of foreign banks, rather than foreign – owned banks, are robustly linked with higher banks’ interest margin. Other researches, instead, have investigated the possibility that state – owned banks could compete differently from private banks due to the difference in objectives: compared to the private banks’ profit and value maximization, in fact, state objective are usually represented by the development of specific geographical areas or industries, the assistance to new entrepreneurs, the expansion of the economic activities and so on. Many researches have shown that large concentration of state – owned banks determines a weaker competition and, in in the time, less favorable economic consequences (Caprio, Levine and Barth, 2001, 2004; Berger, Hasan and Klapper, 2004).
Lately, the academic production has shifted its attention to other developed countries or developing countries and on the international comparison between these countries. Most of the non – United States studies, however, consider the entire nation as a single market, while several nations have had a different history and, thus, should have a different credit market. For example, studies on the European Union credit market often consider it as a single market due to the regulatory changes promoted by European policy makers in order to create a single market. These studies (Goddard, Molyneus and Wilson, 2001; Dermine, 2003) typically have found that differences in profitability and performance among banks placed in different nations still remain due to the different credit
market structures and the complexity in harmonizing them in a single market driven by common rules.
Far from the possibility to include all the researches and relations analyzed in the last twenty five years, the aim of this part of the research has been to briefly summarize the most important contributes developed by academics and practitioners to understand how changes in the size and market power of banks can influence the economy of a country. According to the previous views, when the concentration of banks is not followed by a process of deregulation, the economic environment is weakened due to the increased market power belonging to the banks. If, on the contrary, the consolidation is accompanied by a regulation that increases the competition between these intermediaries, through the removal of barriers to entry or other restrictions, the process of concentration can lead not only to greater system stability financial but also to improve the supply of credit both for people and for companies.
C. Methodology of the research
Methodology applied to the following paper is:
Analytical: through the analysis of articles and previous researches it investigates how and why banks have started to integrate by taking over other intermediaries operating in the same market, (horizontal integration) or through acquisitions of companies operating in a different position of the value chain (vertical integration).
Quali – quantitative: the subject under investigation is too wide to be simply summarized through a numerical approach and too technical to be supported only by observatory evidences. So the descriptive part will be integrated by numerical evidences with the aim of providing more detailed data and supporting findings and implications. Numerical evidences derive from secondary data, obtained mainly from periodical reports of international economic institutions (ECB, IMF, Bank of Italy) and from mandatory disclosures that banks and other intermediaries are obliged to produce according to law.
Deductive: even if it seems reductive to define the outputs of this paper as simply depending on a deductive approach, several economic theories can be applied in order to justify the concentration process, as in industrial sectors as in the financial industry. Case studies provided in the paper have the aim of confirming or denying the economic theories that, in the end, will be applied to the Italian banking industry in order to inductively predict future prospects. A contribution to the deductive analysis will be provided by specialized press reviews, in order to show examples and to link theoretical knowledge with information and episodes coming from the reality of financial markets.
The extensive use of M&As in the banking industry has spread in Europe in conjunction with the emergence of a more competitive banking market and has found fundament in casual factors that have established a common denominator in the evolution of the banking industry at an international level. It refers to the interaction of the so-called
exogenous environmental factors, as the deregulation process, technological innovation, markets globalisation and the introduction of a single currency (Euro), that between the end of 1980s and the beginning of 1990s have weakened the entry barriers in the main European markets, preparing the ground for the entrance of international players in domestic markets. The progressive intensification of the competitive pressures and the resulting danger of market share erosion have imposed, thus, to banks an intense restructuring process with the aim of restoring efficiency and profitability.
In consideration of these premises, this research has the goal of deepening the evolution of the concentration process since now registered in the Italian banking industry, both in the domestic market and in the European one. The purpose is firstly to isolate casual factors that have led to improve the level of competition in the market and the determiners that have pushed banks to use these strategies of external growth and, secondly, the most significant macro-economic effects produced by consolidation.
In this respect, it was decided to structure the present work in four chapters.
First chapter provides the main theoretical background by analysing the rationale of concentration. Thanks to the vast amount of time series available for the United States banking system and relevant amount of studies focused on it; American credit market will be used in order to better explain how different determinants - ascribable mainly to the deregulation process undertaken in the last 30 years of the previous century, the diffusion of technological innovation and the gradual globalization of markets - have changed the external environment and have brought banks to concentrate. Chapter ends with an explanation of the main effects related with the concentration process, distinguishing between the effect on the credit market and the effects on the performance of the operators involved.
