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Breakingviews - How to build a European JPMorgan

LONDON (Reuters Breakingviews) - Europe’s patchwork of middling banks is a major weak point for the bloc’s economy. Top regulator Andrea Enria, who chairs the European Central Bank’s supervisory board, is doing his bit to make cross-border mergers easier. But the creation of a lender with the heft to rival U.S. behemoths requires politicians to make it a priority.

A man walks into the JP Morgan headquarters at Canary Wharf in London May 11, 2012.

SIZE ENVY

The euro zone’s five biggest banks by assets - BNP Paribas, Credit Agricole, Banco Santander, Société Générale and Deutsche Bank – have a combined market value of 110 billion euros and generated 22 billion euros of earnings in 2019. JPMorgan alone is worth twice as much, and produced 38% more net profit.

That lack of scale worries the continent’s bank executives, but should also concern finance ministers like Germany’s Olaf Scholz and France’s Bruno Le Maire. Operating costs at the five major European lenders will consume 66% of combined revenue this year, using median Refinitiv estimates, compared with just 58% for JPMorgan, Bank of America and Citigroup.

The American giants also make expensive technology investments go further: JPMorgan Chief Executive Jamie Dimon can spread the cost of developing, say, a new fixed-income trading system over a much greater number of transactions than his counterparts at Deutsche and BNP. The mismatch cements the Europeans’ status as technology laggards, eroding their market share. Of the income from equities, fixed income, currencies and commodities trading earned by the industry’s top 12 players in the 18 months to the end of June, Deutsche, BNP and SocGen together pocketed just 13.6%.

Such U.S. dominance breeds a risky reliance among European companies on American balance sheets. JPMorgan, Citi, BofA and Goldman Sachs were bookrunners on 25% of German syndicated loans in the first half of 2019, according to Refinitiv data. A year later that proportion had roughly halved, as the Americans retreated just when pandemic-hit firms most needed cash.

ART OF THE DEAL

Mega-mergers of the kind that created the $280 billion JPMorgan are one solution to Europe’s scale deficiencies. A union of Deutsche and BNP, for example, would have a bigger and more diversified balance sheet. Its technology investments in wholesale and retail banking would pack a greater punch.

Enria and the ECB have recently tried to make dealmaking easier. In a July consultation paper, the supervisor said merging banks can use existing bespoke models when assessing the riskiness of different assets. This makes it easier for CEOs to predict how much capital the combined entity will need.

The regulator is also making a virtue of the fact that European bank shares consistently trade below book value. Buying a lender for less than the accounting value of its net assets creates a capital gain – known as badwill – which the acquirer can use to cover merger costs and clean up bad debt.

Nor will the ECB necessarily add extra capital charges after a deal. Indeed, supervisors even have the power to ignore cross-border exposures within the euro zone when calculating whether the combined bank should hold more capital under global rules for systemically important banks, known as G-SIBs. This could shield some combinations from a significantly higher buffer.

The ECB’s pro-M&A message helped grease the wheels for the 16 billion euro union of Spain’s Caixabank and Bankia, unveiled last Friday. But that relatively small-fry combination underscores that most European bank mergers have been domestic affairs.

NET INTEREST

There’s only so much Enria can do about this. Cross-border deals tend to be light on cost savings like branch closures. French, German and Italian mortgages, for example, are covered by different consumer-protection regulations and bankruptcy laws.

National watchdogs also get in the way. In theory, a pan-European bank can move spare liquidity to the most attractive lending opportunities. Yet while that’s technically possible under Europe’s Capital Requirements Regulation, regulators in Germany and elsewhere have blocked it. They’re worried about local savers’ money ending up funding, say, Italian small-business loans.

The regulatory playing field is just as uneven when it comes to capital. ING and SocGen are both in the same risk category under G-SIB rankings. But the Dutch lender’s common equity Tier 1 capital ratio was almost 2 percentage points higher than its French counterpart’s at the end of 2019, mostly because of a charge for systemic riskiness imposed by the Dutch central bank.

Ironing out these discrepancies is currently above Enria’s pay grade. European governments are reluctant to cede more power to his single regulator, since national taxpayers could still be on the hook if a big bank fails.

Yet there are glimmers of hope. Last year Scholz broke a long-held taboo in Germany by calling for a common deposit insurance scheme. More recently, European governments agreed to issue common debt as part of the pandemic response. Both could be seen as tentative steps toward tighter banking integration. The pandemic has underscored the role that large, diversified lenders can play in keeping companies afloat during a cash crunch. If they’re serious about building a European JPMorgan, national regulators and politicians will have to lay the foundations.

Breakingviews

Reuters Breakingviews is the world's leading source of agenda-setting financial insight. As the Reuters brand for financial commentary, we dissect the big business and economic stories as they break around the world every day. A global team of about 30 correspondents in New York, London, Hong Kong and other major cities provides expert analysis in real time.


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