Consolidation and Strategic Positioning in Banking with Implications for Europe

THE UNPRECEDENTED RESTRUCTURING and consolidation that are occurring around the globe are probably best characterized as a financial services sector in flux. Transactions are particularly numerous and breathtaking in the United States and Western Europe, but restructuring is also occurring in Asia. Most striking is the escalating scale of mergers in banking. In just the last few years, in the United States mergers have led to a consolidation of money center banks (for example, the Chase Manhattan and Chemical Bank merger, prior to their subsequent merger with J. P. Morgan) and the emergence of regional powerhouses (for example, the expansion strategies of BankOne and Nationsbank and their mergers with, respectively, First Chicago/NBD and BankAmerica). In Europe mergers have also been prominent. Although cross-border mergers are relatively infrequent—with exceptions in Scandinavia and the acquisitions across the Dutch-Belgian border, ¹ such as the acquisition of the Belgian Bank BBL by the Dutch financial conglomerate ING—domestic mergers typically involve large universal banks and are often spectacular. Noteworthy examples include the marriage of the Union Bank of Switzerland with Swiss Bank Corporation and the acquisition of Paribas by Banque National de Paris. In Japan spectacular mega-mergers have put the Japanese banks among the largest banks in the world ranked by book value of assets.

A parallel phenomenon is the continued broad, if not broadening, scope of many banks. Even banks that traditionally followed well-motivated, focused strategies have given in to this trend. For example, Bankers Trust, with its activities aimed at the corporate market, has put itself in the arms of a scope-expanding universal bank (Deutsche Bank). Scope expansion also originates from investment banks. Major investment banks are redefining their domain by offering traditional commercial banking products like commercial and industrial loans and by moving into retail brokerage. The union of Salomon Brothers (investment bank) and Smith Barney (brokerage) within Travelers underscores the scope expansion in the industry. Similarly, Credit Suisse bought the U.S. stockbroker DLJ, and UBS bought Paine-Webber. The spectacular cross-industry merger by Citicorp and Travelers also brings insurance activities together with bank-oriented financial services. This concept is not really new, however. Some European banks—for example, ING in the Netherlands and the Belgian-Dutch conglomerate Fortis—already engage in bancassurance—that is, the combination of banking and insurance activities. Similarly, Credit Suisse expanded into insurance by acquiring the insurance corporation Winterthur. But in the United States, until passage of the Gramm-Leach-Bliley Act of 1999 many restrictions remained on combining banking, securities underwriting, and insurance.

One question is then immediate. Why are banks consolidating so much and expanding scope? The popular financial press points to the increasingly competitive environment of banking as the culprit. As commercial banking becomes more competitive, banks need to examine all possible ways to wring inefficiencies out of their cost structures. One way to do this is to merge with other banks and to realize efficiencies of scale through elimination of redundant branches and back-office consolidation. Moreover, the diminishing margins in commercial banking invite banks to look outside their traditional domain. Some nonbanking activities may offer higher margins and make scope expansion attractive.

However, these popular explanations are inadequate. The empirical evidence on scale and scope economies in banking is far from conclusive. It is questionable whether these economies are large enough to justify consolidation and scope expansion on the scale that we have observed. ² Moreover, ample research in corporate finance points to the existence of a "diversification discount." On average, diversification seems to destroy value. There is substantial evidence that firms that have refocused have experienced improvements in operating performance and stock returns. ³ Therefore, the important question is why so many mergers and acquisitions are taking place in the industry. This question becomes even more relevant considering the media and...