Bank mergers being delayed or possibly even scuttled by bureaucracy and political squabbling is hardly a Canadian-only experience, as witnessed by a serious fight that has erupted in the European Union.

The EU and Antonio Fazio, Italy’s central banker, locked horns in April when leading Dutch retail bank ABN Amro launched a US$8.2-billion takeover bid for Italy’s Banca Antonveneta. Two days later, Spain’s BBVA announced its own US$8.37-billion bid for Italy’s Banca Nazonale del Lavoro. If successful, a combined BBVA-BNLV would become the second-largest bank in the eurozone by market capitalization. The two offers rocked Italy’s banking sector, and prompted Fazio to declare immediately his intention to protect Italian banks from foreign takeovers.

Fazio’s mercantilist approach to his country’s financial sector is no surprise. He has built a track record of blocking key deals. The difference this time is that the European Commission’s spokesman, Oliver Drewes, has made it clear that Fazio — or any other central banker in the EU — will face severe repercussions should a transnational deal be killed.

The outcome of the public clash will undoubtedly have a deep impact across Europe. Governments in the eurozone have a common cause when it comes to fortifying their national financial sectors. So much so, in fact, that the European market today is made up of 12 separate and fiercely competitive banking sectors, despite the eurozone’s desperate need of consolidation and integration.

Cross-border mergers are rare. Between 1990 and 2000, Europe saw 49 mergers and acquisitions deals, each exceeding US$1 billion. Less than 20% were cross-border. Even then, they tended to be interregional.

Good old-fashioned nationalism is a key factor, as central bankers have turned protectionism into a populist cause.

On a more practical level, product differentiation has also proven to be a difficult hurdle to overcome. Unlike uniform consumer goods, which allow for manufacturing to be centralized, financial products are differentiated by local taxation systems, as well as divergent legal and cultural practices — making it harder to overlap production, draw synergies and create economies of scale. Information technology, for instance, has long been a key target for synergies. But in Europe, banking technology is structured around national consumers, which means in the event of a merger, IT is not always an area ripe for cost-cutting.

The absence of an integrated financial market is one of the biggest gaps in the economic infrastructure of the EU — an irony, given that the creation of a single European market is the original raison d’être of the EU. But the troubles Europe faces aren’t limited to this. Public opinion seems hostile to the idea of a pan-European constitution, while the stability and growth pact — long the fiscal anchor of the EU — is dead in all but name.

This is precisely why the EC is having none of Fazio’s politics. It is already making good on its pledge to tear down the barriers to cross-border financial mergers. It recently appointed banking experts from 25 countries to review EC rules and propose ways of closing any legal loopholes that governments could exploit to block foreign takeovers. It will then submit its recommendations on how to go about removing barriers to the European Parliament to vote on in September.

Europe’s failure to develop a supra-national banking sector has set it dangerously behind U.S. banks, at a time when U.S.
financial conglomerates are wielding formidable global power. Giants such as Citigroup and J.P. Morgan Chase are worth more than US$100 billion today. Compare that to Deutsche Bank, Europe’s premier bank, which has a market cap worth slightly less than US$50 billion, and the picture becomes clearer.

European banks are losing their edge even
in their own backyards, as their U.S.
counterparts have become the top choice of European multinational corporations because of their capacity to absorb risk and underwrite equity at a global level.

Unlike the past two decades, however, when top U.S. banks effectively conquered the global financial market following a wave of consolidation, European banks are now experiencing some of their most spectacular profits, driven by higher consumer borrowing and low debt provisions. Last year alone, the average equity of a retail bank in the eurozone grew 14%. Lending is accelerating across the continent, while the provision of bad debt has fallen considerably.

@page_break@The good times will probably keep on rolling: The global banking sector is about to be governed by a new set of regulations, known as Basel II. When Basel II comes into effect in 2006, it will cut the amount of capital that must be allocated against loans, including retail mortgages and lending to businesses. As a result, European banks will increase their capital liquidity, which they can use to expand.

A shift among Europe’s top bankers in favour of market consolidation is increasingly more palpable. A survey conducted at this year’s Davos world economic forum shows as many as four times more CEOs expected a substantial rise in cross-border mergers in 2005 than they did just two years ago.

Thus, for the first time since the idea of a common European market was conceived more than half a century ago, movements at different levels are coalescing to produce a real prospect for genuine market integration in the financial sector. This is exactly the path that the EU needs to go down if it is to foster proper integration, especially now that the stability and growth pact is gone in all but name, discrediting any uniform fiscal policy. IE