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

Date01 June 2015
Published date01 June 2015
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
Maria J. Nieto
Banco de España, Alcalá 48, 28014, Madrid, Spain
This paper studies the impact of European bank mergers on changes in key safety
and soundness measures of both acquirers and targets. We nd that acquirers in
crossborder 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 nd 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 reect 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, 462490
doi: 10.1111/j.1468-036X.2013.12022.x
© 2013 John Wiley & Sons Ltd
1. Introduction
This paper examines postmerger changes in the balance sheets and operating
performance of acquiring and target banks in the European Union before the start of
the global nancial crisis with an emphasis on the implications for bank safety and
soundness. The EU has a policy of encouraging crossborder mergers as a way of
developing a single market for nancial services with the adoption of the euro providing
added emphasis on integrated nancial markets in the eurozone. Bank mergers, both
within country and across Member States in the EU, may come with an added benetin
the form of safer banks as weaker banks are taken over and nancially strengthened.
Additionally, bank mergers may result in stronger postmerger groups to the extent that
the target imports the benets from relatively stricter consolidated supervision.
Alternatively, mergers could come with the cost of nancially 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 inuence or clout over the
prudential supervisors. This could come about from a weakening of the targets
supervision due to its acquisition by a bank with greater inuence over the supervisor or a
weakening of the acquirers supervision (such as by making the bank toobigtofail) or
Along with this studys 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 postmerger changes in banking organisations. The
existing literature on postmerger 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 shortterm 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
The phrase toobigtofail(or TBTF) was made famous after the collapse of Continental
Illinois in 1984. The phrase has come to be taken to refer any nancial rm that government
policymakers are likely to consider so important that they would not allow it to fail with losses
to its creditors. See OHara and Shaw (1990) for a discussion of the context of the original
© 2013 John Wiley & Sons Ltd
The Safety and Soundness Effects of Bank M&A in the EU 463

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