The information for this report was derived from a wide range of sources, although it should be emphasized that few statistics related to employment impacts of mergers and acquisitions in the sector under review were available. Extensive use was made of publications, press articles, websites and “grey literature”. In addition, valuable information was supplied by a number of employers’ and workers’ organizations. The report was prepared by Claude Duchemin and John Sendanyoye of the Sectoral Activities Department, on the basis of contributions from Michael Mesfin Gabre of the InFocus Programme on Strengthening Social Dialogue (Chapter 6) and Emily Sims of the ILO Equality and Employment Branch. Tan Peng Bo of the Bureau for Employers’ Activities and Robert Kyloh of the Bureau for Workers’ Activities reviewed and commented on the report, while John Myers and William Ratteree of the Sectoral Activities Department provided initial editorial assistance.

The report is published under the authority of the International Labour Office. It goes without saying that any attempt to identify the precise relationship between employment and mergers and acquisitions is complicated by other concurrent processes under way in the financial services sector. It is hoped nevertheless that this report will provide a basis for more detailed research and reflection on a phenomenon that is increasingly attracting the attention of policy-makers, employers, workers, researchers and other interested parties in the world of work.

Introduction

This report has been prepared by the International Labour Office as the basis for discussions at the Tripartite Meeting on the Employment Impact of Mergers and Acquisitions in the Banking and Financial Services Sector, to be held at the ILO in Geneva from 5-9 February 2001. The Governing Body of the ILO decided to convene this meeting at its 273rd Session (November 1998) as part of the programme of sectoral meetings for 2000-01.

At its 274th Session (March 1999), the Governing Body decided that the meeting should be composed of 60 participants and that the following 20 countries would be invited to participate: Argentina, Belgium, Canada, Ghana, India, Japan, Republic of Korea, Luxembourg, Mauritania, Mauritius, Nigeria, Panama, Russian Federation, Slovakia, Spain, Switzerland, Thailand, United Arab Emirates, United States and Venezuela. A number of countries were included in a reserve list from which further invitees would be drawn in the event that a government in the first list declined the invitation: Chile, China, Costa Rica, Dominica, Dominican Republic, Ecuador, Finland, France, Germany, Honduras, Jordan, Lebanon, Malaysia, Morocco, Portugal, Singapore and Tunisia. Furthermore, it was agreed that 20 employers’ and 20 workers’ representatives would be selected on the basis of consultation with the respective groups of the Governing Body.

The Governing Body decided that the purpose of the Meeting would be to exchange views on the impact on employment of mergers and acquisitions in the banking and financial services sector, using a report prepared by the Office as the basis for its discussions; to adopt conclusions that include proposals for action by governments, by employers’ and workers’ organizations at the national level and by the ILO; and to adopt a report on its discussion. The Meeting may also adopt resolutions.

This Meeting is part of the ILO’s Sectoral Activities Programme, the aim of which is to assist governments and employers’ and workers’ organizations to develop their capacities to deal equitably and effectively with the social and labour problems of particular economic sectors. The Programme also alerts the ILO to specific sectoral social and labour issues – primarily through tripartite meetings, which bring together a cross-section of government, employers’ and workers’ representatives from countries that are prominent in a given sector. In line with the reorientation of the ILO around strategic objectives since 1999, these meetings also set out to strengthen tripartism and promote social dialogue at the international level.

1. The banking and financial
services sector

Background

Mergers and acquisitions (M&As) are a global phenomenon, with an estimated 4,000 deals taking place every year.^[1] However, they are not a recent development; four periods of high merger activity, also known as merger waves, occurred in the United States (1897-1904, 1916-29, 1965-69 and 1984-89) before the current one that began in the early 1990s. This latter wave has attained exceptional levels in terms of sheer value and volume of transactions. In the United States, M&As have been instrumental in the decline in the number of banking organizations – between 1980 and 1997 they decreased from 12,333 to 7,122. Europe has also experienced similar M&As; examples include: Unicredito/Credito Italiano and Generale Bank/Fortis in 1998; and UBS/SBS, ING/BBL, Crédit Suisse/Winterthur Group and Vereinsbank/Hypobank in 1997. Between 1980 and 1995 the number of banking establishments in Europe fell, particularly in Denmark (-57 per cent) and France (-43 per cent).

Proponents of financial sector consolidation argue that institutions need size to spread growing information technology and processing costs over larger revenue bases. Another key factor is the need for greater market capitalization, with governments and financial sector regulators accepting financial operators’ arguments that greater size is crucial to cost-cutting and strong national institutions. Smaller countries are also encouraging consolidation to counter growing competition from larger institutions in neighbouring countries.

According to UNCTAD,^[2] the value of worldwide M&As has grown dramatically during the past two decades (1980-99), at the rate of 42 per cent a year. In 1999, their completed value was about $2.3 trillion, representing 24,000 deals.

Developed countries are the most important sellers and buyers in cross-border M&As, accounting for close to 90 per cent and 95 per cent of sales/purchases in 1998-99, respectively. Of the 5-10 per cent of sales/purchases involving developing countries, the bulk (70 per cent) originates in Latin America and the Caribbean. The value of cross-border M&A sales by developing countries increased from $12 billion in 1991-95 to $61 billion in 1996-99. M&A purchases by firms from developing countries rose from an average of $8 billion in 1991-95 to $30 billion in 1996-99.

Acquisitions are considerably more important than mergers in developing and transition countries. In developing countries, cross-border M&A sales fell in 1999, largely caused by reduced privatization activity in Latin America, where the value of cross-border M&As fell from $64 billion in 1998 to $37 billion. In developing Asia, they continued to grow, including in the countries most affected by the 1997 financial crisis. The value of cross-border M&A sales in Central and Eastern Europe doubled between 1998 and 1999 from $5 billion to $10 billion.

This M&A-driven consolidation is raising important public policy concerns, notably with respect to employment. Indeed, the announcement of a merger is usually accompanied by an announcement of cost-cutting redundancies in the merging organizations, often on a massive scale. To gain full merger benefits, two overlapping organizations are compressed into one, trimming duplicated operations which entails redundancies at all levels. It is nevertheless difficult to disentangle the employment effects of M&As from those of other factors such as increased competitive pressures, automation or the introduction of information and communication technologies which are similarly inciting organizations to restructure even in the absence of M&As.

