Fitch – Page 4 – Digital Finance Analytics (DFA) Blog

Political Risk Looms Large for Global Sovereigns in 2017

Global sovereigns face elevated levels of political risk and uncertainty in 2017, says Fitch Ratings, embodied by the unexpected election of President-elect Donald Trump in the US and the UK’s Brexit vote in June.

These risks are reflected in a trend away from political orthodoxy that reduces the predictability of policy direction in advanced countries in 2017. Combined with a general trend towards looser fiscal policy and greater trade protectionism, this carries risks to sovereign creditworthiness among both advanced economies and emerging markets (EM), although the overall outlook for Fitch’s sovereign ratings in 2017 is stable.

While the large majority (82 of 114) of Fitch’s sovereign ratings retain Stable Outlooks as we head into 2017, risks are clearly tilted to the downside, given the distribution of 25 Negative and only three Positive Outlooks. The threat of increased trade protectionism and a stronger dollar will maintain downward pressure on EM sovereigns’ macroeconomic performance and ratings, with 20 remaining on Negative Outlook as we move towards year-end. Key EM sovereign rating sensitivities will include the extent to which policy responses can mitigate the negative effects of subdued commodity prices, weaker trade flows and the potential for renewed dollar strength.

Fitch expects global GDP growth to increase to 2.9% in 2017, from 2.5% in 2016, driven largely by a pick-up in the US combined with a cyclical recovery in some of the largest EMs, which should more than offset continuing weakness in the eurozone and Japan. Our forecast of an acceleration in 2017 US growth to 2.2%, from 1.5%, reflects partly our assessment of the impact of President-elect Trump’s proposed reflationary policies, including corporate and personal income tax cuts combined with a focus on infrastructure investment. We expect this fiscal stimulus (totalling 0.5-0.75% of GDP) to produce a near-term boost to growth, but the president-elect’s rhetoric on trade policy increases downside risks to growth in the medium term.

Following the seismic political shocks of 2016, Fitch expects political risk to remain a key issue for sovereign creditworthiness in advanced economies in 2017, posing risks to medium-term economic growth prospects that would likely be negative for sovereign ratings. Euroscepticism and populism could affect European cohesion in the coming months, with the Italian constitutional referendum in early December to be followed by Dutch, French and German national elections in 2017. Any further significant political shocks triggered by electoral events in Europe could prove hugely damaging for the European project, although such a scenario is not Fitch’s base case.

With advanced economies failing to regain pre-crisis growth rates, the debate on global macroeconomic policy has shifted, with commentators, policy-makers and supranational institutions all calling for a move towards fiscal loosening and away from the reliance on ultra-loose monetary policy that has become the cornerstone of macro policy in recent years. This shift in policy emphasis is likely to be led by the US in view of the proposed reflationary domestic policy agenda and the prospects for higher interest rates. While it is likely to provide a near-term boost to growth, the fiscal impact of the Trump plan would likely be negative for US sovereign creditworthiness over the medium term, as tax cuts alone cannot generate enough growth to make up for the loss in revenue, leading to a deterioration in debt dynamics.

In Europe, fiscal loosening is already being pursued to some extent as austerity fatigue and a focus on political issues such as Brexit, the migrant crisis and security concerns have diverted attention away from fiscal consolidation. This has manifested itself in many eurozone governments moving away from a strict interpretation of the European fiscal rules, typically without sanction by the European Commission. This is likely to be growth-supportive in the near term but further undermines fiscal credibility. High public debt ratios remain one of the key rating weaknesses for western European sovereigns, meaning that few have material fiscal space within their existing rating categories.

Economic recovery in the largest EM countries should gain momentum in 2017 as crises in Brazil and Russia ease. Meanwhile, we expect the slowdown in China’s growth rate to continue on a gradual path, reducing to 6.4% in 2017 from 6.7% in 2016. In Fitch’s view, China will remain committed to its growth target of approximately 6.5%, particularly given the political transition of five of the seven members of the Politburo Standing Committee scheduled for 2H17.