Second chapter, after having analysed factors considered responsible of the change in the competitive environment through the constitution of the European single market
(1993) and the European Monetary Union (1999), focuses on the different effects produced by banking concentration. In particular, analysis intends to deepen the macro-economic perspective with the aim of investigating how structure of European credit markets has changed. Financial crisis of 2007 is taken into consideration separately mainly for two different reasons: from an institutional point of view, crisis has led international policy makers to change direction, moving from the deregulation process to a new regulatory framework – with strong implications over financial markets and banks in particular – while from banks’ internal point of view crisis has laid the foundations for a strategic rearrangement of financial businesses. Chapter ends through the analysis of the European regulation on control of concentration among companies – Regulation CEE N° 139/2004 – issued with the aim of homologating national norms due to the risk of applying within the European single market different rules.
Third chapter focuses its attention on the M&A phenomenon in the Italian banking industry, started only at the beginning of 1990s, in order to underline its distinctive features. In particular, after having underlined the reasons for the delay in the consolidation process - justifications related to the presence of a market that for several decades has been characterized by a lack of competition and efficiency, being divided in different regional sub-markets few connected among them – fundamental characteristics of the M&A process are described both under a quantitative point of view (number of M&As realized, temporal distribution, main modalities used from the Italian banks) and qualitative (territorial distribution and size of the banks involved in this process).
Fourth and last chapter has the goal to provide, summarized, the main results reported in previous chapters and to underline possible future strategies of European and Italian intermediaries in order to face the growing interconnection of the national markets and the increased level of competition due to the change in the environment.
C H A P T E R I
B A N K I N G C O N C E N T R A T I O N P R O C E S S
1.1 Environmental evolution and competitive pressures: evidences from U.S
In the last 30 years, credit industry has been affected by a strong consolidation process among banks, started in 1980s in United States and continued later in several other developed countries. Fast expansion in M&As can be ascribed to the change in the exogenous environmental factors that, from mid-1960s to the beginning of 1990s, have interested the majority of the financial markets of the developed countries, deeply transforming their structures and competitive dynamics: it refers to 1) the evolution in the macro-economic environment, 2) the deregulation process undertaken in the financial markets and 3) the technological evolution. These drivers, even if with different modalities and intensities, have contributed to lower the entry barriers and, consequently, to increase competitive pushes in the banking industries. In order to face this renovate environment, banks started to pursue new strategies to bring back profitability to acceptable values. To do that, banks adopted growth-based strategies, mainly ascribable to two different categories: internal growth and external growth. Dynamics of internal growth consists in the use of structures and resources already present inside the company in order to push the growth while external growth is represented by the increase in company’s size thank to the acquisition of one or more companies already operative. M&A operations – Merger and Acquisition operations –became the more used means both from United States and European banks, being considered the fastest way to acquire a larger dimension4.
In particular, according to the contingency theory, that claims the absence of the one best way as theorized by Taylor and the existence of several different courses of action depending from internal and external factors that influence any business activity, banks
4
have changed their business models in order to adapt themselves to a new and more complex environment. First part of this chapter provides an analysis of the main environmental changes taking into consideration United States financial market. Reason underlying this choice are represented by the presence of a vast amount of time series related to the American credit market that allow to have a numerical evidence around the process of banking concentration.
Regarding the evolution of the macro-economic environment, a crucial role has been played by inflation. The rise in inflation in the 1970s was strongly related with the increases in oil prices engineered by OPEC. On 19 October 1973, the decision undertaken by OPEC Gulf Members of a 5% monthly production cut until the total evacuation of Israeli forces from all Arab territories occupied during the June 1967 war had taken place, brought the oil price to rise from 3.65 $/barrel up to 11.65 $/barrel. The second oil price rise came in 1979 with the Iranian revolution. During that period, price of Saudi Arabian crude oil arrived at 28.00 $/barrel: inflation and unemployment rose in most countries5.
