Lorenzo Bini Smaghi: Banking consolidation, innovation and access to
credit
Speech by Mr Lorenzo Bini Smaghi, Member of the Executive Board of the European Central
Bank, at CESIFIN, Florence, 11 December 2007.
* * *
1. Introduction1
Ladies and gentlemen,
I would like to thank you for inviting me to take part in this conference, which is covering a
very important topic, not only at European but also at local level.
As you know, the financial industry is going through an unprecedented period of
consolidation. Fundamental changes in regulation and technology have spurred a record
number of bank mergers and acquisitions (M&As) in most countries. Very recently, we have
even witnessed a significant series of cross-border M&As in the banking sector, especially in
Europe.
This consolidation has not only brought about major changes in the banking industry, but
also had important consequences for the economy as a whole. In my speech today, I would
like to talk about the implications of these developments for the financing conditions of small
and medium-sized enterprises (SMEs).
After briefly describing the consolidation process, I will consider its impact on: i) the banking
system as a whole, ii) shareholder value, iii) credit to SMEs, and iv) small banks. Moreover, I
will offer some thoughts on the possible implications of the current credit turmoil.
2. Banking consolidation
Let me start with an overview of the banking consolidation that we are currently experiencing.
In the last ten years, the number of banks in Europe (to be precise, in the 15 EU countries
prior to 2004) has decreased by almost 30%, while at the same time the total assets held by
the banking system has increased by more than 100%.2 This process implies that the
average bank size in terms of total assets has risen significantly, from €1.8 billion to more
than €5 billion, an increase of approximately 200%.
In Italy, banking consolidation has not been as strong as in the other 14 countries: the
number of banks has fallen by only 10%, banks' total assets have increased by 75% and the
average bank size has increased by 100%.
Bank mergers and acquisitions are the main path to bank consolidation. This activity has
been buoyant in Europe, judging from the number of deals and the volume, and also in terms
of cross-border transactions.3 Over 800 M&As have taken place in the past ten years, and
their total value is put at €500 billion. Italy alone has seen 200 such deals, with a total value
of €100 billion. All in all, the push towards consolidation in the banking sector has been
substantial.
There has also been a large number of cross-border M&As in recent years: over 100 in just
the past two years in Europe. In the last three years, the average value per transaction has
increased significantly, even without considering exceptional cases such as the acquisition of
ABN Ambro by RBS, Santander and Fortis. In Italy, by contrast, cross-border deals have
been few and of limited average value, both in comparison with other European countries as
well as with domestic M&As.
The main reasons for this unprecedented wave of consolidation in the financial sector are
common to most countries. In response to fundamental changes in regulation and
technology, financial institutions have attempted to improve their efficiency and attract new
customers by expanding internationally and adding to their range of products. The desire to
preserve falling margins by increasing market share and attracting new customers is often
fulfilled by way of M&As, since they allow financial institutions to grow rapidly and to improve
their knowledge of new products and markets.4
By achieving economies of scale and scope, mergers can make banks more efficient5, not
least by eliminating poor management, and might also help financial institutions to better
diversify their portfolios.
3. Effects on the banking system
There are several ways in which bank M&As can improve efficiency.6 First, bigger banks
may gain access to cost-saving technologies or spread their fixed costs over a larger base,
thus reducing average costs. Efficiency gains may also result from economies of scope: the
deal may allow the merging parties to enter new markets and cross-sell their products to a
wider customer base. Finally, consolidation may improve managerial efficiency. However, the
extent of exploitable scale and scope economies might be smaller than commonly thought,
and efficiency gains resulting from better management might be elusive in large, complex
institutions.
The direct costs arising from M&As can take several forms: consolidating different
organisations is not an easy task and may lead to inefficiencies.
There are also external costs. These can take several forms. First, for some financial
products (in particular, deposits and small business lending) markets are mainly local.
Therefore, M&As involving banks with large market shares might cause adverse price
changes, harming consumers. Second, M&As might distract some participants from small
business lending, which relies on soft information at local level, to less custom-made
products that are more easily manageable within large organisations, as I will elaborate on a
little later. Third, depending on the type of business and geography, bank M&As could harm
bank customers by reducing competition.