The Director-General’s report, Decent work, noted that: “Policies of economic liberalization have altered the relationship between the State, labour and business. Economic outcomes are now influenced more by market forces than by mediation through social actors, legal norms or state intervention. International capital markets have moved out of alignment with national labour markets, creating asymmetrical risks and benefits for capital and labour. There is a feeling that the ‘real’ economy and the financial systems have lost touch with each other.”^[3] A key element of the “creative destruction” hypothesis advanced as a necessary precondition to full exploitation of the possibilities of the “new economy” is widespread rationalization and restructuring in all sectors. Finance is a key facilitator in this process.

In view of the rapid development in M&As worldwide, some information in this report (all received before mid-October 2000) will be outdated when the Tripartite Meeting is held in February 2001. Nonetheless the report provides an overview of the sector at a given time and pinpoints the principal forces shaping its performance and driving the consolidation process; it is designed to serve as a basis for discussion of employment trends in the banking and financial services sector.

The financial services sector: Characteristics,
role and general trends

Financial services support employment in two ways: as a source for high-quality employment and through a pivotal role in providing credit to other sectors. A well-functioning financial sector is essential in financing the operations of an economy through both intermediation (borrowing money from one sector to on-lend to another) and through auxiliary services such as securities broking and loan flotation, where financial enterprises arrange the processes of funding but do not step between the borrower and lender.^[4]

The institutions, services and products that comprise the financial sector vary from country to country, but generally include: the central bank; depository organizations such as banks, building societies or mortgage banks; credit unions or cooperatives; insurance and pension funds; general financiers; cash management firms; and others engaged in financial intermediation. The last category might include securitizers, investment companies, leasing companies, hire purchase and the provision of personal and consumer credit. In some instances, a wider perspective needs to incorporate not only the finance sector but also the business services that support its operation.

The financial system in any country has three overlapping components – financial enterprises (such as banks) and regulatory authorities; the financial markets (for instance, the bond market) and their participants (issuers and investors); and the payment system – cash, cheque and electronic means for payments – and its participants (e.g. banks). The interaction of these components enables funds for investment or consumption to be made available from savings in other parts of the national or, increasingly, international economy. Financial institutions mainly engage in intermediation and provision of financial services – for example, by taking deposits, borrowing and lending, supplying all types of insurance cover, leasing and investing in financial assets. Banks in most countries are the largest deposit-takers and financial services providers, but the market shares and power of other organizations like insurance companies is increasing. Banks and insurers are also among the largest and most profitable enterprises in both domestic and global markets. This is hardly surprising, since money, the business of financial services, went global before “globalization” became a buzzword; however, liberalization and technological advances are increasingly pushing the sector towards greater globalization in which M&As are both a cause and a consequence. Sixty-four banks and 53 insurance companies figure among Fortune Magazine’s Global 500.

Observers believe that cross-border M&As in the financial services will be the next phase once internal consolidation is complete and the drive towards higher concentration will only end when there are no more acquisition targets. Jacques Attali, former President of the European Bank for Reconstruction and Development, says that “in 20 years, there will be no more than four or five global firms in each sector. Alongside, there will be millions of small temporary enterprises subcontracted by the large ones”. David Komansky, CEO of Merrill Lynch, also believes only six to eight global banks will soon be competing on the world’s financial markets, with regional entities, notably in Europe and Asia, existing side by side with these big international players. Others believe M&As will continue given that companies restructure for various reasons including poor performance or changes in business strategies. Rapid Internet development makes medium-term predictions regarding the nature and pace of M&As in the financial services particularly risky as technology is increasing the ability of newcomers to contest certain “niche” markets and intensifying the competitive pressures that are contributing to sectoral consolidation.

A 1999 KPMG survey of company directors whose companies had participated in major cross-border M&A deals between 1996 and 1998 found that 82 per cent of respondents believed the deals they had been involved in had been a success. However, this was a subjective estimation as only 45 per cent of the companies had undertaken formal post-deal reviews. Benchmark analyses based on comparative share performance one year after deal completion found that only 17 per cent of deals had actually added value to the combined company, 30 per cent had produced no discernible difference and 53 per cent had actually destroyed shareholder value. Companies focusing attention on finance or legal issues (to the detriment of other areas) were found 15 per cent less likely than average to have a successful deal.^[5]

Factors driving M&As

Academics and other observers advance value-maximization,^[6] managerial ego, mimicry, the need to reduce uncertainty and defensive considerations (acquire to avoid being acquired; ensure that growth keeps up with that of competitors, etc.) and high levels of corporate reserves and share valuations among the motives behind consolidation in financial services.

Supporters of M&As allege that they facilitate synergies between merged organizations, generate efficiency improvements and increase competitiveness. Indeed, they hold that mergers, by increasing economies of scale and spreading costs over a larger customer base, enable financial operators to provide services at lower prices. Demonstrating that M&As improve efficiency is thus central to making the case for the consumer benefits of mergers and in assessing their potential impact on consumers.^[7] If mergers improve efficiency, then larger, combined firms may be expected to pass some savings on to consumers through lower prices or improved service.

If mergers are primarily cost-cutting exercises, involving job cuts and branch closures, the impact on consumers is most likely to be a lowering in the quantity and quality of services; individuals are affected by branch closures in rural regions and low-income urban neighbourhoods and have to bear the brunt of a generalized decline in quality resulting from reduced effort in certain product lines or service modes (e.g. teller service, cheque-cashing, transaction and other basic services). Those opposing financial sector M&As strongly contest their consumer gains and maintain that they only result in employment losses and diminishing access to services. Claims that small businesses – generally agreed to generate most employment worldwide – also benefit from mergers have met with considerable scepticism among those businesses themselves. Studies have indeed revealed that larger financial institutions tend to charge more and higher fees than their smaller counterparts and note an inverse relationship between the sizes of financial institutions and their loan portfolios to small businesses. Assertions that size generates economies of scale essential to compete in global markets have similarly been disputed on the grounds that size is irrelevant to international competitiveness and cross-border mergers (so far rare among financial M&As outside the Nordic region) would be more logical to international competitiveness. It has been argued from a pro-merger perspective that, rather than size problems, banks have “excess capacity in their domestic markets, which drives up their costs, making them uncompetitive both domestically and internationally”. According to this argument, mergers enable rationalization of networks and associated cost reductions.