The threat of less open trade relationships between the US and key trading partners, including China, combined with a stronger dollar would be generally negative for EM countries, and particularly so for smaller open economies. A “trade war” between the US and China would have adverse consequences for GDP growth and inflation in both countries, and could lead to depreciation of the RMB and financial market risk aversion, which would likely spill over to other emerging markets.

Basel IV Proposals May Lead to EU/US Divergence

Basel Committee discussions on “Basel IV” at the end of November may expose deep divisions between national members and could lead to further differentiation between the EU and internationally agreed Basel standards, Fitch Ratings says. This would exacerbate challenges for market participants attempting to compare the capital strength of banks globally and could undermine confidence in a framework aimed at promoting a level playing field.

The latest Basel III amendments (sometimes referred to as “Basel IV”) seek to restrict the use of internal risk models, which are associated with wide divergences in risk-weighted measures, and potentially set overall capital requirements using the revised standardised approaches. EU politicians have expressed significant concerns in their parliamentary submissions ahead of a vote on the EU’s finalisation of Basel III on 24 November. Meanwhile, regulators such as Thomas Hoenig of the US FDIC recently warned against the dilution of the reforms and support tougher equity-based requirements.

If enacted the proposals are likely to increase capital requirements for lower risk-weight portfolios, such as mortgage loans, despite the committee’s intention not to significantly raise capital requirements for banks globally. European banks generally hold larger mortgage portfolios and would be more affected. EU regulators seek to balance the economic consequence of any increase in capital requirements against the challenges banks face to boost capital internally in light of negative yields and low growth prospects. EU lawmakers say they are aiming for “global standards with local calibration”.

In contrast, US banks would be less affected as they typically sell their mortgage loans to US government agencies and larger firms already hold capital on the higher of the standardised and internal ratings-based (IRB) approaches. US supervisors also might be more willing to set higher capital standards due to the more supportive operating environment and lower reliance on loan-based finance than the EU.

These tensions are likely to be reflected in two key areas in the 28-29 November Basel discussions. The proposal for a capital floor based on a certain percentage of the standardised approaches has the greatest potential for EU divergence. Whether the committee sets an overall floor or one for each risk category is important. EU lawmakers have publicly protested that a floor would severely punish stable banks focused on traditional low-risk lending, while banks with higher-risk assets would be less affected. The impact on European mortgage banks may be a key consideration here as residential mortgage loans are potentially most vulnerable, especially if a permanent capital floor were to be applied on a risk-category basis.

We believe outright elimination of internal ratings models for certain credit exposures is unlikely. The speech by Stefan Ingves, chair of the Basel Committee on 10 November did not mention this. EU lawmakers are concerned about the impact on credit flow to the real economy and have argued that working to enhance trust in IRB models is preferable to abandoning them for portfolios such as large corporates. We believe there would be a generous transitional phase-out period even if the committee does move away from using models for these portfolios.

We think it is more likely that specific constraints will be introduced to reduce risk-weight variability, as proposed for modelling mid-sized corporate and retail exposures, and to ensure a minimum level of conservatism, for example through the introduction of specific loss given default floors in models for residential and commercial real estate exposures. But other measures, such as a model floor for unconditionally cancellable commitments, which may effectively increase capital charges for these exposures, face opposition from both sides of the Atlantic due to concerns it would constrain banks’ lending capacity.

Digitalisation Key as European Banks Adapt Business Model

Large European banks’ ability to modernise their banking platforms and improve digital services will be critical to remaining competitive in the long term, Fitch Ratings says.

Data-Grapgic

But the cost of these new systems is high and comes at a time when record low interest rates are weighing heavily on earnings and burdensome regulatory changes are eating up time and resources. Banks that take too long, or which cannot afford to invest on a continuing basis, may see their franchise fall behind.

Banks are investing to ensure their support systems are compatible with their product offerings so they can service clients’ needs as seamlessly as possible. This is part of a wider shift from product-focused to client-focused business models, which we believe perform better over time. They are also responding to smaller, digitally focused challenger banks.