Therefore, since bank M&As affect not only banks themselves but also their customers,
quantifying the efficiency gains becomes difficult. An important first step towards analysing
some potential externalities to the bank customers is to assess the value created for bank
shareholders and depositors. This is what I am going to do now. Later on, I will analyse the
impact of bank M&As on the financing of small firms and on entrepreneurship.
4. Creating value for shareholders
The main message from the academic literature is that banking consolidation is beneficial up
to a relatively small size, but there is little evidence that mergers yield economies of scope or
gains in managerial efficiency.7 However, value creation from bank mergers and acquisitions
has improved over time, possibly because such activities are complex and because lessons
have been learnt.8
Moreover, most of the estimated value gains from bank mergers stem from cutting costs by
eliminating overlaps and consolidating backroom operations.9 In addition, mergers that focus
both on activity and geography enhance shareholder value.10
With respect to risk, there is evidence that M&As reduce bank risk. The evidence indicates
that the primary determinants in bank risk reduction comes from diversification gains, gains
associated with achieving too-big-to-fail status, and, to a lesser degree, synergy gains.11
5. Implications of mergers and acquisitions for small and medium-sized
enterprises
Now let me turn to some of the social benefits and costs stemming from banking
consolidation, in particular with respect to the financing of small firms and entrepreneurship.
Banking consolidation through bank M&As implies a reduction in the number of banks and an
increase in bank size. This can have repercussions on the access to credit for small and new
firms since bank M&As change bank efficiency and competition, but it also changes the way
banks evaluate corporate borrowers: it decreases soft vs. hard information for lending
decisions, i.e. bank M&As might distract some participants from small business lending,
which relies on soft information at local level.
The academic results based on US data suggest that small business lending increases
following a merger of small banks, but decreases when large banks combine. Therefore, in
the short run it looks as if small businesses are hurt by large bank mergers. This negative
effect, however, can partly be offset by lending from other banks in the same market,
especially after some years. That is, provided the banking system is competitive, so that
when the new and bigger post-merger bank starts cutting its lending to small firms, other
banks in the system will step in and start lending to those companies.12
As a consequence, in terms of lending volume to small businesses, bank M&As do not seem
harmful in the medium term. However, it could be the case that other lending standards
become tougher - especially loan spreads - after a merger. The empirical evidence
suggests that there is a reduction in spreads if the acquirer and the target bank have some
market overlap and, consequently, more potential for cost savings. However, spreads widen
when there is significant market overlap and, therefore, increased market power post
merger.13
In fact, when we look at megabank mergers in the US, empirical evidence suggests that this
type of merger implies shareholder value creation for the banks involved but losses for loan
customers, especially if they are small and credit-constrained, or if the acquisition is an
inmarket deal.14 All in all, the impact of bank M&As on lending to small firms depends on
whether the reason for the merger was to increase market power or to reduce costs and,
therefore, improve efficiency.
These conclusions appear to be even more robust when we also analyse the European
experience since, on this side of the Atlantic, banks play a special role in the financing of
many firms.15 Let me now consider some evidence from European countries.
The evidence is similar to the studies done with US data, and sometimes the evidence is
even stronger, since in Europe banks are the key source of finance for many firms.16 For
instance, Italian data show that bank M&As have an adverse effect on credit, especially if an
M&A is followed by the termination of a business relationship. The effect lasts for three years
and by the end of that period it has been absorbed, suggesting that firms are able to
compensate for the negative shock.17 In addition, also based on Italian data, contract interest
rates on bank loans fall when banks with small shares in the local banking market combine.
The opposite result is observed for mergers between large banks.18
Based on evidence from some countries, relationship customers of the target bank are more
likely than acquirer customers to have their relationships terminated with their bank. These
effects are more pronounced for smaller customers with no alternate lending relationships.19
Furthermore, mergers reduce the equity value of small publicly traded firms that are
customers of the target bank and the reduction in value increases with the size of the target
bank.20
6. Role of small banks
All in all, the evidence from Europe is very similar to that of the US. If small businesses tend
to suffer from bank M&As, especially when the banks involved are not small, then it seems
that there is a role for small banks. The key characteristic of lending to SMEs is the
"softness" of the information generated in the decision-making compared with large banks
that rely more on "hard" information. Hard information is based on accounting data and not
on personal knowledge and repeated interaction between lender and borrower.21 Because
soft information is important for lending to small businesses, the supply of credit to small
firms may be negatively affected by M&A activity because the resulting larger banks show a
preference for transaction-based lending over relationship-based lending.