Whatever the arguments, many countries’ competition policy in the financial sector is tending towards an easing of regulations and the elimination of obstacles between different market segments to promote greater competition among financial institutions. A paradox of these policy changes is that they seem to be encouraging concentration and formation of oligopolies, rather than increased competition, although the ability of technology to lower entry barriers to new types of financial service providers somewhat reduces the power of concentration. Furthermore, United States and European case studies suggest that despite the fact that M&As in the financial industry may be partly driven by potential efficiency gains, managers and governments, who appear to have more influence over consolidation decisions for financial institutions than for non-financial firms, may have other motives.^[8] Empire-building is included among possible non-value-maximizing motives given that executive compensation tends to increase with firm size, although part of the higher compensation of managers of larger institutions rewards greater skill and outcomes. Banking organizations may overpay for acquisitions when corporate governance structures are insufficient to align managerial incentives with those of owners; what is more, management teams with large ownership stakes often block outside acquisitions.

Many financial executives argue that preventing consolidation and the efficiency gains M&As make possible would be tantamount to forcing enterprises to engage in “social policy” through retaining unnecessary levels of employment and preserving distribution outlets that would be redundant in the event of a merger. They therefore believe that M&As are part of necessary restructuring to improve efficient use of resources – which can only be beneficial for long-term employment. But opponents stress the fact that financial sector operators lack transparency and accountability with respect to the social and economic impact of sectoral consolidation. They argue that privately owned financial institutions perform essential public functions and so government regulation is the corollary of the rather privileged and profitable positions these companies enjoy.

In most countries, the scope of regulation relative to M&As is narrowly focused on financial probity and competition issues; however, in some countries – such as the United States – a degree of socio-economic accountability exists. The Community Reinvestment Act (CRA) provides benchmarks under which bank performance on loans, investment and consumer service is measured whenever banks apply to expand their operations. Critics of mergers among financial service companies believe that an adaptation of this approach is needed to ensure consideration of the employment effects of organizational changes and to enhance transparency and accountability. Similarly, systematic tracking of banks’ transactions with the small business community may now be timely.

Deregulation, liberalization, market
integration and financial crises

The financial industry used to be highly regulated and compartmentalized even within domestic markets. With changes spurred on by advances in information and communications technologies and the expansion in international trade, this type of market organization was considered an obstacle to economic modernization. In December 1997, 102 countries signed an agreement to free trade in financial services under the auspices of the World Trade Organization (WTO). As in many other sectors of the economy, M&As in the banking and financial services sector are a driving force behind and a consequence of globalization. Global consolidation is accompanying and strengthening the internationalization of capital markets, as institutional investors and pension funds increasingly demand rapid access to worldwide financing sources and investment opportunities. Dramatic advances in technology, facilitating easier and faster access to information, mean that investors are almost instantaneously aware of corporate performance in different markets.

Nimble newcomers armed with a tight business focus and strong consumer brands are harnessing the power of technology to take advantage of deregulation and liberalization and gain a market share, thereby increasing pressure on profit margins of established institutions. Some have argued that financial services giants, especially banks, should emulate these new entrants, breaking themselves up and focusing on their constituent businesses; others believe this would overlook the real advantage of incumbency: scale, reach and enduring relationships with huge numbers of customers.

In Europe, integrating financial service markets and facilitating cross-border provision of financial services are a primary objective of the European Monetary Union (EMU). Mergers have so far been overwhelmingly domestic, directed at creating national champions. However, with the completion of the single financial market in the European Union (EU), consolidation across the whole area is expected to speed up. While wholesale banking services to large corporations are already global, retail banking has been, until recently, overwhelmingly domestic, with cross-border transactions accounting for only 1 per cent of total volumes. Some banks have chosen the Internet rather than mergers or the opening of branches as their route into cross-border retail business. Introduction of the euro and European Commission moves to speed up harmonization of EU regulation and the supervision of financial markets are expected to accelerate market changes and increase competition and efficiency. But many bankers are concerned that, with entry costs greatly reduced because of the Internet, monetary union opens national financial markets to competitors who can cherry-pick profitable segments – with the result that banks with low returns on capital increasingly risk being taken over by predators focusing solely on shareholder value. Nevertheless cross-border M&As in Europe are inhibited by national differences in customers’ financial service needs and how they are met. British and Spanish consumers, for example, roll-over credit card debt each month while Germans typically get credit through overdrafts, using debit cards for purchases; and German and Netherlands mortgages are at a fixed rate, whereas 80 per cent are variable in Spain.

According to Heikki Koskenkylä, head of the Financial Markets Department at the Bank of Finland, various segments of the EU financial markets are, to different degrees, already experiencing the effects of the euro. Since its launch, the idea of a single money market has gained momentum with short-term money markets, three-month interest rates and even long-term government bond rates converging rapidly. With the consolidation of national financial markets well advanced, many expect that the next stage will shift M&As towards creating pan-European institutions.

Financial crises, often a result of badly executed liberalization programmes, have given a boost to M&As. Deregulation has intensified competition via two mechanisms: by opening the sector to new entrants (foreign banks and non-banks) and easing the rules previously preventing expansion into various financial segments (retail banking, investment/merchant banking, etc.); and by encouraging development of new products and convergence in services provided by different types of financial operators. These developments have intensified competition, thereby reducing operating margins and profitability. Financial institutions compensate for the erosion in margins through a scramble for volumes and easing of credit standards which leads to a deterioration in loan portfolios. Property bubbles often form through this sort of sequence.

Given the importance of the financial sector to any country’s economic well-being, the risk of a sectoral meltdown usually has governments scrambling to intervene; sometimes they encourage sound institutions to merge or acquire distressed rivals to reduce sectoral capacity, increase margins for surviving institutions, thus hoping to restore some health to the financial system.

Many industrialized countries experienced such crises in the mid-1980s. Ten years later, it was the turn of the newly industrialized countries of Asia and Latin America to feel the crunch. The common factors in these crises are threefold: the extent and rapidity of regulatory change; overvalued property markets; and supervisory deficiencies. In the United States, approximately 1,500 commercial banks and 1,200 savings and thrift funds were liquidated, restructured or sold off under the aegis of the Federal Deposit Insurance Corporation (FDIC) between 1984 and 1995. In Japan, the entire economy was destabilized by the crisis in its financial services sector. The crisis in Asian emerging markets, where Japanese financial institutions were highly exposed, further increased the impact.