These challenger banks have shown some success in retail banking niches, but we believe economies of scale should give Europe’s large banks an advantage once they have successfully updated their infrastructure. The costs of compliance, credit risk management, and regulatory systems and staff will weigh particularly heavily on challenger banks as they develop. Small retail banks, like their larger rivals, also need to invest to address the threats of digitalisation, such as cybercrime, which we see as one of the greatest risks facing banks and one of the hardest to control.

As banks plan these investments, they are also having to adapt their business models to cope with a lower-for-longer interest-rate environment and regulations that are heightening capital and liquidity needs and, in some cases, driving changes to their legal structures.

The clearest impact of low rates is in traditional retail banking, where even interest-free deposits are no longer attractive and very low interest rates on mortgage loans are hurting net interest margins. Low rates are also making it harder for Europe’s banks to generate revenue from corporate lending and fixed-income products as investment demand is very low. Wealth management operations are feeling pressure due to the disappearance of risk-free returns on client deposits and a reduction in client activity.

The ability to adapt business models to meet these challenges can be critical for ratings. Over the past year we have downgraded Credit Suisse Group and Deutsche Bank based on our view that their capital markets-focused business models have become less resilient to changes in regulation and their business environment, especially as the banks are undergoing costs of implementing turnaround strategies, in Deutsche Bank’s case including substantial IT spend.

Successful execution of the strategies introduced by new chief executives of both banks in 2015 depends on building up stronger core client franchises. For Deutsche Bank, this is primarily with European corporates, for Credit Suisse it is largely with Asian high-net-worth individuals.

Australia’s Major Banks Face More Profitability Pressure

According to Fitch Ratings, the operating profit of Australia’s four major banks is likely to come under further pressure in the next 12 months, as stress emanating from the mining and apartment-building sectors continues to undermine asset quality, says Fitch Ratings. However, Australian banks are still likely to remain highly profitable compared with their international peers, and are in a strong position to cope with capital pressures that might result from upcoming regulatory changes.

The four major banks – Australia and New Zealand Banking Group (ANZ), Commonwealth Bank of Australia (CBA), National Australia Bank (NAB) and Westpac Banking (WBC) – posted the first drop in their combined pre-tax profit in eight years in the financial year 2016 (FY16). Pre-tax profit fell to AUD41bn (USD32bn), 7% lower than FY15. Profit was hit by a 36% increase in loan-impairment charges – albeit from a cyclical low – which reflected problems in the resources sector and its knock-on effects for businesses and households in mining areas. CBA was the only one to report pre-tax profit growth, of 2%. ANZ’s pre-tax profit dropped the most, by 22%, largely owing to restructuring costs and valuation adjustments. Further restructuring costs are likely in FY17, as ANZ says it is refocusing on the Australia and New Zealand market, and its profitable Asian institutional business. Restructuring costs also weighed on NAB’s pre-tax profit, but the sale of its UK business and partial sale of its life insurance operations are now completed and will not affect FY17 results.

Fitch expects Australia’s banks to face a weak operating environment again in FY17. Net interest margins are likely to be squeezed further by higher wholesale funding costs, and tougher loan and deposit competition. Falling mining investment and weaker employment in the resources sector will continue to weigh on the performance of banks’ mining sector exposure, despite the recovery of some commodity prices this year. Increased technology expenses and compliance costs will undermine efforts at cost management.

Property developers may also soon start experiencing problems settling agreed apartment sales, which may feed through to banks over the next 18 months. The decision by the four major banks earlier this year to stop lending to non-resident property investors means the latter are now likely to find it harder to source finance to complete agreed purchases, and may back out of deals.

Australia’s major banks are in a good position to cope with the weaker conditions, in our view, as their balance sheets are robust. All banks have issued additional common equity in the last 18 months to boost capital buffers in response to regulatory changes. Even with a drop in profitability they have the flexibility to meet increases in capital requirements that might come with the introduction of Basel IV or changes to the Australian Prudential Regulation Authority’s guidelines.

Moreover, their direct exposure to the mining and property development sectors is relatively small and manageable. Asset quality is likely to remain relatively strong in the absence of broader problems in the mortgage market, which dominates banks’ balance sheets.