In fact, evidence suggests that small banks use soft information for lending and are,
therefore, key for SME lending.22 Moreover, as I said earlier, M&As between small banks
increase bank efficiency and lending to SMEs. Small banks also lend to riskier firms, which
generally are SMEs.23
14
See Carow et al. (2006).
15
See ECB (2007).
16
See ECB (2007).
17
Bonaccorsi Di Patti, and Gobbi (2007).
18
Sapienza (2002).
19
Degryse, Masschelein, and Mitchell (2005). See also Sapienza (2002).
20
Karceski, Ongena, and Smith (2005).
21
Stein (2002).
22
Berger, Miller, Petersen, Rajan, and Stein (2005).
23
Jiménez, Ongena, Peydró-Alcalde and Saurina (2007).
BIS Review 147/2007
We have seen that after an M&A deal a bank is less likely to extend credit to small
businesses. Therefore, it could be especially difficult for those firms with almost no credit
history (e.g., start-ups) to obtain credit, especially after M&As between large banks. Empirical
evidence suggests that bank consolidation slows down the rate of new business formation
and that it is primarily driven by large bank acquirers. Consolidations between small or
medium-sized banks show a positive impact on new business development. But in any case
these effects are only short-term.24
As a result, the effects of bank M&As on new firms resemble those on the financing of small
firms.
7. Outlook
I would now like to touch upon developments in the current period of financial turbulence and
offer some comment on its potential impact on consolidation and firms' access to credit.
Obviously, it is very difficult at this stage to predict developments and I shall refrain from
doing so, but I shall nevertheless try to draw some conclusions.
The sub-prime mortgage crisis could give rise to three types of scenario. First, it would seem
likely that for a certain period of time securitisation will decline. The valuation of these
operations, which have a multiplier effect for banks and allow for credit to be used more
efficiently, has proved difficult, even for rating agencies. There will be a tendency for both the
rating agencies and the banks themselves to review valuation models of illiquid assets in
general.
Furthermore, financial intermediaries - in particular banks - will need to overhaul their
liquidity management practices. The strong demand for liquidity which we are currently
witnessing, and which continues to prompt banks to obtain funds directly from the monetary
authorities rather than from the interbank market, demonstrates that the risk of not being able
to liquidate assets quickly and at low cost on the market has been underestimated. A return
to normal conditions in the markets, hopefully in the New Year, will require some re-thinking
by financial institutions of their valuation models as well as their dependence, for their
liquidity management requirements, on other counterparties which could experience the
same kinds of difficulty.
Thirdly, some financial intermediaries may need to increase capital so as to absorb potential
losses or to refinance investment vehicles which until now were off-balance-sheet items, and
which, with Basel II as from next year, should appear on the balance sheet.
What impact will these developments have on banking consolidation?
On the one hand, banks could focus on themselves over the next few months and aim to
review their internal organisation, improve their balance sheets and restructure. There could
then be a pause in the consolidation process. Furthermore, the more restrictive financing
conditions could discourage mergers and acquisitions, which are often financed over the
short term by bank loans. On the other hand, one way of reinforcing the solidity of the assets
side of the balance sheet could be to proceed with either mergers or acquisitions. Recently,
we have witnessed a strengthening of the capital of some large banks with the emergence of
new shareholders, in particular foreign shareholders. The emergence of large sovereign
funds in countries where the financial system needs to be strengthened is an interesting
development for the international financial system, even if it raises a number of questions in
terms of transparency, objectives and stability.
Overall, the process of concentration may continue over the next few months and affect
some of the major financial institutions. Recent developments have also shown that the
process of concentration is not necessarily all in one direction, i.e. consolidation. In
particular, we have seen the break-up of one large European institution, which had perhaps
grown disproportionately large. The need to strengthen the asset base of some banks could
lead to the downsizing or elimination of some business lines, thereby creating opportunities
for other institutions.