State intervention may also be a factor in financial sector consolidation, with governments acting as sellers in privatization. In Latin America and Central and Eastern Europe, privatization has been an important channel for attracting foreign capital; and in Africa it is the favoured means for transferring the expense of running burdensome financial institutions to private operators. In France the privatization of financial institutions in the 1990s allowed banks to engage in M&As or strike up partnership arrangements. In 1999, the scenario was different in Japan: the Government became a shareholder in several banks with a view to consolidating their capital and preparing strategic alliances. In return for this injection of public funds, Japanese banks committed themselves to liquidating 10 trillion yen of bad loans and to cutting 20,000 posts over three years.

The race for size, efficiency,
synergies and profitability

Global corporations today expect their bankers to have the expertise, products and presence to serve them anywhere. Many bankers believe that a greater resource base and presence across a wide range of markets is necessary to satisfy their corporate customers and argue that restrictions on M&As, including among major domestic financial institutions, should be relaxed to enable the development of institutions with the size and resources to compete globally. Consolidation for size and increased efficiency is for many the chosen strategy to stay alive and remain competitive. Economies of scale (size) and scope (product mix), long part of economists’ theoretical jargon, are now everyday topics in the financial community. In a radically consolidating industry, banks are also convinced that size is not only an effective defence against being taken over, but that M&As provide the springboard to increase profitability through greater economies of scale and improved operational efficiency. They argue, in addition, that M&As provide the necessary resource base for investments in such high-cost areas as product development and believe sufficient regulatory provisions not involving restrictions on mergers already exist to protect consumers from the increased concentration M&As might encourage.

There are those who believe that efficiency-based arguments in favour of M&As confuse size, cost-cutting and efficiency. Stephen Rhoades, United States Federal Reserve Board economist, explains the distinction between efficiency improvements and cost-cutting thus: “Reductions in operating expenses may result from cutting employees, closing branches, consolidating headquarters offices, closing computer and back office operations and so forth. Such reductions in expenses, however, do not automatically translate into improvements in efficiency as measured by an expense ratio, such as expenses to assets or revenues. Reductions in expenses may be accompanied by corresponding reductions in assets and revenues, which simply represent shrinkage of the firm rather than efficiency improvements. An improvement in efficiency requires that costs be reduced by more than any decline in assets (revenues).”^[9] Rhoades maintains that the failure to distinguish between cost-cutting and efficiency gains may partly explain the continuing disagreement between bankers “who emphasize the cost reductions to be achieved through mergers” and researchers “who generally study the efficiency effects of mergers”.

Synergy, achieved by combining the forces of two companies with complementary strengths, is another rationale advanced to support M&As. Some academics have questioned synergy as a justifiable basis for M&As – and post-merger experience of most firms would seem to support their doubts. One author has maintained that dreams of synergy lead managers to pay lofty acquisition premiums that are tantamount to making charitable contributions to random passers-by, never to be recouped by the buying company no matter how long the acquisition is held. In the case of most acquisitions, achieving significant synergy is unlikely; when it does occur, it usually falls far short of required performance improvements priced into the acquisition premium. Putting together two profitable, compatible, well-managed businesses is not enough to create synergy as competitors are ever present.

Whatever the motives driving M&As, many fear that the quest for size is leading to the unhealthy creation of superbanks. Sectoral consolidation and reduction in competition suggest no immediate benefits for customers or staff who find themselves in the front line of rationalization and having to bear the brunt of its costs. Consistent with the findings of many others, a study by the Bank for International Settlements (BIS) reports the experience of the majority of mergers as “disappointing”, with organizational problems almost inevitably underestimated and most acquisitions overpriced, noting the creation of banks “too big to fail”. The superbanks’ sheer size and unwieldiness can encourage complacency and offer no more protection against failure. However, the failure of such huge banks would be of such consequence that host governments may be forced to use taxpayers’ money to bail out any which encountered difficulties^[10] because of the serious implications for the financial system; consequently, this “virtual insurance policy” allows large financial institutions to pursue imprudent credit and investment policies. It has been suggested that international comparisons over a 100-year period show how changes in the structure and strength of safety net guarantees may affect financial institution risk-taking – and, by extension, the motive to consolidate to increase the value of access to the safety net, if financial market participants perceive very large organizations to be “too big to fail”.^[11]

Other critics contend that the rush to size and scale through M&As is rarely about market success and satisfying customers or investors, but more the product of the ambitions of chief executives and the need of investment bankers for ever-spiralling transaction fees. They compare the contemporary process with conglomerate mergers of the 1970s and asset plays of the 1980s, many of which were eventually unbundled. They stress that it is rare for the market power and scale economies associated with market dominance not to fall victim ultimately to hubris, insulation from the market and sheer bureaucratic inefficiency that goes with such size. Size creates greater complexity in terms of bureaucratic controls, slows the ability of organizations to respond fast to changing market conditions and leads to complacency.

Given the importance of credit access by small businesses to employment creation, it is essential to highlight the findings of a report^[12] on the impact of bank M&As on small business lending. The report stresses that the weight of evidence points to more negative than positive effects of banking industry consolidation on small business lending. Small firms can expect some difficulties in obtaining bank credit as the banking industry undergoes structural change and resultant adjustments in competitive market conditions. Whether the negative effects are short-run or long-run was impossible to discern from the data reviewed and the report recommends further research on the effects of consolidation on small business credit.