Chart 1 –Inflation in United States 1970 – 2012
Source: Federal Deposit Insurance Corporation - OECD
5 Kahn, (1985), p. 27 -10,00 20,00 30,00 40,00 50,00 60,00 70,00 80,00 90,00 100,00 0,00% 5,00% 10,00% 15,00% 20,00%
Higher inflation brought to increase interest rate. In that period banks were constrained by several regulations, such as the Regulation Q6, that didn’t permit to adapt
the rates of interests in function of the specific level of inflation. Many investors became more sensitive in front of the yield differentials on different assets and the result was a disintermediation process, through which clients took their money out of banks and started purchasing higher yielding assets, weakening banks.
The impact of regulation, which is considered the second factor heavy influencing the competitive environment of any industry, banking system included, has a deep impact on market structure and, thus, on strategies and organizations of players within that market. Since 1970s, regulation has been used in order to limit competition, due to the implicit assumption of policy makers that limiting competition among credit institutions was the only way to limit risk taking and thus, to guarantee stability of the financial system. There have been several motivations to impose regulatory restrictions to banks’ activities. According with Edey and Hviding (1995), direct control was used to allocate financing to specific industries according with the economic development plan of Governments, to restrict market access and competition in order to guarantee more stability, to protect savers and to use banks as instruments of macroeconomic management.
“The shortest way to characterize the transformation of the banking industry is to say that the emphasis has gone from regulation to competition. Indeed, in the first period, regulation rate, entry restriction and charter limitation of banks (including the separation of commercial and investment banking) have been used by regulators to limit competition. Other regulatory facilities, like the lender of last resort and the deposit insurance, have been widely implemented in order to prevent runs and instability in the banking system”7.
In particular, until the early 1970s financial markets were characterized by several restrictions, including interest rate controls, quantitative investment restrictions on
7
financial institutions; line – of – business restrictions and regulations on ownership linkages among financial institutions and restrictions on the entry of foreign financial institutions.
From mid – 1970s, a significant process of regulatory reform has been undertaken in many developed countries. This process, based on a shift towards more market – oriented forms of regulation, cannot be seen as an independent pattern due to the presence of inter-related factors, such as the diminishing effectiveness of traditional controls due to financial innovation and rapid technological development; the development of various types of regulatory avoidance – just as example, the rise in out of balance sheet methods of financing – and the increased competition between financial institutions under different regulatory environments8.
Regulatory reforms have brought several different benefits by giving to financial firms more freedom to adopt the most efficient practices and by allowing them to develop new products and services able to compete against non – bank financial companies that had beforehand benefitted from the disintermediation process caused by the rise of inflation. Second, deregulation and the increased level of competition obliged banks to take under control efficiency by forcing the exit of inefficient firms and by encouraging the consolidation of the financial system.
The third factor that has influenced the competitive environment of banks has been the technological evolution. The development of Information Technology in order to collect, store, process and distribute data has influenced (and still influences) banking activities for two reasons: first, IT has modified the way in which customers can have access to banks’ services and products, mainly through automated channels, grouped under the name of remote banking. The application of this technological progress to the banking activity has permitted to overcome temporal and spatial boundaries, allowing banks to sell services and products independently from the opening times of their branches (temporal boundaries) and in geographical areas not touched before (spatial boundaries).
On the other hand, IT has contributed to the reduction of the costs associated with the management of information by replacing paper–based and labor–intensive methods with automated processes. The possibility of achieving cost reductions especially in the
8
retail businesses, due to the reduction of labor force, the existence of scale and scope economies, the rationalization of production and distribution structures, the standardization of banking processes, the shorter response times and the improved utilization of customer information have led banks to adopt these technologies.
According to the ECB (1999), however, technology cannot be considered the major driving force for M&As among banks. Despite investments in IT are quite expansive, a critical size in order to be able to amortize those costs and to remain competitive is not the only solution banks have. Strategic alliances among banks currently exist, based on the reciprocal incentives these operators may find in sharing IT development costs and in providing interoperable systems, like common platforms for the use of ATMs, compatible payment instruments and compatible technical standards. For the most part of the literature that has analyzed the impact of technological development over financial and non – financial industries, the focus of the research has been the cost side, claiming that technological investments represent a possibility to lower costs and, thus, increase efficiency. Under this perspective, banks should chose to invest in IT simply to have a competitive advantage in front of direct competitors.
However, technological evolution has affected the competitive environment of banks by increasing competition and allowing customers to better serve their interests without passing through the banks. Edwards and Mishkin (1995), claimed that advance in information and data processing technology have enabled non-bank competitors to originate loans, transform these into marketable securities and sell them to obtain more funding. Computer technology has destroyed the competitive advantage of banks by lowering transaction costs and enabling non-bank financial institutions to evaluate credit risk efficiently through the use of statistical method.
