The impact of banks dimension on profitability, sustainability and efficiency: An analysis for the Iberian financial system

A Work Project, presented as part of the requirements for the Award of a Masters Degree in Management from the NOVA – School of Business and Economics

Mergers and acquisitions in the European financial sector peaked in 2007 and then stalled following the liquidity crisis that struck in August of that year. From 2007 to 2009, volumes dropped by almost two-thirds as we saw unprecedented government bailouts and capital injections by governments and sovereign wealth funds. Inevitably, the crisis has made many investors wary. Concerns about asset quality persist and regulators have been forced to support the industry and prevent widespread fire sales. However, the lack of capital and liquidity that brought buyers to a halt is now triggering a surge in seller activity that can bring new M&A opportunities. Up to EUR 800 billion of equity is waiting to change hands (equivalent of up to EUR18 trillion of financial assets) from four sources: 1. Forced restructuring of bailed-out banks… Governments intervened to save “too-big-too- fail” banks, injecting almost EUR 200 billion of public capital in 39 institutions analyzed by McKinsey. Now, whether forced by either European or national regulators, many European banking CEOs are having to face restructuring programs. Such restructuring will of course release businesses into the market – in both core and noncore markets, separate banking from insurance, and reduce the asset base (by half in some cases), among other painful measures. 2. Government divestitures... Government bail-outs put around EUR 3 trillion of financial services assets in public hands. Growing public deficits, pressure from public opinion, and the desire to promote competition and realize profits will naturally drive governments to divest their holdings. 3. Need to strengthen capital base... Mckinsey estimates that European banks need around EUR 600 billion of equity to reach an 8 percent tier ratio. Despite the efforts to deleverage the balance sheet and improve capital ratios, banks are still hungry for capital. Given its scarcity in the market, players are being forced to divest in order to raise capital or make new calls on investors. 4. Need to exit sub-scale/non-core businesses... Industry returns are expected to be structurally lower, driven largely by the new regulatory frameworks. To reinvigorate these returns, financial institutions need to focus on reaching critical mass in their core businesses and divest sub-scale, non-core, and capital consuming operations. This will lead to a shift towards scale, and lines of business run by their best “natural owner” (the player best positioned to extract a high return from the underlying asset). The result will be that some of the moves in the last wave of M&A will unravel, and there will be a spate of mergers of equals looking for scale in their core business In such context, this Work Project gains a significant relevance. Determining, whether financial institutions in Iberia really benefited from years of organic and merger growth 3 to achieve sizeable results in terms of profitability, efficiency and sustainability. The crisis proved that even the larger banks needed rescue. Our project sustains that despite being more profitable, medium sized banks are more sustainable than larger and smaller ones.