Current financial turbulence has forced an aggressive wave of consolidation within the banking industry, as the financial institutions with the most robust balance sheets pick off those that are faltering under the liquidity constraints. The acquisitions of Merrill Lynch by Bank of America, HBOS by Lloyds, Lehman Brother’s north American businesses by Barclays, Bear Stearns by JP Morgan Chase and the most recent sale of Fortis’s Belgian insurance business to BNP Paribas will all lead to lengthy transition periods for the institutions involved. The speedy alignment of their businesses and operations will be critical to the success of these mergers and the overall stability of the financial markets.
These acquisitions have been driven by circumstance rather than being pre-planned take-overs. As a result, each acquiring bank will be facing some difficult decisions right now and a number of challenges. (Keep up-to-date with all the latest mergers and acquisitions here: The Credit Crisis Timeline
Mergers & Acquisitions (as of 7 October 2008)
Wall Street’s fifth-largest bank, Bear Stearns, is acquired by JPMorgan Chase for US$240m in a deal backed by US$30bn of central bank loans.
At the same time, in the UK, the Nationwide merges with two smaller rivals, the Derbyshire and Cheshire Building Societies.
US bank Merrill Lynch agrees to be taken over by Bank of America for US$50bn.
Britain’s biggest mortgage lender HBOS is taken over by Lloyds TSB in a £12bn deal creating a banking giant holding close to one-third of the UK’s savings and mortgage market. The deal follows a run on HBOS shares.
UK bank, Barclays, buys Lehman’s north American investment banking and trading unit for US$250m, and pays US$1.5bn for its New York headquarters and two data centres.
In the largest bank failure yet in the US, Washington Mutual (WaMu), the giant mortgage lender which had assets valued at US$307bn, is closed down by regulators and sold to JPMorgan Chase.
Wells Fargo announces it is set to buy Wachovia for US$15.1bn, which scuppers an earlier US government-backed rescue deal in which Citi would buy Wachovia’s banking arm for US$2.2bn.
French bank, BNP Paribas, buys the Belgian insurance business of Fortis.
“If you are on the Board of an acquiring company, the first thing you need to consider is the brand,” says Nigel Walder, CEO at Business Control Solutions (BCS). “For instance, Bank of America has bought Merrill Lynch but will it keep the name? It seems like an easy question but it is actually incredibly difficult to answer because there is inherent value in the name but by keeping separate brands, culturally, it will make it difficult to create one firm.” He argues that this cultural element is something that is not often considered at the initial stages of an acquisition but is a significant issue that needs to be addressed in order to drive synergies across businesses lines and operations.
Systems and Modelling Techniques
According to Bart Patrick, UK head of risk at SAS, another vital issue for acquiring banks is consideration of the multitude of systems and databases in place on both sides and how they are going to achieve an overall understanding of these systems. “This will have a direct effect on the amount of risk these banks have in running their business because their left hand won’t necessarily know what their right hand is doing,” he says. “There are also credit and market risk issues to consider because the acquiring bank will have its own asset and liability management in terms of its treasury systems but how does this align with their acquisition’s existing systems?”
He also voices concern about the analytical platforms that banks have in place for functions, such as portfolio management, customer data analysis or asset liability management, which might not necessarily produce consistent results. “The modelling techniques that are being used at each bank might deliver different results because of the way they are constructed,” he explains. “Fundamentally, the acquiring bank must ensure that it has a clean set of consistent, accurate data before it starts to re-model and align its risks and businesses.”
A further issue highlighted by Walder at BCS is people management because the biggest risk that a company has is actually people-centric. “Lloyds’s acquisition of HBOS represents significant cost saving opportunities so naturally employees are concerned about the security of their jobs,” he says. “When people are anxious and jittery, it is more likely that mistakes will be made.” He argues that the banks involved in the current spate of acquisitions need to work out what their business operating model is and get their senior management team in place as soon as possible in order to avoid operational risk.