“When credit risk can be evaluated using statistical techniques, as in the case of consumer and mortgage lending, banks have no longer an advantage in making loans. In addition, these improvements have made easier for households corporations and financial
institutions to evaluate quality of securities, allowing business firms to borrow directly from the public by issuing securities9”.
The advance in Information Technology, thus, before becoming an opportunity for banks, has represented a threat caused by the increased number of competitors that have weakened their supply of credit products and consequently profitability in their core business.
To survive and maintain adequate profit levels, banks had to face different alternatives, such as through the increase of lending activities towards riskier clients, by providing other services not connected with interest rates and by pursuing new off – balance sheet and derivatives activities. Both these possibilities have been strongly criticized due to the excessive risk that banks may take.
Chart 2 – Rise in non-interest income for commercial banks in U.S 1970 - 2011
Source: Federal Deposit Insurance Corporation
Edward and Mishkin (1995) underlined that standard measure of commercial bank profitability, such as ROE or ROA, don’t provide a clear picture of the state-of-health of this industry. The reasons are mainly ascribable to the increase of non-traditional businesses of banks. 9 Cit. Mishkin, (1995), p. 32 0,00% 5,00% 10,00% 15,00% 20,00% 25,00% 30,00% 35,00% 40,00%
Chart 3 – Historical ROE and ROA for United States banks 1970 - 2012
Source: Federal Deposit Insurance Corporation
Nevertheless, in any industry the decline in profitability usually results in an exit from that industry (often caused by defaults and bankruptcies) and in a transformation of market share. This occurred in the United States during the 1980s through bank failures and the beginning of a consolidation process of banking system.
Chart 4 – Bank failures in United States 1970 – 2012
Source: Federal Deposit Insurance Corporation 0,00% 2,00% 4,00% 6,00% 8,00% 10,00% 12,00% 14,00% 16,00% 0,00% 0,50% 1,00% 1,50% 2,00% 2,50%
ROE ROA ROE ROA
0 100 200 300 400 500 600
Chart 5 –Credit Institute in United States 1970 - 2012
Source: Federal Deposit Insurance Corporation
In conclusion, the consolidation of the banking industry has started as an answer to the changes in the environment that have led banks to lose part of their market share, all to the good of non-banks intermediaries, and consequently part of their profitability. In order to block the wave of defaults that have determined United States banking industry during the 1980s and part of the 1990s, policy makers intervened through a deregulation process that increased the opportunity for banks to grow and to restore a suitable level of profitability. The reduction of constrains brought banks to extend their traditional activities outside from their original boundaries, which can explain the M&A phenomenon among banks operating in the same business or to differentiate into different business, driven by goals of profitability or growth rate.
1.2 Main determinants of banking concentration.
Once understood as influences from outside are crucial in modifying business performances, any player can have more than one justification in order to merge or takeover other intermediaries. In particular, literature has classified several economic or extra-economic reasons to explain why banks should conclude an M&A. Referring to the multiple determinants that may drive a bank to aggregate itself with other banks, it proves
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to be difficult to arrive at a classification univocal, well defined and able to include all the possible motivations that can lead a banking company to carry out these operations of external growth. Motivations around these processes vary in fact from situation to situation. Nevertheless, it is possible to group all justifications into two different categories: business economics and extra-business economics motivations.
All those situations that lead a bank to takeover or merge with other institutions with the aim of increasing shareholder value or the economic performance are called Business economics motivations. These are:
1. An increase in efficiency: the improvement of the operative efficiency among the banks interested by mergers can be achieved in different ways. It can happen through the recourse to economies of scale, depending on the possibility of lowering the average cost of production thanks to the new size reached, or economies of scope, that allow to produce goods or services jointly at a lower price compared with separated productions. Academic studies, as reported by Berger and Humphrey (1994), have determined that scale effects account for 5 per cent of the costs in smaller banks, while in large banks constant average costs or diseconomies of scale prevail, due to the increase in coordination & control costs. Regarding economies of scope, Berger and Humphrey showed that jointly production can bring to a cost reduction of 5 per cent. The same authors, however, underlined that managerial ability in defining the more appropriate combination of inputs in order to minimize costs and maximize revenues is considered much more important than scale/scope economies: they refer to the so-called X-efficiency as theorized by Leibenstein (1966).
