|02 August, 2019

Digital realities and the comeback of industry shaping M&A

Infosys Finacle provides a breakdown of the primary factors driving this modern wave of consolidation in the banking sector

Image used for illustrative purpose. Businessman working with laptop computer and digital tablet on table

Image used for illustrative purpose. Businessman working with laptop computer and digital tablet on table

Getty Images/Busakorn Pongparnit

After a steep slump in consolidation activity during the financial crisis—barring the inevitable capital infusions, government-sponsored deals, and restructuring to salvage institutions—the upswing in the years following the crisis, especially after 2013, was a clear sign of the industry ‘shrinking back to health’.

Key deals such as the merger of RBS with local players, Citigroup’s withdrawal from unprofitable segments, and ANZ bank’s multi-year divestment programme in Asia dotted the M&A landscape during the period, but in the vigilant wake of post-crisis regulatory scrutiny, activity was limited to small banks at large.

However, the announcement of the BB&T-SunTrust merger in February this year, the biggest in a decade, has signalled a fresh surge in large banking deals. A similar trend is visible in other parts of the world too, where consolidation and restructuring are driving the response to market headwinds.

Earlier this year, in a first three-way merger in India, the Reserve Bank of India announced the consolidation of three public sector banks to form the country’s second-largest public lender. In the Middle East, an exceedingly overbanked region, the success of the merger between First Gulf Bank and National Bank of Abu Dhabi is setting a favourable M&A trend in motion. So, what are some of the primary factors driving this modern wave of consolidation in banking?

Pressure on ROE: Amidst decreasing interest margins and only a marginal increase in fees and commissions, the banking sector is plagued with declining ROE globally. Some banks in the EU and the US are battling to meet their cost of equity, and reportedly, EU banks were among the worst performing market sectors of 2018.

Banks are facing tough questions from their investors and have little choice but to optimise investments and achieve sustainable profitability, for which consolidation is a viable pursuit.

Huge technology investments: Leading banks on an average spend about $10 billion every year on IT-related technology requirements. In times when banks are faced with multi-dimensional change and unprecedented competition, any bank that is serious about increasing shareholder value would rather not justify investments like these when recourse exists.

High cost of operation: Translating reduction in operating costs into profitable performance is also driving modern consolidation activity, as banks are compelled to look at real-estate synergies, optimise footprint by reducing rental overheads, rationalise physical expenditure, and pass on these benefits to customers and investors.

Rising competition: The largest wallet provider in Singapore today is not a financial service provider but a ridesharing company called Grab. Apart from competition from such unlikely quarters, FinTechs and BigTechs continue to increase the scepticism around whether banks can be the successful digital platforms of tomorrow.

As banks reinvent their business model to stave off competition, they also need to transform traditional cost structures, and become leaner, meaner, and hungrier to win big. Because clearly, this rising digital tide is not one that lifts all boats.

Increasing regulatory costs: The regulatory mandate for capital adequacy in the years following the financial crisis severely affected the liquidity positions of banks. Regulatory pressures have only risen since then as new and emerging regulations continued to join existing ones to increase the cost of compliance.

Consider the continually evolving regulatory landscape from Basel II, Basel III to KYC, and more recently Open Banking, PSD2 and GDPR. The challenge of uncertainties associated with regulation and increasing compliance requirements can be overcome with consolidation, making it easier to navigate regulation and share costs which run into trillions of dollars for individual banks on an average.

The reasons stated above point towards the clear advantage of scale with consolidation in the current environment of constant change. What’s more, mergers and acquisitions augment human capital and synergies by bringing together the best of tech and business brains.

However, to achieve goals of improved efficiencies, greater economies of scale or even diversification, a thorough evaluation of the following considerations would hold banks in good stead:

Culture: Many an acquisition come a cropper due to cultural conflicts. To bridge the gap between the cultures of two merging entities, a planned integration and open communication go a long way and prevent post-deal misalignment.

Value articulation: Addressing potential concerns of external stakeholders, that is, customers, investors, and partners is as vital as allaying concerns internally. It is important for the investor relations teams to create a communication strategy that goes beyond just publishing the rationale, intent, and objective to include timely intervention with the right messages from senior management and a thorough assessment of the market sentiment and pulse of investors.

Existing IT landscape: Successful mergers make the common business goals of the merging entities possible with fewer resources. A key focus for mergers and acquisitions has always been the ability to allow banks to spread their costs over a broader asset base, reduce staff, and decrease branches.

But a new and extremely crucial consideration now, is also technology and IT. A large number of disparate systems often require the merging banks to bring in a third integrated platform for standardisation. A harmonised platform is essential to realise synergies and capitalise on the future digital possibilities, but it may defeat the purpose in the short to medium term due to costly IT investment at the outset.

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