Information and communications
technologies (ICTs)

Technology presents both an opportunity and a threat to the financial services industry, especially banking. It enables enormous efficiencies in transaction costs and allows financial companies to reach a broader range of clients. Indeed, ICTs have had an impact on all aspects of financial services provision; they have helped reduce costs and modified the channels through which customers access services and products. According to data from the United States Office of the Comptroller of the Currency, the cost of average transactions at bank teller windows was four times higher in 1997 than the cost of transactions on automatic teller machines (ATMs) and a 100 times more than over the Internet. Computer and information management systems reduce operational costs by facilitating: the development of standardized products; automation of procedures; development of new credit-scoring programmes; organization of internal data transfers; and centralization of processing tasks away from branch networks. They enable the assembly and analysis of large quantities of information about customers, moving that information rapidly over long distances and providing remote access to banking facilities. All this provides the possibility of diversifying into additional business areas and improving tools for information and risk management. Competition is affected from both the demand and supply sides. Customers can more easily compare prices of services and shop around; barriers to entry into the retail banking market are lowered, allowing small and perhaps specialized banks and “niche” institutions to become competitive. Apart from the costs associated with developing and maintaining large-scale information management systems which place additional pressure on bottom lines, technology generates its own challenges. There is, for instance, understandable pressure on financial institutions to seek alternative, cheaper methods for delivering services than traditional brick-and-mortar branches. However, as remote banking turns from a supplementary to a core service in the longer run and branch networks are pruned, customers may also defect as information on financial service prices becomes fully transparent, overcoming the traditional inertia on which banks have long depended to retain customers. These developments are intensifying sectoral competition even more and exerting such pressure on profits that many observers believe many traditional financial firms may not survive. Increasing technological costs affecting banks’ viability are a factor usually mentioned for M&As.

Another technology-related problem for service providers involves the mix between self-service and personal contact in branches. Although technology contributes to higher productivity and cost reductions in a work-intensive industry, failing to strike the right balance between self-service and personal interaction with clients can result in a loss of clients, a clear majority of whom continue to prefer branches and personal contact despite the growing importance of ATMs and home and telephone banking. Computer-based access to banking poses its own set of problems. The technology is expensive, creating a barrier for low- and medium-income customers. To use the Internet, a consumer must have a phone, modem and Internet provider, which many low-income people (whose community branches are most likely to be axed first in cost-cutting programmes) cannot afford.

While Internet banking clearly has a potential to provide services for rural and remote customers, its use is not widespread in many countries. An Australian survey found that although 30 per cent of rural, regional and remote respondents had a computer, 90 per cent had never used the Internet; of those who had, only 4 per cent had used it several times. ABS statistics show that only 8 per cent of those outside capital cities had household access to the Internet and, from December 1997 to February 1998, only 0.3 per cent of those adults using the Internet paid bills or transferred funds via the Internet.^[13]

A PriceWaterhouseCoopers annual survey of customer attitudes to financial services over the Internet lends direct support to the above findings, ^[14] revealing that in 1998:

67 per cent of respondents were not comfortable if financial products and services were only available over the Internet – by 1999 this had increased to 70 per cent;

66 per cent of respondents were not comfortable providing personal details over the Internet – increasing to 71 per cent by 1999;

76 per cent of all respondents knew nothing or little about financial services available over the Internet. This position remained unchanged;

91 per cent of respondents said they needed a good or very good knowledge of the institution before they started using its products or services over the Internet – increasing to 95 per cent by 1999.

Consumers have other concerns. Although the Internet offers a wider choice and flexibility to access new products and conduct business at any time, some fear the risks of depersonalization in financial relationships. The chance of plunging into hazardous operations in the absence of traditional personalized professional guidance has increased tremendously – and it is easier to fall victim to fraudulent services providers. The British Banking Code Standards Board has released a report condemning online banks for giving “unacceptably low” levels of information to customers.^[15] A report compiled by the Foundation for Information Policy Research concludes that, unlike those with conventional accounts, the United Kingdom’s 2 million Internet bank customers may not be adequately protected from fraud,^[16] raising questions not just about stand-alone online banks but also about web services offered by the high street banks. In 1997, European Union Bank, registered in Antigua, collapsed – with its founders disappearing with the depositors’ money; it had marketed itself by claiming that “since there are no government withholding or reporting requirements on accounts, the burdensome and expensive accounting requirements are reduced for you and the bank”.^[17] Examples such as these discourage even those who might otherwise be attracted to online financial services. Thus, the general trend in industrialized countries towards a sharp reduction in the number of branches and staff to achieve cost savings parallel to the increase in alternative delivery channels may be a high-risk strategy.

There are growing predictions, however, that the financial industry is on the verge of a revolution inspired by the Internet and e-commerce. The Internet – and associated technologies such as digital television, smart cards and advanced mobile telephones – bring a number of challenges for financial services. Because set-up and transaction costs are low it makes it easy and cheap for Internet-only banks to be created from scratch and to offer very competitive products. The power of Internet-only banks, for instance, is illustrated by Egg, the direct banking arm of Prudential, which has persuaded a large number of customers to do their banking online although the bank offers a loss-making interest rate. Alliances, joint ventures and cooperative arrangements between financial institutions or other actors are springing up daily with the aim of starting online operations. In April 2000 the British bank HSBC announced an alliance with the investment bank Merrill Lynch to launch a global online banking and investment service. The scramble not to be left behind in online banking is accompanied by massive investments in marketing and communication facilities. The linkage between financial sector M&As and Internet expansion is best illustrated by the alliance between Telefónica, Spain’s biggest telephone operator and Banco Bilbao Vizcaya Argentaria (BBVA), the largest bank by capitalization on the Madrid Stock Exchange; they have taken shareholdings in each other, increased cooperation among some of their subsidiaries, announced intentions to develop joint Internet-based banking and have a joint subsidiary, Uno-e, offering mobile phone-based Internet banking services. Uno-e recently merged with the United Kingdom’s First-e to create UnoFirst Group. In the same manner, the French-Belgian bank Dexia announced the launch of mobile phone banking in association with Nokia. These link-ups between banks, telephone operators or manufacturers are already common in Scandinavia, where the Swedish-Finnish MeritaNordbanken operates mobile phone banking services.

Some bankers predict that banks from different countries will soon team up to develop alternative Internet-based distribution strategies to bypass the need for domestic branch networks. They believe an institution with the right strategy could leapfrog the domestic competition, much as the outsider Royal Bank of Scotland (RBS) achieved a dominant share of the English insurance market through its telephone subsidiary Direct Line. M&A advisers are therefore preparing for a new wave of consolidation, this time with European banks buying smaller outfits – not using their own equity but that of their Internet start-ups, just as BBVA and Telefónica did when they bought First-e.^[18]

New market entrants

Commercial bank operations cover a wide range of activities that can, a priori, be carried out independently of one another. There are, however, advantages in bundled delivery (for economies of scope) and in a one-stop service centre for consumers. This has a direct impact on the number and nature of M&As in the sector. But there is no reason why each service could not be generated by different producers, particularly as globalization and technology facilitate profitable market segmentation.