“Scale and scope economies in banking are not found to be important, except for the smallest banks. X-efficiency, or managerial ability to control costs, is of much greater magnitude - at least 20% of banking costs”10.
2. Risk diversification: the creation of a stronger banking subject allows to better diversify risks not only through a new and more complete portfolio of financial products and services but even for the possibility of trading them in more sectors and geographical areas. Hughes, Moon et. al (1999) showed that probability of default tended to decrease in connection with consolidation strategies enhancing geographical diversification. Nevertheless, consolidation can expose banks, such as other institutions, to managerial moral hazard, being bank conglomerates too big to fail (Berger, 1998; De Nicolò, 2000; Gorton and Winton, 2002).
3. An increase in the market power: studies conducted on the consolidation of the banking industry in U.S in 1990s that have examined dynamic effects of bank M&As on prices have found that mergers, and thus consolidation, have increased quality of banking services thanks to superior branching networks, access to ATMs, etc. but even higher fees to pay (Board of Governors of the Federal Reserve System, 2003). An Italian study of bank M&As over the same topic has shown that in the short period banking services prices were unfavorable to consumers while in the long term they became favorable. Panetta and Focarelli (2004), authors of the research, considered as a possible justification of this behavior the dominating effect of market power in the first period while, secondly, efficiency allowed to lower prices. Berger and Hannan (1989) found that in more concentrated local markets, banks charge higher rates on SME (Small and Medium Enterprise) loans and pay lower rates on retail deposits. Neumark and Sharpe (1992) obtained same results.
4. Investment opportunities (growth rate): growth rate can have an effect over the concentration decision for two different reasons. Kocagil et al. (2002) empirically showed that some banks with high growth rate experienced problems due to managerial and/or structural inability to deal with high level of growth. Bidder banks, thus, may be interested in purchasing these banks in order to better exploit their potential. On the other hand, Moore (1996) found that banks could be interested in M&As even when the growth rate is quite slow thanks to the possibility of increasing market value of the target.
On the contrary, extra-business economics motivations are ascribable to interests and purposes of the management. In particular:
5. Private and opportunistic reasons of managers: according to this view, agency costs can have an impact over the consolidation strategy of a bank due to the managerial interest of enhancing salaries and prestige, diversifying personal risks or protecting their working positions through the construction of empires, at the expense of shareholders (Bliss and Rosen, 2001; Hughes et al., 2003).
6. Protective/defensive purposes: size of a bank can be considered as a deterrent against M&As for different reasons. Large banks are more difficult to be acquired due to the higher liquidity necessary to conclude the deal. Focarelli (2002), found in the Italian banking sector a negative and statistically significant correlation between size and probability to be acquired, while Wheelock and Wilson (2000) reported that smaller banks are more probable to be acquired than large ones. Other possible explications are represented by the possibility for large banks to fight against hostile acquisitions thank to the bigger amount of resources available and by the difficulty for bidder banks to integrate big intermediaries in their organizations.
Before concluding, it is important to underline that M&As cannot be considered all equal. According with Sapienza (2002), it is possible to distinguish between in – market mergers and out – market mergers. The firsts are characterized by combining banks that belong to the same local market while the latters are represented by operations undertaken in order to penetrate a new market. Evidences have shown that effects on market structure are different. In the first case (in – market mergers) banks can decrease the number of competitors and acquire more market power and adopt a cooperative behaviour. The result is a less competitive environment where players can reduce their output and rise prices. On the other hand, these kinds of mergers may offer more opportunity for cost savings due to the possibility to remove the least efficient operations when they overlap. On the other hand, out – market mergers are considered able to rise competition among market players
due to the interest of the bid company in penetrating the new market through the already existing structure of the bank incorporated.
1.3 Effects on the structure of credit systems.
Focusing attention on one of the most widespread implication of the concentration process just described, it leaps out the creation of a limited number of big financial groups that tend to take on the role of key – actors in the events of the market, affecting significantly the processes of transformation of the same.
Even if large – size bank has always existed (in relation with the specific historic period), the impression is that this phenomenon has assumed innovative features in the recent times in relation to:
- to the positions of domain taken by these subjects in many domestic markets, in specific business areas and, in some cases, even in widely globalized activities;
- to the ever increasing internationalization of their activities and the dissemination of distributive networks in a large number of countries in the world, not least the large emerging markets;
- to the central position taken in the financial markets and in the wide range of services and activities that these intermediaries provide in the markets.
