In the Event of a Merger, Both Credit Institutions Would Face Enormous Costs

According to the German Federal Minister of Finance, Europe needs larger global banks to satisfy the needs of the economy. I beg to differ. The German industry is in no particular need of a larger national champion in the banking sector. Nevertheless, there are good reasons for a merger of the two largest private banks in Germany. To be specific, costs could be substantially reduced by closing redundant branches and merging back-office operations such as trading and compliance. With the business models of Deutsche Bank and Commerzbank varying considerably in their outlook, a “Deutsche Commerz” would also have a broader focus than each of the banks alone. This would probably make the merged bank more resilient than the individual banks are by themselves.

There is still a lot of consolidation potential on the German banking market. The problem lies in the implementation. In the event of a merger, both credit institutions – which are already troubled – would face enormous costs. Both banks have certainly not had very good experiences with takeovers. Even ten years after the purchase of Postbank by Deutsche Bank and of Dresdner Bank by Commerzbank, the acquired banks have not yet been fully integrated.

A merger between Deutsche Bank and Commerzbank will certainly not reduce the systemic risk. The size of the merged bank, however, which in the end would probably be much smaller than the sum of its parts, is not decisive here. A bank constitutes a systemic risk if, in the event of insolvency, it jeopardises the functioning of the financial system at national or global level and must therefore be rescued. Deutsche Bank does not necessarily outclass Commerzbank because of its size, but because of its level of integration into the global financial system. It is indeed difficult to imagine an institution whose systemic relevance is much higher than that of the Deutsche Bank at the moment. In the Financial Stability Board’s list of systemically important banks, only JPMorgan Chase is rated as more systemically relevant. Deutsche Bank is indispensable to the global financial system in several areas, including global euro payment transactions, foreign trade financing, foreign exchange transactions and business with fixed-interest securities.

Despite the poor profitability of the two remaining large private banks in Germany and many other institutions in Europe, the banking market has enhanced its resilience over the past ten years. At the end of 2018, the core capital ratio of the major euro zone banks was 14 per cent, with sufficient liquidity being available. The strong interdependence between banks and their home countries, however, is still a problem. In extreme cases, a so-called ‘doom loop’ between banks and sovereigns could be set in motion, with both sides finding themselves entangled in a downward spiral. Greater integration of the European banking sector is needed to cushion shocks and break the ‘doom loop’. This can be achieved through cross-border bank mergers, for example, or through a substantial expansion of intra-European trade in securitised bank loans.

Measured by their profitability, European banks are performing below average in international comparison. Although the reasons for this vary from country to country and from bank to bank, three major problems can be identified. Firstly, banks still struggle with old liabilities. In particular, the repayment of non-performing loans from the balance sheets of Italian banks has turned out to be a lengthy process. Secondly, the low interest rate environment in the eurozone is putting pressure on banks’ revenues. At the same time, many banks fail to reduce their operating costs. On average, costs have even risen, partly because of regulation having become tighter following the crisis. Thirdly, not all banks succeed in keeping up with technological progress. The competitive environment is increasingly changing with fintech companies offering bank-like services, though they are not regulated as strictly as banks. Those who want to remain competitive in the future must not oversleep the technological change. It will be particularly costly to spruce up many of the banks’ outdated IT systems.