Constancio Says ECB Supervision May Prompt Bank Mergers

European Central Bank Vice President Vitor Constancio said the region could see a wave of bank mergers as the presence of the Single Supervisory Mechanism prompts deeper integration.

“The weak profitability and excess capacity of the European banking sector suggests that efficiency gains could be achieved,” Constancio said at an event in Dublin today. “I would not be surprised if the SSM would open a period of restructuring in the European banking sector.”

The Frankfurt-based ECB is set to assume oversight of euro-area lenders in November 2014, as part of a regional banking union that aims to fix some of the faults of monetary union. The ECB has already started to examine bank balance sheets and has encouraged financial institutions to raise capital ahead of the publication of results next year.

“M&A activity has been very weak in the euro area since the crisis -- from 2008 to 2012 the overall value of deals decreased fourfold to just 10 billion euros ($13.5 billion),” Constancio said. “I expect this process of restructuring to be driven first and foremost by the incentives of the private sector to raise profitability and increase returns on assets.”

Limited Growth

Transactions involving western and eastern European lenders have slumped to $84 billion so far this year, putting it on track for the slowest year in a decade, according to data compiled by Bloomberg, as financial firms focus on boosting capital and cleaning up their balance sheets.

“European bank M&A could be driven by limited organic growth potential and the removal of uncertainty following the reviews as well as improvements in the sovereign debt crisis,” Berthold Fuerst, Deutsche Bank AG’s head of mergers and acquisitions for Germany, told reporters at a briefing in Frankfurt today. “That’s something that could start in the second half of next year and continue from there.” Deutsche Bank is Europe's largest investment bank by revenue.

Constancio said the ECB will use the most modern, forward-looking methods once it takes over supervision and push forward harmonization of banking practices across the region. The ECB will directly supervise about 130 of the euro area’s biggest banks, including Deutsche Bank and Intesa Sanpaolo Spa, and has the right to intervene directly in any lender in the currency bloc.

NPL Standards

“The SSM will have to address the problems created by the heterogeneity in the way that banks calculate risk-weighted assets,” Constancio said. “Investors seem to still have concerns about their robustness due to lack of transparency on how they calibrate their internal risk models, as well as differences in how models are validated across jurisdictions.”

In addition, the ECB will promote a more standardized treatment of banks’ bad loans, Constancio said. While the London-based European Banking Authority criteria on defining NPLs will take time to implement, the ECB will “adopt its own simplified standards” as it checks balance sheets, he said.

“We will explain by the end of January the methodology of an enhancement of this simplified version,” Constancio told reporters. “The EBA has two models; a more complex one and a more simplified one. The solution for the comprehensive assessment will be something between the two.”

A decline in the size of the banking industry in Europe can be expected, Constancio said, as well as a shift away from a bank-based model for funding the economy to greater importance for capital markets.

“The euro area would greatly benefit from deepening debt capital markets for long-term financing, in particular for infrastructure projects,” Constancio said. Even so, “I do not think we should go too far in the opposite direction and replicate the U.S. model” of high reliance on capital markets, he said.

“A balanced funding mix is best for financial stability,” he said. “We need to have profitable, viable and stable banks in the euro area.”

(Updates with comment from Deutsche Bank in sixth paragraph. See TOP CRIS for more on Europe’s debt crisis.)
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