SEPA Drives European Merger Activity
‘ABN AMRO moves quickly in Barclays-deal’, ‘ING considers Benelux merger’, ‘Rabobank pops up in merger speculations in European banking sector’. These are just three headlines from recent editions of Dutch financial newspapers and a sign that consolidation of the banking sector has started.
Consolidation was always inevitable in Europe – there are approximately 8000-9000 financial institutions. The largest part is composed of relatively small banks that are primarily domestic. For example, the average market share of cross-border banking, including payments, has been around 15% for the last few years. For Rabobank, the cross-border share is 2% of which there are 2 billion payment transactions per year in total. In the Netherlands, domestic sector consolidation has already happened. The top three Dutch banks are responsible for approximately 80-90% of the finance sector’s balance total. In Germany, on the other hand, by far the largest institution, Deutsche Bank, has a market share of less than 10%. Not surprisingly, Germany is one of the most fragmented financial markets.
In a merger, usually a more efficient institution takes over a less efficient one based on the cost-income ratio and the return on equity (RoE). Inefficiency is often caused by problems in operational management, the distribution infrastructure or, in most cases, bad management.
Also, when looking at payments services in Europe, there are big differences between countries. A European Commission (EC) investigation into the payment cards markets revealed intra-European price differences between 100% for consumers and 650% for SMEs and corporates. In southern Europe, banks earn around 20-30% of their income through payment services; while in the Netherlands, the delivery of payment services is, on average, a loss-making or break-even business.
Compared to other economic blocks, particularly the US, the (financially) fragmented EU, with higher operational costs and a higher capital market interest rate, is demonstrably less efficient. It is not an understatement to say that resolving this fragmentation is a huge challenge.
In an attempt to turn the tide, in March 2000, the EU heads of states and governments agreed to make the EU “the most competitive and dynamic knowledge-driven economy by 2010” under the Lisbon Agenda. Integration of the fragmented national financial markets into one European market was one of the most important preconditions. For that purpose, the EC developed the Financial Services Action Plan (FSAP) with 42 measures including the new international accounting standards (IAS); Markets in Financial Instruments Directive (MiFID) and Basel II framework.
The EC also called for transparent payment services in the eurozone: the single euro payments area (SEPA). The formation of SEPA is aimed at removing the national differences in the field of regulation, technology, procedures and costs (market imperfections) where “everybody will be able to make any payment as easily, safely, efficiently and inexpensively as within national borders,” in the words of EU Commissioner McCreevy.
As a result of existing differences, harmonising national market practices and legislation between the euro countries will take a lot of blood, sweat and tears. In addition to ongoing high costs for maintenance and service continuity, the number and magnitude of imposed investments are huge. In the coming years, each European financial institution will have to make substantial investments in new product systems in order to comply with legal demands. Boston Consulting Group estimated average investments for the period until 2010 at US$80-120m per individual bank. A large part of the costs in delivering payment services is fixed. Another factor is that large banks suffer from what are called ‘legacy’ systems at the end of their lifecycle, which hinder decisive commercial developments. Unfortunately, getting rid of legacy systems requires substantial investment.
Most of the European banks will not be able to bear the investments required for SEPA compliance. Many of them will have to look for opportunities to reduce costs by means of co-operation and outsourcing. Only a few of them will, via insourcing, develop into large processors. This category includes ABN AMRO with its transaction services business unit and Equens, the merger between the Dutch Interpay and German TransAktionsInstitut (TAI).
We have been waiting for large-scale consolidation in the field of processing payment transactions for a long time. Ongoing standardisation of payment and processing services in the eurozone will be an important facilitator.
European consolidation will not be limited to the domain of processing payment transactions. The formation of SEPA is expected to have a significant effect on the pricing of payment services. Cap Gemini has estimated a €18-23bn reduction in sector level payments business volume. We discussed earlier the differences in profitability of payment services between European countries and the importance of this source of income. Growing investment and a sharp reduction in income will lead to considerable shifts in national and international competitive relationships. Based on the financial newspaper headlines mentioned at the beginning of this article, we can see that consolidation of the European banking sector has finally started.