ECB promises banks it will do more in urge to merge

Europe’s top banking supervisor has sought to persuade more of the region’s lenders to merge by clarifying its approach to takeovers in an effort to reassure executives that such transactions will be encouraged.

European banks have fallen further behind their US and Chinese rivals in profitability and size since the 2008 financial crisis, prompting officials at the European Central Bank to make regular appeals for the fragmented sector to consolidate.

In its latest effort, the ECB on Wednesday published a guide to how it would handle banking deals in three key areas, all of which it believes may have been perceived in the past as hurdles to lenders considering a merger.

The supervisor said it would recognise the accounting gain — known as negative goodwill, or “badwill” — that can be generated when a bank buys a rival for less than the fair value of its assets minus its liabilities.

The projected €2bn gain from negative goodwill was a key factor cited by Italy’s largest lender Intesa Sanpaolo in its takeover bid for domestic rival UBI Banca in February. Some analysts suspect the expected regulatory treatment of “badwill” also contributed to the collapse of merger talks between Deutsche Bank and its rival Commerzbank last year.

On Wednesday, the ECB clarified its position by saying it “recognises duly verified accounting badwill from a prudential perspective, expecting it to be used to increase the sustainability of the business model of the combined entity, for example by increasing the provisioning for non-performing loans, to cover transaction or integration costs, or other investments”.

The ECB also said it would not automatically impose higher capital requirements on banks that merge. Instead, it would take an average of both banks’ capital requirements as its starting point, which could then be “adjusted upwards or downwards on a case-by-case assessment”.

Finally, the supervisor said it would allow merging banks to continue to use their existing internal risk-assessment models to calculate their capital needs for a period of time.

Mergers and acquisitions between European banks have fallen dramatically over the past decade. Last year there were only 77 such deals worth just over $6bn, the lowest number for over a decade and a tiny fraction of the 218 deals worth $123bn done on the eve of the financial crisis in 2006, according to data from Refinitiv.

The case for consolidation was underlined by data published by the ECB earlier this year, showing that return on equity at the 113 banks it supervises fell last year from 6.2 per cent to 5.2 per cent — far below most of their US and Asian rivals. The sector’s profits are expected to suffer a further hit from the economic and financial disruption of the pandemic.

“Well-designed and well-executed consolidation can help address the overcapacity and low profitability problems that have been damaging the European banking sector since the last financial crisis, and thereby contribute to the overall financial soundness of the banking system,” Édouard Fernandez-Bollo, an ECB supervisory board member, wrote in a blog post.

“I believe that providing clarity about how we assess the risks and benefits of the consolidation projects submitted to us can help market participants develop consolidation strategies that are sustainable,” he said.