These players take on a crucial importance in order to analyse and to understand the processes of transformation of the credit structures and markets; and to direct the function of government oversight, function become very sensitive in the context of globalization11.
In particular, according to the Group of Ten research (2001) conducted on the Member Countries (Belgium, Canada, France, Italy, Japan, Netherlands , Sweden, United
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Kingdom and United States), it is possible to consider the effect of concentration on 4 different aspects of the credit system: 1) financial risks; 2) monetary policy; 3) competition and credit, 4) interbank payment systems.
Financial risk
Potential effects of the concentration process of the credit market on the risk exposition of banks are various and the final outcome cannot be generalized. In any case, it seems possible to underline some features common in the different countries taken into consideration.
The reason for which consolidation seems better able to limit the business risk is linked with the diversification, especially geographic, of activities. Even in this case, however, risk reduction is not a sure result since profitable returns depend on the composition of the bank’s portfolio. After consolidating, some institutions have modified the composition of their portfolios towards riskier activities increasing in this way the operational risk. Other issues could depend on the increased complexity of the managerial structure. Systemic financial risk – that is the risk determined by interdependencies in a system or market, where the failure of a single entity or cluster of entities can cause a cascading failure – can be transmitted more likely through larger – value activities of bigger intermediaries: consolidation may have increased the likelihood that situations of business disruption can cause strong repercussion on the whole system.
Empirical evidences suggest that the interdependences among the major players of the banking industry in the last two decades are strongly increased in United States, Japan and Europe. Causes can be ascribed mainly to globalisation of the markets and to the existence of few national – giants with a strong influence on the national credit market. Among the areas when the interdependences have grown more there are interbank loans, relation on the OTC markets and payment and settlement systems.
Monetary policy
According to the Group of Ten (2001), consolidation process can have an impact on the implementation on monetary policies due to the its impact on the interbank market or the one used by Central Bank to modify the money supply. Consolidation may reduce the level of competition on these markets, increasing the cost of liquidity for some banks and hindering the process of arbitrage between the prevailing interest rates in the various markets. Consolidation process may even alter the monetary transmission mechanism that regulates Central Banks monetary decisions and operations towards the rest of the economy. It can happen through the Monetary Channel – that is the transfer of changes in interest rates controlled by the Central Bank to the other interest rates including rates on deposits and bank lending – through an increase in the spread between active and passive rates. The increase in the degree of concentration may also affect the delay with which monetary policies are transmitted in two different ways:
- by reducing the delay, if these bigger players are able to process information more rapidly thank to the improvement of the IT system;
- by increasing the delay, if banks are able to exploit the inertia of consumers in response to changes in interests rates.
Concentration process may also affect the transmission mechanism through effects on other 2 channels of monetary policy. These are primarily the Bank Lending Channel, operating through monetary policy actions on the supply of bank loans, or through the Channel of Financial Statements of companies, by modifying the value of collateral and the availability of credit to lend.
Competition and credit
Effects of concentration on competition depend on specific condition of the demand and supply of credit in the markets and in this juncture a relevant factor is represented by
the presence of barriers to entry. For retail banking products, empirical evidences on the Group of Ten countries show that market are geographical segmented, with the prevalence of few leading players with higher market power. Local markets usually coincide with restricted areas of a country, such as Provinces, Regions, Metropolitan Cities or Cantons, according with evidences that suggest families and SMEs benefit mainly from banking services offered by companies located at a short distance.
Phenomenon just described may have negative repercussion on consumers, in particular in the markets of SMEs loans, retail deposits and payment services. In particular, SMEs make an important contribution to the economies of the countries surveyed: in agree with the research conducted by The Group of Ten, in 1996, 66% of the total employment in Europe depended on these companies while in United States the amount of employed was around 50%. The reduction in the number of small banks, due to the consolidation, may adversely affect credit availability for smaller customers. Bank resulting from the consolidation process, in fact, could restructuring its portfolio through a credit expansion to customers of larger size thanks to the greater amount of information available, capable of reducing the information asymmetry between the parties and therefore the credit risk. Insofar the credit relationships between small banks and SMEs are characterized by higher information asymmetry, small companies must face an increasing difficulty in finding financing. This problem is more serious in Europe because of the specific characteristics of the credit market that, unlike the United States, has not been subjected to a disintermediation process during the 1970s and 1980s.