High underemployment appears to be creating stress for some mortgage borrowers – arrears have risen over the last year, albeit to a still-low 1.14% of total mortgages. Moreover, high debt levels make households vulnerable to a rise in interest rates or further deterioration in the labour market. However, Fitch does not expect the Reserve Bank of Australia to start raising its cash rate until 2018, and the unemployment rate is likely to remain stable. Improvements in banks’ underwriting standards since mid-2015 should also provide a cushion, especially since the sharp increase in property prices since then has boosted the equity of earlier home buyers.

Trump Regulatory Changes May Not Be a Win for Banks

Fitch Ratings says US financial institution (FI) regulatory reform may feature as a priority legislative agenda item, reflecting the campaign of President-elect Donald Trump as well as the ongoing views of several key majority Congressional leaders.

Fitch does not foresee any changes to US FI ratings as a result of the election. Changes that potentially reduce capital or liquidity requirements are likely to be a negative, but the impact on individual ratings will depend on how banks respond to this change. To the extent that capital or liquidity levels decline materially, that could result in negative rating implications, but Fitch views this scenario as unlikely.

The Dodd-Frank Act (DFA) has featured as a target in President-elect Donald Trump’s campaign statements, but most aspects of DFA have been implemented, and it is unclear whether a wholesale repeal could pass or what a partial repeal may encompass.

The Consumer Financial Protection Bureau is a relatively high-profile target for those opposed to the DFA, but its elimination on its own would be unlikely to have a material impact for banks in the aggregate. Notably, there has been little specific discussion of peeling back the Volcker Rule or Resolution Authority, some of the more costly aspects of the DFA. Fitch notes that the reduction in proprietary trading activity linked to Volcker has been largely positive for banks, while the resolution process has been largely positive for banks’ governance.

Anti-Wall Street sentiment has been a recurring theme in the presidential campaign for both candidates, so it remains an open question as to the likelihood or urgency of any proposed financial sector regulatory reform or repeal. Smaller regional or community banks may be viewed as more worthy beneficiaries of regulatory relief than money center banks. In addition, the reintroduction of Glass-Steagall (GS) is unlikely to be a policy priority. The reintroduction of some elements of GS was included in both parties’ platforms, but it was not a prominent theme in the campaign. The industry is likely to continue to strenuously oppose regulation that would re-impose restrictions that had existed under GS.

It is also important to note that capital and liquidity requirements have not historically been dictated by the Legislature but through banking regulators in the US. The US has adopted Basel III and those requirements will continue to be implemented, regardless of the administration. Therefore, while aspects of the DFA may be peeled back, core banking regulation is unlikely to change.

Generally, US financial institutions’ performance tends to be correlated with the overall US macroeconomic environment, particularly as it relates to economic growth. Judging by the campaign, the new administration’s economic policy is likely to revolve around tax cuts, renegotiating trade agreements, de-regulation and higher infrastructure spending. However, it remains to be seen the degree to which Trump will implement or be able to carry out his policy initiatives and the long-term effect policy changes will have on growth.

In the near term, increased policy uncertainty could dampen prospects for private investment growth. If the Fed judged these effects were likely to outweigh the impact of any additional fiscal easing, it may prompt them to raise rates at a slower pace than previously expected over the coming year. This would delay any positive operating leverage from rate hikes out further, as the impact tends to be lagged. Overall, Fitch expects that incremental interest rate increases would be positive for banks’ net interest margins.

Political Uncertainty, Low Rates Will Weigh on 4Q U.S. Bank Earnings

Fitch Ratings says U.S. banks experienced modest earnings expansion in the third quarter of 2016 (3Q16) relative to 2Q16; however, earnings will not materially expand in the near term given political uncertainties, prolonged low interest rates, modest economic growth and softness in key economies globally, according to their 3Q16 U.S Banking Quarterly Comment which reviews the largest 17 U.S. banks.

“Political uncertainty has resulted in softer demand for commercial credit from businesses, particularly in the middle-market, which resulted in sluggish loan growth for most U.S. banks and could extend into 4Q16,” said Bain Rumohr, Director, Fitch Ratings.