Globalization has made a difference in three ways. First, global capital markets make it easier for any reputable company – big or small – to raise capital. Physical size is no longer a precondition for attracting capital and the advantage of size is thus diminished. Second, the removal of barriers to geographic competition gives companies access to millions more customers, so those companies can build big customer bases even if they focus on just one narrow product. Finally, the digital revolution means that a business can be built on much narrower specialities for several reasons. For example, it used to make little sense for a bank to outsource credit card processing; it was cheaper in-house, even if the bank was not very good at it. Now the marginal costs of interacting with other firms are falling rapidly, enabling specialists to work together more easily. Thus new entrants unburdened by expensive fixed-cost investments may build big businesses just on what they excel in and outsource the rest. Companies that do not specialize will not be as good as competitors that do. Analysts argue that these companies in effect earn more by using less physical capital and their market capitalization rockets as a result; they suggest replication of such success by operating in more than one speciality, thus increasing size without lowering returns. Straying into areas where they do not have strong intangible capital – knowledge, brands, relationships, skills, etc. – risks the fate of the old conglomerates.

New service providers, such as insurance companies (e.g. Prudential, Zurich), stockbrokers (Schwab), distributors (Virgin, Carrefour, Quelle) and even manufacturers (General Electric, Volkswagen) are thus competing for provision of banking products. The multiplicity of new entrants and the competitive power the Internet provides have altered traditional market rules. The impact of these new entrants on some of the richest financial markets is very dramatic. Although their market shares may still be small, effects on margins have been significant with, for example, pressure from competitors such as British Gas’s Goldfish and MBNA causing British credit card margins to shrink from nearly 20 per cent to an average of 12 per cent.

Consumer issues

Consumer benefits in terms of better price and higher quality service are commonly advocated in support of financial sector M&As; since M&A-related cost savings should be viewed as efficiency gains, banks and other financial services providers could pass these on to consumers in the form of lower service costs. It is therefore advanced that denying mergers creates opportunity costs to consumers, equal to the size of the projected cost savings. But there is another side to the argument: a Euro-FIET (now UNI-Europa) survey reports consumers have little or nothing to gain from M&As, apart from a few cases of improved or slightly cheaper products and services. More usually they lose personal services to which they were accustomed and find “a strange face at the door”.

Although technology is providing alternative delivery channels that enable finance companies to rationalize their traditional distribution channels, the future of branch networks is a major issue for communities in almost all bank mergers. Branches and their personnel, play a critical role in the economic life of communities. Historically, branch personnel have also been the “eyes and ears” of banks, gathering highly localized information about businesses and other clients to understand the community’s specific needs so as to serve it better. The more bank personnel are thinly stretched out over larger and larger geographic areas, the harder it becomes to gather in-depth information and manage relationships with the community. Branches are also symbolically important because they bear witness to the fact that the bank believes in the economic and social viability of the community. Banks contribute to economic vitality and employment and their branches offer convenient access with a personal touch to retail customers, many of whom may have little or no prior experience with banks. A branch in the neighbourhood signals that the bank is interested in doing business with the community and these intangibles can make an important difference when it comes to meeting local credit needs.

Bearing in mind the difficulty of disentangling the impact of other factors such as increasing global competition or technological change in assessing the impact of M&As on consumers Andrew Leyshon argues that, in general, the number of products on the market has increased significantly in recent years, offering more choice at reduced prices – at least for larger and wealthy clients – as most new market entrants are seeking to compete on the basis of price. They are able to do this because information and communications technologies (ICTs) allow them to save costs by operating with fewer – or indeed without – a traditional branch network. It is also claimed that new product providers are able to offer time flexibility to many clients who no longer have to rely on branch opening hours to conduct their business. Traditional providers have responded to this trend – to meet consumer need and cut running costs – by closing branches. This has had a detrimental effect on a significant minority of individuals lacking access to the technology or the knowledge to use it, which increases social exclusion as such groups tend already to suffer from educational, social and economic disadvantages. Sometimes the disappearance of mainstream alternatives has opened the door to predatory financial service providers offering lower quality, more expensive services to those most in need. As restriction of competition is very often the raison d’être of merger activity, more mergers are, in the long run, likely to be a disservice to consumers.

The reaction of corporate clients should also be disturbing to many banks, given the importance of this market in merger calculus. According to a Treasury Management Association survey carried out at the peak of the merger boom, three-quarters of North American treasurers had experienced some service disruption, account errors or more bureaucracy following mergers.^[19] It found that 40 per cent of the respondents felt service quality had declined when banks were integrated, 43 per cent felt their organization’s business had become less important to the bank as a result of the merger, almost half said relationship officers lacked adequate knowledge of the bank’s capabilities and 47 per cent perceived banks as less loyal after the merger. More positively, 37 per cent of treasurers said the banks offered a broader array of services following consolidation and 61 per cent of respondents conceded that the banks were financially stronger as a result.

Creating shareholder value

Increasing shareholder value is generally held to be the paramount objective of most M&As today. However, experience from most M&As in the mid-1980s is not very encouraging in this regard. At that time, many newly merged banks and insurance companies found their cost structures increased, resulting in duplication of structures and costs rather than predicted savings. The much slower growth levels in the 1990s and the high premiums usually paid to shareholders of target companies, mean that the restructuring needed to achieve satisfactory cost savings from mergers can only be obtained with much deeper cost cutting, imperilling the ability of merged companies to achieve the higher levels of sales revenue required to repay merger-related debt and increase shareholder value.

According to Professor Laurence Booth of the Rotman School of Management, University of Toronto, the economic justification for creating shareholder value as the overriding objective of the firm primarily comes from an assumption implicit in most of the finance literature that all the markets in which the firm operates are perfectly competitive. Employees are indifferent if the firm’s employment is increased or decreased; they get market wages if they are hired and can immediately obtain equivalent jobs elsewhere if they are laid off. Similarly, suppliers and consumers can switch to other firms and government taxes will be the same regardless of the firm’s operations. As a result, the welfare of all other stakeholders in the firm is unaffected by the firm’s operations, so that maximizing the welfare of stockholders causes no loss to other stakeholders. The implicit assumption underlying most of the shareholder-value literature is that there are no other stakeholders in the firm, except the stockholders. The reality is that such hypotheses are questionable, at least for large businesses. In many of the less diversified European economies, the impact of certain large firms is critical for the functioning of their economies – as a result of which there is usually “worker” representation on the board of directors and the legal responsibility of the board is to take into account factors other than stockholders’ interests. At the other extreme, creating shareholder value has become the mantra of corporate United States, since this country has by far the most diversified economy and the most competitive markets.^[20]

At its most basic, creating shareholder value means that the market favours firms that increase the productive use of their assets by increasing turnover ratios, margins and profitability.