What are the effects of these trends on credit to non-financial firms, in particular on small and
medium-sized companies?
On the one hand, the need for the restructuring and strengthening of assets, beyond the
drying-up of securitisation, could lead to a slowdown in lending by the banks, particularly
those more affected by the recent turbulence. On the other hand, maintaining the profitability
of the banks could lead to a reinforcement of the relationship with their own clients,
particularly the high-quality ones in terms of balance-sheet profitability and transparency.
From this point of view, credit to small and medium-sized companies, which is less
standardised, could suffer.
However, if some banks cease to pursue certain types of activity, in particular larger banks
which have more options with regard to the reorganisation of their activities, the current
turmoil could create opportunities for competitors to enter new markets in search of new
customers. Consequently, the level of bank competition could increase considerably in the
coming months and this could benefit the end customer.
It is still too early to predict which of these effects will prevail in the coming months. The
situation differs greatly across countries, sectors and institutions.
The most recent data on credit conditions indicate a further increase in the cost of financing
for non-financial corporations, particularly for debt instruments, i.e. excluding financing
through the stock market. Although the overnight rate remained practically unchanged
between June and September 2007, short-term bank interest rates on loans to corporations
increased by around half a percentage point in the euro area, and by a similar amount in
Italy. As regards long term interest rates, market rates fell by around half a percentage point
between June and September, but long-term rates on bank loans increased by 15 to 30
basis points. The Bank Lending Survey published by the European Central Bank at the end
of September indicates that conditions for credit to corporations have become more
restrictive as a result of the market turbulence. This tightening seems to have been more
pronounced for larger corporations, and this is in line with the evidence available for the
United States and the United Kingdom. Nevertheless, the fact that the cost of bank financing
has increased more than total financing costs, which also include market financing, might
suggest that credit conditions have become on the whole less favourable for corporations
that are more dependent on bank credit, in particular small and medium-sized corporations.
As regards the reasons for differing attitudes among banks with respect to credit activity, the
Bank Lending Survey provides evidence of a certain reappraisal of expectations regarding
growth, both in general and at sectoral level, as well as the cost and availability of financing
for banks, which are at the heart of the current market tensions. Indeed, in response to a
question added to the latest version of the survey, banks reported a perceptible worsening of
their own financing conditions, not only with regard to the interbank market but also to all
debt instruments and all maturities.
Despite the less favourable supply conditions, demand for credit and credit actually granted
remained very dynamic into the third quarter of 2007, not only in the euro area as a whole
but also in Italy. This suggests that, overall, it cannot be concluded that a credit squeeze is
currently occurring in the euro area. Credit supply conditions remain more favourable than in
previous surveys. This does not rule out less favourable developments ahead, in line with the
intentions recorded in surveys.
These considerations suggest that caution is needed when assessing future developments.
Too often in the past, hurried forecasts have been proved wrong in one way or another.
Therefore, it is important to closely monitor the underlying market conditions by asking
financial institutions to clarify, as soon as possible, not only their current balance sheet
positions but also their future strategies, in particular with regard to their relations with
customers.
Thank you for your attention.
References
Amel, D., C. Barnes, F. Panetta and C. Salleo (2004), "Consolidation and efficiency in the
financial sector: A review of the international evidence", Journal of Banking and Finance, vol.
28, n. 10.
BCE (2007), "Il finanziamento delle piccole e medie imprese nell'area dell'euro", Monthly
Bulletin, August.
Berger, A.N., A. Saunders, J.M. Scalise and G.F. Udell (1998), "The effects of bank mergers
and acquisitions on small business lending", Journal of Financial Economics, vol. 50, n. 2,
pp. 187-229.
Berger, A.N., L.G. Goldberg and L.J. White (2001), "The Effects of Dynamic Changes in
Bank Competition on the Supply of Small Business Credit", European Finance Review, vol.
5, n. 1-2, pp. 115-139.