After a strong start to the year, loan growth was muted, particularly for commercial loans. Fitch also believes a regulatory commercial real estate (CRE) regulatory guidance from December 2015 has impacted CRE loan growth. However, banks are increasing their consumer lending efforts with many growing credit card balances and mortgage portfolios while pulling back from indirect auto lending which has shown recent signs of weakness. Large mortgage originators all reported growth in originations and applications in 3Q16. Despite sluggish loan growth, deposit growth continues to be strong as consumers and businesses remain relatively less levered.

Overall most banks with large loan portfolios reported sequential improvement in loan losses, but Fitch expects losses to deteriorate from currently unsustainably low levels. Median credit losses for the group have been 50-60 bps lower than the FDIC long-term average over the last five quarters.

Citing a slowdown in growth and broad credit improvement some banks released loan loss reserves this quarter; however, JP Morgan Chase and Citi both built reserves tied to credit quality expectations and growth in consumer portfolios going forward.

Following a good 2Q16, capital markets results for the large global trading and universal banks were once again strong in 3Q16, relatively flat to 2Q but increasing 20% from the year-ago quarter. Higher revenues from FICC trading, drove the growth while equities trading remained relatively muted.

“As we expected, most banks reported flat or compressed net interest margins for the quarter and Fitch reiterates that a sustained and consistently steep yield curve will be critical to improving NIMs for a meaningful period and the shape of the curve to be more important than the level of short-term interest rates,” added Rumohr.

Given this persistently low rate environment banks of all sizes have been especially focused on controlling and/or cutting expenses. During the 3Q16 earnings season, many large U.S. banks pointed to new or expanded cost cutting measures to be carried out going forward In general, Fitch believes that many of the easier cost cuts have already been executed on and that incremental savings will be more difficult to produce going forward.

The Great Policy Rotation

Unconventional monetary policies have been better for asset prices than the real economy. A “fiscal reflation” may be the opposite. By James McCormack, via Fitch Why Forum.

The shift in policy emphasis toward greater fiscal easing in many advanced economies could support economic growth in the short term, but may be accompanied by financial market disruption. With markets so closely linked to the policy backdrop, investors should be sensitive to the risks ahead.

Policy settings at the European Central Bank and Bank of Japan, and the Bank of England’s post-referendum initiative, indicate that continued monetary easing outside the US is a certainty in the coming months. This is despite policymakers and markets’ increasing awareness of the unintended consequences of negative interest rates — most notably for bank profitability and the viability of pensions — and recognition that the benefits of easing are more evident in financial asset prices than the real economy. The first of these considerations has resulted in policies becoming increasingly complex, particularly in Japan. A widely drawn conclusion, based in part on central bank officials’ admissions that additional easing offers diminishing returns, is that monetary policy is running out of options and room to operate.

The “Three Arrows” of Abenomics Go Global

The international policy community is building a consensus that stronger growth requires current easy-money conditions to be maintained (except by the Federal Reserve) and supplemented by greater fiscal stimulus. The G20 leaders’ communique following the Hangzhou Summit tellingly listed “potential volatility in the financial markets” as the leading downside risk to the global economy, ahead of commodity prices, weak trade and investment, slow productivity and employment growth. Recognition of financial market volatility as the key global risk — when markets are being driven intentionally by central bank actions — point to a clear continued accommodative bias to monetary policy.

In the July update of its World Economic Outlook, the IMF sounded decidedly Japanese, making reference to the need for demand support and structural reforms “without leaving the entire stabilisation burden on the shoulders of central banks”. This will be a recurring theme at the upcoming IMF/World Bank annual meetings, where it is likely to face little, if any, opposition.

In Europe, the fiscal requirements of the Stability and Growth Pact are effectively non-binding for the time being, as shown by the Commission’s recommendation in July to impose no fines on Portugal or Spain after the Council found that neither country had taken sufficient action to correct excessive deficits. This reflects the political realities of today’s Europe, where anti-EU sentiment is high, and most evident on issues surrounding security and migration, and the imposition of fiscal austerity.