Referring to wholesale banking products, investment banking services, currencies market and derivatives, even if these markets usually have a national or international dimension, consolidation process and the creation of bigger player may affect negatively them due to the exercise of the grown market power.
Interbank payment systems
Bank consolidation has repercussion on the efficiency of the processes of payment settlement and transfer of securities, on the level of competition between banks and market
infrastructures, on financial and operational risks. It has also implications to the approach taken by Central Banks in the oversight of the interbank payment systems. Consolidation, in fact, has led to concentrate payment and settlement flows in a smaller number of counterparts within the credit, and more in general financial, markets.
The emergence of multinational institutions and specialized providers of services involved in a number of systems for payments settlement and securities transactions, as well as the growing interdependence in terms of liquidity between different systems, contribute to further accentuating the role that payment and settlement systems may have in the transmission of the effects of a financial contagion. For this reason, in the last 10 years Central Banks have made considerable efforts to reduce the systemic risks arising from liquidity problems, in particular through the adoption of systems for real – time gross settlement and urging the introduction of effective measures to control the risk in the net settlement systems: European Union experienced, in 2007, a shift from the interbank payment system TARGET to the newest one TARGET 2 (Trans-European Automated Real-Time Gross Settlement Express Transfer System).
1.4 Effects on the stock performance of the banks involved.
The analysis of the effects of stock market performance of the banks involved in an M&A has the aim of investigating whether these operations are able or not to create value for the bidder banks and their shareholders. Technique typically used in these situations is called “Event Studies” and represents an empirical analysis that allow to measure the impact of an event, such as the merger announces, on the value of a specific company. Through this technique, share price is divided in two different components: one is called Normal Return and reflects “the expected return without conditioning on the event taking place” while the second part of the share value is given by the Abnormal Return, that is “the actual ex-post
return of the security over the event minus the Normal Return of the firm over the same period”12. For firm i and event date τ, the Abnormal Return (AR), is:
ARiτ = Riτ – E(Riτ|Xτ)
where Riτ is Actual Return, that is the share price at the observation date; E(Riτ|Xτ) is
the Normal Return. Xτ is the conditioning information for the normal return model. There
are two choices for modeling the Normal Return: the Constant Mean Return, which considers Xτ is a constant and assumes that the mean return of a given security is constant through
time; and the Market Model, where Xτ is the market return, under the hypothesis of a stable
linear relation between the market return and the security return.
Abnormal Returns can be positive or negative. When positive, it means that market is willing to bet on a value creation while, in the opposite, when Abnormal Return is negative, it means that expected return from the event announced is consider to impact negatively on the global performances of a company.
Unfortunately, literature does not permit to reach univocal conclusions about the effect that M&As produce on economic performances of a company and, thus, on the share price. Hannan and Wolken (1989), have shown that there is no clear evidence of a production of new value, but only a redistribution of wealth among shareholders of the acquired bank and sold. In particular, focusing on a total of 112 United States banks (43 buyers and 69 acquired) during the period from 1982 to 1987, researchers have shown that, even if in presence of negative Abnormal Returns for bidder banks and positive for the target ones during a period of +/- 15 days, outcomes have determined a null impact on the creation of wealth for the shareholders involved in the deal.
The study conducted by Hawawini and Swary (1990) has come to slightly different results, according to which the loss of value suffered by the bidder bank is more than offset
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by the positive Abnormal Returns registered by the acquired bank. According to this view, M&A operations seem to create value, on the whole, for shareholders interested.
Among the most recent studies, it should be mentioned Ferretti (2000), who has deepened the M&As’ stock performance referring only to bidder banks. The results have permitted to claim that United States market reactions were not univocal, being observed both positive and negative reactions. Nevertheless, according to the study, in the more recent time negative reactions have prevailed over the positive, clear evidence that investors consider mergers as a transfer of wealth from bidder bank to the target one.
Referring to the European market, studies investigating stock performances before and after an M&A are quite lesser due to the primacy of United States in the process of aggregation and because of the methodological difficulties in analysing the highly fragmented European banking market. However, among the main studies conducted, Cybo, Ottone and Murgia(2000) claimed that, after having analysed 54 European M&As, in the majority of the situations reactions have been strongly positive, considering those operations as a future value creation. Authors have, thus, underlined that in domestic operations, that is operations between counterparts of the same country, banks have benefitted from the aggregation process. This study, however, does not reach the same answer when it considers the cross – border aggregations.