Increasing sales growth adds shareholder value as long as reinvestment earns returns that exceed the firm’s cost of capital. Conversely, firms without such opportunities destroy shareholder value by reinvesting and should return the money to shareholders through dividend increases or share buy-backs. These are largely motherhood statements in finance, but are often not reflected either in managerial policies or corporate culture. The KPMG study cited above reports that shareholder value maximization is specified by only 20 per cent of executives polled in the survey as an objective of M&As.

The basic argument that M&As increase shareholder value through exploitation of synergies is based on the assumption that the combined organization can be operated in a way that generates greater value than would be the sum of the value generated by the “stand-alone” companies (the 2+2>4 equation). Potentially, synergies may be extracted from cross-selling products, increasing economies of scale, elimination of duplicated functions and premises and greater market capitalization – and therefore lower financing costs.^[21]

Studies tracking shareholder returns for every large, publicly traded North American acquirer in the 1990s showed that only 44 per cent of deals initiated by these companies yielded superior investor returns. On average, acquirers underperformed their respective industries by 3 per cent. Banking deals in the United States performed even worse. Only 18 per cent of acquirers provided superior returns to shareholders. Consolidators underperformed the total return index for their industry by an average of 13 per cent during the three years following deals – their shareholders were 13 per cent worse off than if they had simply held a bank industry portfolio mirroring the index. According to a 1999 Mitchell Madison Group study, bank acquirers in North America lagged the market by an average of 13 per cent in the three years following their transactions. It was found that mergers typically rewarded only the target’s shareholders, disserving investors in the acquiring entity.^[22] Observers have given different reasons for the failure in successful exploitation of synergetic potential, including the fact that while firms have been skilful at post-merger cost cutting, achieving revenue synergies is a fundamentally different and more challenging task. When pursuing cost savings, a company mostly confronts internal decisions which, though often difficult, are nevertheless within the acquirers’ power to make. Managers can decide whom to fire, which headquarters to abandon, which branches to close, which systems to use and so on. Achieving revenue synergy, by contrast, requires decisions from powerful external constituents – the customers. They must be offered an attractive value proposition in order to keep their accounts at the merged entity and expand their business with it. Branch rationalization models typically do a good job assessing the likelihood of customer attrition, but fail to take into account a branch’s value in attracting future customers so that managers who wield the cost-cutting axe too heavily may inadvertently truncate future growth and the very same shareholder value the deal was supposed to increase.

In 1999, the European Central Bank (ECB) expressed concern regarding the possibility that some banks might be forced into high-risk strategies, defined as those of “the rather short-term oriented shareholder value philosophy”. Shareholder value was an important element in the failed merger attempt between Germany’s Deutsche Bank and Dresdner Bank in 2000. The attempted merger, justified on shareholder maximization, would have represented a break from the post-war consensus – shared in much of Europe – that saw companies as accountable not only to shareholders but also to other stakeholders such as workers, suppliers and the wider community. Early adopters of shareholder-value goals include Lloyds-TSB and banks in Scandinavia, Spain and the Benelux countries. In 1999, ABN-AMRO of the Netherlands announced a policy shift to shareholder value, requiring greater focus on the expansion of highly profitable activities like asset management, private banking and corporate finance, all of which require only relatively limited capital. Such a shift in management focus involves breaking down the business into smaller units designed around products or groups of customers and analysing the return on capital employed by each unit. Managers are expected to allocate shared costs and put valuations on capital assets, with a view to identifying and discarding activities determined to be making less than the firms’ internal rate of return. Business units not yielding sufficient returns on capital are either sold or closed, or restructured to produce higher returns on less capital, while low-margin but necessary parts of the business, such as payments-processing, are pooled between several banks or contracted out to specialists under the rationale that such parts may be the necessary price to pay to hold onto customers who may purchase other, higher return, services.

Bancassurance

“Bancassurance” (the selling of pensions and insurance products by or through banks) covers diverse economic activities. In the same way that consumer credit is very different from money management in banking, life and property insurance activities are also extremely dissimilar. Insurance companies and banks look like adopting bancassurance as one of a range of multi-distribution options in the Internet age, although some analysts doubt the viability of M&As between banks and insurance companies on the grounds that their core occupations remain very different despite the growth and diversification of financial products. Similar M&As among companies in comparably different sectors, e.g. between chemical and pharmaceuticals enterprises, auto and aeronautical companies, have frequently failed. Nevertheless bancassurance has been a key consideration in some recent European financial sector M&As as increased control over bank branch networks is considered to provide expanded distribution channels for insurance products. This development partly reflects rapid convergence between banking and insurance.^[23] Had the merger between the Deutsche Bank and Dresdner Bank succeeded, Allianz, a major shareholder of both, would have taken a substantial stake in the banks’ retail operations to secure access to their branch networks and counteract the domination of the insurance market by sales agents. Allianz’s 14,000 tied agents and 35,000 non-tied agents handle 80 per cent of life insurance sales and almost all sales of property and casualty insurance. Equally, bancassurance was an important factor in the 1999 M&A contest involving France’s BNP, Paribas and Société Générale (SocGen). CGU, wanting to protect its position against Axa in France, unexpectedly intervened, taking a £500 million stake in SocGen to help it see off a takeover by BNP. CGU played a similar supportive role in the Royal Bank of Scotland’s successful hostile bid for NatWest in exchange for an agreement to buy 50 per cent stakes in NatWestLife and RBS’s own life assurance subsidiary. It will manufacture the products and invest the funds under management in the joint venture, which will give it access to about 2,000 bank branches. CGU also took over as RBS’s partner from Scottish Widows, the mutual life and pensions group that agreed to a £6.7 billion offer in 1999 from Lloyds-TSB, a direct competitor of its Edinburgh neighbour. Lloyds’s purchase of Scottish Widows marks the most ambitious attempt yet to make bancassurance work in a market where it has historically failed to thrive. CGU’s recent £20 billion merger with life assurance rival Norwich Union should increase the resources devoted to British bancassurance. Prudential had agreed to buy NatWest’s life assurance business if the Bank of Scotland had won the battle and with it exclusive rights to sell the group’s life, pensions and mutual fund products through NatWest branches.

