The Safety and Soundness Effects of Bank M&A in the EU: Does Prudential Regulation Have any Impact?

• Date: 01 June 2015
• Published date: 01 June 2015
• DOI: http://doi.org/10.1111/j.1468-036X.2013.12022.x

The Safety and Soundness Effects of

Bank M&A in the EU: Does Prudential

Regulation Have any Impact?

Jens Hagendorff

University of Edinburgh, 29 Buccleuch Place, EH8 8JS, Edinburgh, UK

E-mail: jens.hagendorff@ed.ac.uk

Maria J. Nieto

Banco de España, Alcalá 48, 28014, Madrid, Spain

E-mail: maria.nieto@bde.es

Abstract

This paper studies the impact of European bank mergers on changes in key safety

and soundness measures of both acquirers and targets. We find that acquirers in

cross‐border deals tend to perform better when their home country prudential

supervisors and deposit insurance funding systems are stricter than that of the

target. For target banks, we find that stronger supervision and tougher deposit

insurance funding regimes result in positive post merger changes in liquidity and

performance. Overall, while bank mergers have undermined bank safety and

soundness in some cases, our evidence indicates that strong regulation and

supervision can partly ameliorate this.

Keywords: banks, mergers, Europe

JEL classification: G21, G34, G28

The views expressed here are those of the authors and do not necessarily reflect those of the

Banco de España. The authors are particularly indebted to Larry Wall. The authors would like

to thank John Doukas (the Editor) and two anonymous referees for valuable comments. We

also thank Leonidas Barbopoulos, Allen Berger, Benton Gup, Arnie Cowan, Ignacio

Hernando, Paul Kupiec, Chen Liu, Tobias Michalak, Krista Minnick and Francesco Vallascas

as well as participants at the 9th INFINITI conference (Dublin), the Southern Finance

Association (Key West), the 2012 Eastern Finance Association (Boston) and the 2012

Western Economic Association meetings (San Francisco). This project was completed while

Jens Hagendorff was visiting at Banco de España. The usual disclaimer applies.

Correspondence: Jens Hagendorff.

European Financial Management, Vol. 21, No. 3, 2015, 462–490

doi: 10.1111/j.1468-036X.2013.12022.x

© 2013 John Wiley & Sons Ltd

1. Introduction

This paper examines post‐merger changes in the balance sheets and operating

performance of acquiring and target banks in the European Union before the start of

the global financial crisis with an emphasis on the implications for bank safety and

soundness. The EU has a policy of encouraging cross‐border mergers as a way of

developing a single market for financial services with the adoption of the euro providing

added emphasis on integrated financial markets in the eurozone. Bank mergers, both

within country and across Member States in the EU, may come with an added benefitin

the form of safer banks as weaker banks are taken over and financially strengthened.

Additionally, bank mergers may result in stronger post‐merger groups to the extent that

the target imports the benefits from relatively stricter consolidated supervision.

Alternatively, mergers could come with the cost of financially weaker acquirers and

targets. Banks could become weaker and more dependent upon the safety net if they are

able to reduce the effectiveness of regulation either by exploiting new opportunities for

regulatory arbitrage between countries or by obtaining greater influence or clout over the

prudential supervisors. This could come about from a weakening of the target’s

supervision due to its acquisition by a bank with greater influence over the supervisor or a

weakening of the acquirer’s supervision (such as by making the bank too‐big‐to‐fail) or

both.

1

Along with this study’s contribution to our understanding of bank consolidation in the

EU, this paper also provides unique insights into the impact of bank supervision and

deposit insurance funding systems on post‐merger changes in banking organisations. The

existing literature on post‐merger changes has focused on US mergers. The limitation of

such a focus exclusively is that US banks face a relatively homogenous set of prudential

regulations and a common deposit insurance premium schedule. In contrast banks in the

EU can have substantially different regulatory and no common rules on setting deposit

insurance premiums.

Our analysis focuses on three variables of interest to prudential supervisors: (1)

capitalisation as proxied by the equity capital to total assets ratio, (2) performance as

proxied by return on assets (ROA), and (3) liquidity as proxied by the funding ratio (the

ratio of liquid assets to the sum of customer deposits and short‐term funding). Bank

capitalisation has long been the focus of prudential supervisors as banks with more capital

have a greater solvency buffer for dealing with unfavourable shocks to asset values and

have easier access to liquidity in the markets. Higher performance similarly creates a

larger buffer providing greater ability to absorb adverse shocks to asset values and greater

ability to rebound as conditions improve. Liquidity also provides a buffer from

unfavourable shocks but in the form of time rather than loss absorption. If a bank absorbs

an adverse shock with low liquidity buffers, it may come under considerable stress to

obtain liquidity in the market in the short term, whereas banks with large liquidity buffers

will have time to demonstrate their underlying solvency to the market. Moreover, even if a

1

The phrase ‘too‐big‐to‐fail’(or TBTF) was made famous after the collapse of Continental

Illinois in 1984. The phrase has come to be taken to refer any financial firm that government

policymakers are likely to consider so important that they would not allow it to fail with losses

to its creditors. See O’Hara and Shaw (1990) for a discussion of the context of the original

phrase.

© 2013 John Wiley & Sons Ltd

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