In terms of risk management, he believes that aggregating credit and market risks will be a relatively straightforward task based on the assumption that the valuations are performed accurately across both businesses. “The operational risk world is changing though,” he says. “The focus was traditionally the calculation of capital required for compliance with Basel II, not on how these institutions manage down the risk in their operations.” He underlines the fact that the potential for operational risk has heightened dramatically, compounded by the fact that financial institutions do not have solutions in place that measure the operational risk associated with what’s going on in their underlying business on a daily basis. “Operational risk within these institutions will increase dramatically over the next few years,” he says.
The operating models that the new ‘super banks’ put in place will therefore be a significant decision. Most large firms have recently adopted a centralised approach to their operations compared to about five years ago when a decentralised structure was more common with greater autonomy among business units.
“We are now seeing the creation of huge financial ‘one stop shops’, which will create astronomically large organisations,” he says. “These banks are going to be made up of constituent parts of a business and each one will have its own culture and business dynamics and therefore it will be difficult, virtually impossible, to implement a centralised approach. This will make it very difficult to get a consistent customer experience across the firm.” In fact, Walder believes corporate customers are unlikely to see any benefits from the current bank consolidation for the next few years because banks will first focus on getting their own businesses and operations in order.
Impact on Corporate Customers
It is clear that banks must continue to offer advisory services to their corporate customers who will also require committed lines of liquidity over the next few years. It is also true to say that risk appetite is also lower so corporates with a higher risk profile will find it harder to gain access to credit but, according to Patrick at SAS, the current climate could actually provide the scope for an improved business environment for corporates with banks paying greater attention to their needs. (Also read: Finding Best Practice for Corporate Treasury in the Deepening Credit Crisis
“Corporate customers – and the amount of investments they hold with these financial institutions – are the lifeblood of these banks,” he told gtnews. As a result, he argues that banks need to deal with their customers’ concerns quickly and comprehensively. “If I were a corporate customer, I would be asking for a measure of liquidity from my banking partners,” he says. “Banks should be able to implement some form of liquidity modelling and management immediately.”
A liquidity measurement and standard is certainly something that the industry will see put in place in the future he believes. “Basel II has done a great job in making sure everyone has enough assets to cover their liabilities but we also need to measure how cash-ready financial institutions are and that they have effective liquidity management in place,” he says. (Read more about liquidity risk models here:
For those banks that have acquired other financial institutions or parts of their business, risk management will be a significant factor in their transition period towards alignment of businesses and operations. Walder at BCS believes the fundamental challenge will be how they manage risk in a holistic manner, which includes credit, market, liquidity, operational, reputational and balance sheet risks. He also suggests that banks need to re-think their attitude to regulation.
“Regulators have been doing their best to install discipline via the likes of Basel II, Sarbanes-Oxley and MiFID, etc. Historically, firms have focused on the minimum to comply with these imposed regulations, with the result being silo-based solutions that are not joined up,” he says. “Firms should be looking at regulations from a more holistic perspective. If they took this culturally different approach then, by default, they would comply with the vast majority of new legislation with minimal effort and also have a far more robust control framework in place”.
While many still think the banking sector is characterised by legacy systems and lack of innovation, this could not be further from the truth. 2018 marks the year when a multitude of external factors will shake up the industry once and for all and reinvent the way people bank. Inevitably, this presents a threat, but also an opportunity.
There has been an uptick of treasurers inquiring about interest rate risk management in recent months as interest rates in the US and UK have started to show a rise in momentum, said Chatham Financial at the annual Bellin treasury conference.
The global economy has seen about eight years of growth, but we are starting to see the end of this which is triggering some volatility in global markets, Stefan Bielmeier, DZ Bank, argued in his keynote speech at the Bellin annual 1TC conference. Other speakers discussed blockchain, cyber crime and netting.
A series of governments are now very worried about the idea of bitcoin and these currencies because customers would be able to make sustainable ongoing transactions and payments without having to ever introduce the use of a typical financial model or banking system. To combat this potential threat, several countries including major central banks like the Bank of England and the Bank of Israel will be launching their own version of a cryptocurrency. This could bring big advantages to customers.