(Bloomberg) -- The solution for Europe’s struggling banks, many of their CEOs agree, is consolidation that creates cross-continent superbanks -- an American-style fix that by several measures is slipping further out of reach.
Europe’s banking system is getting more fragmented, not less, 10 years after a sovereign debt crisis shook its foundations. While politicians accept some domestic mergers, they’ve resisted the idea of larger tie-ups.
The effects can be seen in cross-border lending: French, German, Dutch and U.K. banks’ outstanding loans were $1 trillion less in so-called periphery countries -- Greece, Ireland, Portugal, Spain and Italy -- than before the crisis, according to the Bank for International Settlements.
The retrenchment started soon after the 2008 global financial crisis. European Union governments bailing out their banks demanded that future lending be focused within national borders. The Balkanization got worse after the bailout of Greece by its EU partners in 2010, followed by troubles in Spain and Italy. The so-called banking union, an EU project aimed at creating a unified financial system, is still barely half-completed.
“The bleeding has stopped, but the blood has not been recovered,” said Jan Schildbach, head of research for banking and financial markets at Deutsche Bank AG (DE:DBKGn) in Frankfurt. “We haven’t seen a restoration of trust in the region’s banking system. That has prevented capital flow to the peripheral countries.”
Interest rates offer more evidence that the goal of a pan-European bank is getting more elusive. Borrowers in the four major economies pay significantly less than in the outlying nations, which for the most part are in Southern (NYSE:SO) Europe.
The European Central Bank became the main regulator for more than 100 of the biggest EU banks in 2014 as one of the three pillars of the bloc’s banking union initiative. The second pillar, a unified resolution mechanism to take care of weak banks, went into effect in 2016. There’s been no agreement on how to implement the final leg -- a centralized deposit-insurance program.
Despite becoming a central banking supervisor, the ECB hasn’t replaced local regulators or taken power from national governments, which are still loathe to allow banks under their authority to fail or be replaced by firms from other countries. Even though the central bank has been voicing support for cross-border mergers, politicians don’t look favorably on such tie-ups, especially if it means giving up on their national champions.
In 2017, when the ECB designated a small Spanish lender and two Italian peers as “failing or likely to fail,” Italy orchestrated a 17-billion-euro ($18.3 billion) government bailout. And last year, Germany spurned a bid from private capital for a stake in failing Norddeutsche Landesbank-Girozentrale in favor of a 3-billion-euro state bailout. Spain was the exception. It agreed with the ECB’s prescription, allowing creditors of its failing bank to bear losses in an ECB-orchestrated takeover by a larger rival.
What the CEOs say:
“The question for Swiss and EU banks has changed. It is no longer too big to fail, but rather too small to survive.” --UBS Group AG Chief Executive Officer Sergio Ermotti
“Europe needs more pan-European banks.” --UniCredit SpA’s Jean-Pierre Mustier
“The real chance of consolidation lies in crossing national borders in Europe. Only then is it possible for true European champions to emerge.” --Deutsche Bank AG’s Christian Sewing
Domestic mergers have come more easily because political resistance is lower. Italy’s biggest bank made an unsolicited bid on Monday for a smaller rival. Shares of Intesa Sanpaolo (MI:ISP) SpA, the buyer, and its target, Unione di Banche Italiane SpA, were little changed on Wednesday. UBI shares surged 24% on Tuesday to match the premium Intesa is offering.
Christian Scarafia, an analyst covering European banks at Fitch Ratings in London, said restrictions on the flow of money across borders is a big impediment to international mergers. “Also, financial products in the various European countries can vary and be subject to different rules and regulations, which makes it less efficient to be a region-wide bank,” Scarafia said.
Weak banks in some of the so-called core EU countries have also contributed to the decline in cross-border banking. German banks -- beset by losses from both the U.S. mortgage meltdown and the European crisis -- have cut their exposure to the periphery more than other lenders. French banks have halted much of their cross-border retrenchment, stabilizing at 2016 levels.
The ECB, through its long-term financing operations, has filled some of the gap by providing liquidity to lenders in need. Italian and Spanish banks have been the biggest borrowers from the ECB while German and French companies have the largest deposits sitting at the central bank.
The fragmented industry is one reason consumers and companies face vastly different borrowing rates depending on where they live. The average rate for new consumer loans in the periphery was 7% in December, compared with 3.8% in the core, according to the latest ECB data.
German banks, flooded with savings and unable to find enough domestic demand for loans, face margin compression. In Ireland, with a more consolidated banking system and higher demand, banks can lend at wider spreads.
Without a more integrated banking system, European financial institutions won’t be able to compete effectively against stronger U.S. rivals or their recently expanding Asian peers, Deutsche Bank’s Schildbach said.
“European countries are too small on their own to have a home market for their banks that is similar to the U.S. or China or Japan,” Schildbach said, adding that while the ECB and EU recognize the need for a more unified industry, “it’s not clear whether the national governments all see the need. And for real change, you need political agreement.”
(Adds Italian bank stock prices in 10th paragraph.)