Beitel and Schiereck (2001) obtained the same result through a study based on a sample of 98 cross – border M&As conducted by European banks over EU and extra-EU intermediaries coming from different fields of the financial markets during the period 1985 – 2000: by analysing the reflection of banks mergers on shareholders, they concluded that cross – border mergers destroy value.
1.5 Concluding remarks
The aim of this first chapter is to provide the reader with the key-tools to understand the process of concentration in the financial markets. Supported by evidences coming from the U.S. market, it has been possible to verify how the concentration process among banking intermediaries has been caused by changes in the external environmental. Rise of
inflation, mainly caused by the Vietnam War in the 1960s and the 2 oil shocks in the 1970s, technological innovation, that permitted to non-banking intermediaries to enter in the
loan market by becoming able to evaluate credit risk, globalisation, which decreased the entry barriers through a growing interconnection of national economies; and deregulation, often required in front of overwhelming changes in a business ecosystem, have caused a strong decline in banks’ core-business profitability, obliging them to find a way to restore adequate level of profits.
Companies usually have 2 different possibilities to support the expansion of activities: through the recourse to own resources (internal growth), or through the acquisition of other companies (external growth). When a company merges or acquires (M&A) another player, it means that it is financing its growth in an external way.
There are several factors that can explain the recourse of companies to M&As operations. These can be grouped into 2 different categories: business economics
motivations, mainly ascribable to an increase in efficiency, risk diversification, an increase in
market power, investment opportunities; and extra-business economics motivations, that refers to private and opportunistic reasons of managers or to protective/defensive purposes.
Changes in size and number of intermediaries in the credit markets can have severe repercussions on the market itself under 4 different perspectives:
1) Financial risk: on one hand, geographical diversification allows banks to limit the impact of systemic risk but not the operational risk, strongly related with the portfolio
composition. On the other hand, systemic risk can be transmitted with more intensity through a single larger entity, increasing the likelihood of cascading failure.
2) Monetary policy: consolidation can have an impact on the way in which monetary policies are implemented by Central Banks due to its impact on interbank market. Consolidation may increase in fact the cost of liquidity and hinder the process of arbitrage between the prevailing interest rates in the various markets.
3) Competition and credit: consolidation may have a negative impact on credit lending, in particular for householders and SMEs. The reasons is manly ascribable to the intention of large banking group to reduce the information asymmetry between the parts. Referring to the wholesale market, concentration may affect negatively the environment due to the increased market power.
4) Interbank payment system: consolidation reduces the number of payments in the interbank system but increases the amount of each transfer. Concentration of payment flows can increase the probability of contagion among intermediaries.
Consolidation process has been analysed even under the lens of the stock market performance of the banks involved in the M&A operation. Through an Event Study, the impact of the merge or acquisition is studied in order to quantify the Abnormal Return over the share price Normal Return. A positive Abnormal Return means that investors considers merge able to create value; a negative Abnormal Return, on the opposite, means that value destruction is expected.
C H A P T E R II
T H E E U R O P E A N B A N K I N G I N D U S T R Y
2.1 Concentration of the banking sector in Europe: general evolution
During the 1990s, financial systems of the major European countries have been subjected to deep changes that, with particular reference to the credit industry, have determined a substantial growth of competition, until then remained at very low levels. In front of these competitive pressures, banking intermediaries have reacted with a broad recourse to external growth with the aim of implementing their supply, increasing efficiency and obtaining the operative dimension essential to compete in an renovate environment.
It is possible to describe the evolution of European banking industry under the lens of the chronological evolution of the European integration. After the II World War, European countries realized that the only way to prevent other destructive conflicts was to begin a process of economic, social and politic integration. The first effort in this direction was represented by the establishment of the Coal and Steel Community (Treaty of Paris, 1951) followed by the will of future integration in other economic areas. A turning point in the European integration has been represented by the signature, in 1957, of the Treaty of Rome that led to the foundation of the European Economic Community (EEC) aimed to allow freedom of providing goods, services, labour and capital across Member States within the Community. Although several progresses were achieved in some areas, including the creation of common customs, the abolition of quotas and the free movement of workers, full integration remained incomplete.