The absence of much debate on the traditional “three Ts” of fiscal expansion (timely, targeted and temporary), probably because they are already agreed, provides further confirmation of the growing acceptance of pending fiscal easing. The consensus seems to be that the right time is now, the best target is infrastructure spending, and whether it is temporary depends on how long central banks can keep interest rates lower than GDP growth, which is a reasonable proxy for the return on infrastructure investment.

Successful Fiscal Expansion Could Mean Market Uncertainty

There is plenty of evidence that monetary policy has not been as effective as desired at raising inflation and supporting economic growth in recent years. The most compelling is the degree to which “unconventional” policies have become accepted as necessary and rolled out with less surprise and impact over time. But there is no reason to believe that traditional fiscal policy will not work, at least in the short term, if large spending projects that contribute directly to GDP are undertaken, as is currently contemplated.

There are two reasons why financial markets could react unfavourably to successful fiscal expansion. First, there may be concerns that a return to stronger economic growth would weaken the case for continued monetary easing. Even without an immediate pickup in inflation, a growth spurt could call into question the justification for maintaining exceptionally easy money. Second, a “fiscal reflation” is possible, whereby an investment-led surge in growth contributes to higher prices and wages. Investment is typically more trade-intensive than consumption spending, and employment related to trade usually commands higher wages. This also lends support to the view that co-ordinated fiscal policy is most advantageous, as there can be cross-border growth support.

Successful fiscal scenarios would conflict with the understanding that policy interest rates will remain “lower for longer” and that inflation is improbable into the medium term. Given how widely accepted these tenets are, and the degree to which market positioning is aligned with them, what may turn out well for the real economy might be considerably less positive for financial markets. This is a risk for investors and policymakers alike.

The final risk with the turn to fiscal stimulus is that it does not work. Fiscal expansions are ultimately intended to be displaced by private sector growth that, once spurred by public spending, gains its own traction. An alternative and much less appealing result is a quick return to lower growth but with higher government debt when public spending has run its course. In that scenario, it would not only be Japan’s “three arrows” that other advanced economies emulate.

Mortgage arrears go against seasonal trends

From Australian Broker

Credit rating firm Fitch has described an increase in Australian mortgage arrears over the June 2016 quarter as surprising.

Released this week by Fitch, the latest Dinkum RMBS Index shows mortgage arrears rose 0.4% to 1.14% over the three months to June. On a year-on-year basis, mortgage arrears are 0.6% higher than they were at June 2015.

According to Fitch, the increase in arrears over the June quarter went against seasonal trends, with arrears that originated in the first three months of the year continuing through the quarter.

“The increase… was mainly in the 90+ days bucket, following the migration of the 30-60 days arrears in 1Q16 into longer-dated arrears,” Fitch said in statement.

“Historically, arrears that materialise in the first quarter are due to seasonal spending and tend to cure themselves in the next quarter. However, recent data indicates households that had financial difficulties in 1Q16 also had them in 2Q16,” the statement said.

While Australia’s unemployment levels are falling, Fitch believes increased levels of underemployment are likely behind the arrears increase.

As of the end of Australia’s unemployment rate sat at 5.6%, while the underemployment rate sat at 8.8%. Underemployed workers are defined as part-time workers who want and are available for more hours of work than they currently have and full-time workers who worked part-time hours during the reference week for economic reasons.

While arrears do appear to be increasing, Fitch said there may be some improvement as the impact of the Reserve Bank of Australia’s August rate cut works its way through the market.

“Monetary policy has not significantly benefitted mortgage performance in 2Q16 and lower mortgage rates only marginally helped 30-60 days arrears,” the Fitch statement said.

“However, the effects may be delayed and households may feel positive outcomes on arrears in 3Q16. The August 2016 rate-cut may also improve 2H16 arrears.”

Fitch expects 90+ days arrears to increase further in Queensland, Western Australia and the Northern Territory as the impact of the mining boom slowdown continues to be felt.

M&A is More Likely Among Mid-Tier EU Banks – Fitch

Mergers and acquisitions among mid-tier EU banks are more likely than large-scale deals such as between Deutsche Bank and Commerzbank, whose recent discussions were reported in the media, says Fitch Ratings.