Berger, A.N., N.H. Miller, M.A. Petersen, R.G. Rajan and J.C. Stein (2005), "Does function
follow organization form? Evidence from the lending practices of large and small banks",
Journal of Financial Economics, vol. 76, n. 2, pp. 237-269.
Berger, A.N., R.S. Demsetz and P.E. Strahan (1999), "The consolidation of the financial
services industry: Causes, consequences, and implications for the future", Journal of
Banking and Finance, vol. 23, n. 2.
Black, S.E. and P.E. Strahan (2002), "Entrepreneurship and Bank Credit Availability", The
Journal of Finance, vol. 57, n. 6, pp. 2807-2833.
Bonaccorsi di Patti, E. and G. Gobbi (2007), "Winners or Losers? The Effects of Banking
Consolidation on Corporate Borrowers", The Journal of Finance, vol. 62, n. 2.
Carow, K., E. Kane and R. Narayanan (2006), "How Have Borrowers Fared in Banking
Megamergers?", Journal of Money, Credit and Banking, vol. 38, n. 3.
Degryse, H., N. Masschelein and J. Mitchell (2005), SMEs and bank lending relationships:
The impact of mergers, Discussion Paper del CEPR, n. 5061.
DeLong, G. (2001), "Stockholder gains from focusing versus diversifying bank mergers",
Journal of Financial Economics, vol. 59, n. 2, pp. 221-252.
DeLong, G. and R. DeYoung (2004), Learning by Observing: Information Spillovers in the
Execution and Valuation of Commercial Bank M&As, Working Paper of the Federal Reserve
Bank of Chicago, n. 17.
Erel, I. (2006), The Effect of Bank Mergers on Loan Prices: Evidence from the U.S., Working
Paper of the Charles A. Dice Center, Ohio State University, n. 19.
Focarelli, D., F. Panetta and C. Salleo (2002), "Why Do Banks Merge?", Journal of Money,
Credit and Banking, vol. 34.
Francis, B., I. Hasan and H. Wang (2007), Bank Consolidation and New Business Formation,
Working Paper.
Gorton, G. and R. Rosen (1995), "Corporate control, portfolio choice, and the decline of
banking", The Journal of Finance, vol. 50, n. 5, pp. 1377-1420.
Houston, J.F. and M.D. Ryngaert (1994), "The overall gains from large bankmergers",
Journal of Banking and Finance, vol. 18, n. 5.
Houston, J.F., C.M. James and M.D. Ryngaert (2001), "Where do merger gains come from?
Bank mergers from the perspective of insiders and outsiders", Journal of Financial
Economics, vol. 60, n. 2-3, pp. 285-331.
Jensen, M. and R. Ruback (1983), "The market for corporate control: The scientific
evidence", Journal of Financial Economics, vol. 11.
Jiménez, G., S. Ongena, J.L. Peydró-Alcalde and J. Saurina (2007), Hazardous Times for
Monetary Policy: What Do Twenty-Three Million Bank Loans Say About the Effects of
Monetary Policy on Credit Risk?, CEPR Discussion Paper n. 6514.
Karceski, J., S. Ongena and D.C. Smith (2005), "The impact of bank consolidation on
commercial borrower welfare", The Journal of Finance, vol. 60, n. 4, pp. 2043-2082.
Penas, M.F. and H. Unal (2004), "Gains in bank mergers: evidence from the bond markets",
Journal of Financial Economics, vol. 74, pp. 149-180.
Piloff, S.J. (1996), "Performance changes and shareholder wealth creation associated with
mergers of publicly traded banking institutions", Journal of Money, Credit and Banking, vol.
28, n. 3(1).
Roll, R. (1986), "The Hubris Hypothesis of Corporate Takeovers", The Journal of Business,
vol. 59.
Ryan, S.J. (1999), Finding value in bank mergers, intervention at the Federal Reserve Bank
of Chicago conference on the structure and competition in the banking sector.
Sapienza, P. (2002), "The effects of banking mergers on loan contracts", The Journal of
Finance, vol. 57, n. 1, pp. 329-368.
Stein, J. (2002), "Information production and capital allocation: Decentralized versus
hierarchical firms", The Journal of Finance, vol. 57, n. 5, pp. 1891-1921.