This is because many of the larger banks, traditional acquirers of other banks, are capital constrained, making it more difficult to fund sizeable deals. Convincing board members and shareholders that consolidation is a sound choice at a time when returns generated by many EU banks are poor is likely to be tough.

Data published by the European Banking Authority shows that EU banks earned an average return on equity of only 4.7% in 2015, well below the 10% cost of capital that EU banks typically quote as a benchmark figure. Banks in more concentrated banking systems, such as Sweden, the Czech Republic and Slovakia, report relatively strong returns, suggesting that consolidation in countries with more fragmented banking systems would strengthen the banks.

The EU’s competition authorities may raise objections if two large EU banks wanted to merge. However, in a recent interview, Daniele Nouy, Chair of the ECB’s Supervisory Board, said “for us supervisors, in the euro area we do not see any markets with too few banks. I would even say that in some parts of the euro area there is room for consolidation and bank mergers.”

There are over 3,300 banks operating in the EU, but over half of these are savings and cooperative banks operating as part of mutual support banking groups. Smaller banks not linked to such groups may struggle to continue to operate independently in a challenging environment of low interest rates, mounting regulatory pressures and still sluggish economic growth. We forecast eurozone GDP growth of 1.4% 2017 and 2018.

Savings and cooperative banks that are part of wider groups benefit from operational support from central bodies or from liquidity and wholesale banking arrangements with specialist banks in their groups. The local banks continue to merge among themselves and there is a trend for greater centralisation, but at a faster pace in some countries than in others. In January 2016 Rabobank’s 106 local cooperative banks were merged into their central institution and the group now operates under a single banking licence. Germany’s two remaining central cooperative banks, DZ BANK and WGZ BANK, merged on 29 July, but over 1,000 local cooperative banks and over 400 savings banks operate in Germany.

Recent M&A activity among EU banks has mostly been tailored to specific situations, such as where vested interests are already present. The planned merger of Nordea’s and DNB’s Baltic operations, announced on 25 August, should be straightforward, as both are long-term investors in the region. However, even transactions involving acquirers with vested interests can experience high execution risks.

CaixaBank’s offer to acquire the shares it does not already own in Banco BPI is a good example. If CaixaBank takes full control of BPI, it should be easier to implement strategic changes at the Portuguese bank. The current ownership structure – where CaixaBank holds 45.16% of BPI but its voting rights are capped at 20% – has complicated this. Execution risks are high and lifting CaixaBank’s voting rights limit – a precondition for the take-over – is not yet agreed. Shareholders, set to vote on 6 September, were frustrated by a court injunction introduced by a minority shareholder. BPI’s general assembly will resume on 21 September.

Italy has acted to solve such corporate governance issues by requiring its popolari (cooperative) banks to transform into limited liability companies. This helped pave the way for the merger of Banco Popolare and Banca Popolare di Milano, which received regulatory approval on 8 September.

France’s Oddo et Cie’s acquisition of Germany’s BHF-Bank earlier this year is an attempt to strengthen a niche franchise cross-border. The combination of Oddo and BHF-Bank could be an interesting independent player with presence in two large European economies. BHF-Bank was the third acquisition Oddo had made in Germany in 18 months.

CMA Remedies Could Mean Slow Profit Erosion at UK Banks

Remedies listed in the Competition & Markets Authority’s (CMA) final report on the UK’s retail banking market could lead to a slow but steady erosion of profitability at the major UK banks, says Fitch Ratings. But the initiative depends on customers being comfortable sharing sensitive financial information with other banks and third parties, which could represent a major barrier.

The remedies hinge on using technology to ensure that customers get the best deal, implying a loss of revenue for the banks. For example, several of the CMA’s remedies are directed at making sure customers can either reduce or avoid overdraft charges, which the CMA says bring in one-third of total revenue generated by retail banking activities in the UK.

UK current account holders are already able to ‘switch’ their account between banks in seven days by using the Current Account Switch Service (CASS), in place since September 2013. CASS was set up by the UK government to improve competition, but switching rates remain relatively low. In 2015, only around one million customers, equivalent to 3% of current account holders, used CASS.