Bancassurance is also a key priority for Banca Intesa, Italy’s largest banking group, which is poised to expand in Europe after completing its integration with Banca Commerciale Italiana (BCI). The expanded group wants to develop synergies with one of its large shareholders, the French bank Crédit Agricole. At the same time, the BCI acquisition reinforces the presence of Commerzbank in the Intesa group and increases the weight of Assicurazioni Generali, Italy’s leading insurer. Intesa has announced intentions to develop bancassurance with both Crédit Agricole and Generali. Fortis, the Belgian-Netherlands financial group, plans a bancassurance platform in the Benelux countries, with the highest market share in some segments.

Banking industry restructuring is often accompanied by a blurring of boundaries among different categories of financial intermediation and financial conglomerates have special prudential problems given that their composite units may fall under different supervisory agencies. The problem is aggravated when subsidiaries’ operations are spread over many countries. Since the mid-1980s, cross-shareholding and other forms of partnership between banks and insurance companies have grown both at the national and international levels. The trend is particularly striking in Denmark, France, Germany, the Netherlands, Spain and the United Kingdom.

Table 1.1. Bancassurance market share in western Europe (1997)


	Life insurance (%)	Non-life insurance (%)

Germany	10	5
Belgium	19	4
Spain	50	19
France	60	4
Italy	20	1
Netherlands	20	15
United Kingdom	22	1
Sweden	20	1

Source: Economic and Social Council: Panorama et évolution de la distribution d’assurance en Europe (Paris, 1997).

Bancassurance comparable to that in Europe does not exist in Japan because the banking law forbids credit institutions’ involvement in non-banking activities. Nonetheless, links exist especially in common membership of keiretsu, multipolar groups characterized by very close collaboration among members, usually organized around a bank, a manufacturing company, a trading firm, etc.

Bancassurance is also developing at a rapid pace in the United States, as evidenced by the creation of the largest bancassurance company with the merger between Citicorp and Travelers Group.

2. Obstacles to success in
financial services M&As

The 1993 ILO study on banking^[24] noted that efficiency improvements through mergers were frequently overestimated. Contemporary research confirms this observation. Worldwide, two-thirds of mergers end in failure – some because of staff hostility and others because of insufficient preparation and inability to integrate personnel and systems. Even more failures are due to irreconcilable differences in corporate cultures and management. This chapter examines a number of obstacles to mergers and acquisitions in the financial services.

The race for size – An obstacle course?

Most retail banks try to obtain economies of scale by expanding – either by extending their networks or widening their range of products and services. However, there is no automatic link between size and profitability. In fact, this attempt to expand can often produce the opposite effect. The complexity of managing large operations can nullify the benefits and losses related to top-heavy organization are often underestimated. The lack of transparency of financial activities and the fragmented nature of debts and capital, especially for megabanks, prevent creditors, shareholders and regulators from imposing discipline. Internet banking is also a challenge with which large banks have to contend.

Moreover, public policy requires banks, as well as other financial institutions, to be closely supervised because their activities have such impact on the financial system and the economy as a whole. Strong, efficient and profitable financial institutions are vital to economic success, especially as an engine of economic vitality through their role in creating and maintaining credit systems for other sectors, not only nationally but globally. In this framework, regulation is essential to avoid system failures that have devastating consequences, as was the case in South-East Asia in 1997. National regulatory frameworks are therefore being revised to ensure financial services adhere to prudential principles and competitive imperatives.

Regulation

During the 1990s, financial system controls in many countries were strengthened and initiatives were taken to increase transparency of institutions’ financial statements and their risk management practices. For instance, the central banks of the Group of Ten adopted a report in 1994 on procedures for communication on market and credit risk; in 1995, the Basel Committee on Banking Supervision and the International Organization of Securities Commissions (IOSCO) published guidelines on the subject; and in 1997 the Basel Committee adopted 25 core principles for effective banking supervision widening the areas for international harmonization. In more general terms, central banks wanted to make firms assume greater responsibility for managing liquidity and credit risk in payment and settlement systems. When financial difficulties were widespread in some cases, the authorities opted for a rationalization of the banking sector.

Trade union organizations, such as the International Federal of Commercial, Clerical, Professional and Technical Employees (FIET, now UNI), have recognized that with banking systems there is a need to “accommodate wider interests than the financial interests of the individual bank or even of banks collectively”, contending that there is a good public interest associated with systemic stability that affects the monetary system as well as national and international economies. They argue for a broad-based, independent commission to look at regulation of international financial markets, rather than the behind-closed-doors approach being adopted for the Financial Stability Forum (FSF) at Basel. FIET (UNI) believes that such a Commission should redefine the role of the key institutions (IMF, World Bank, OECD, Bank for International Settlements, Basel Committee on Banking Supervision) to create a global system of governance for international financial markets and seek to ensure that structural adjustment programmes also consider human rights, job creation and poverty reduction. Among the measures advocated to curb the damaging effects of short-term capital flows are: an international tax on foreign exchange transactions; minimum deposit requirements with stable dollar, euro and yen financial blocs; and open and transparent banking systems with effective disclosure and satisfactory minimum reserves.

In the United States, several federal banking agencies and the Justice Department have authority to review all bank merger proposals. Policy standards for bank consolidation were modified in the 1980s on the rationale that deregulation and market innovation had substantially made the structure of local banking markets more competitive. Their modified policy has resulted in approval of almost all bank mergers, including those of the largest banking organizations. Some organizations feel that there is little evidence that consumers and small businesses have gained from greater efficiency and competition. Even though carefully scrutinized for anti-competitive structural effects on local markets, they have had anti-competitive consequences; and the bank consolidation movement is producing new structural configurations that tend to restrain competition.^[25]

The repeal of the Depression-era Glass-Steagall Act in the United States in 1999 lifted long-standing prohibitions on banks, stockbroking houses, security firms and insurance companies from venturing into one another’s businesses. These constraints had already been eased in 1997, allowing a number of important acquisitions during the period 1997-98. These reforms are expected to result in the emergence of financial services giants, with United States consumers able to obtain financial services and products from banks, stockbrokers or insurance companies.

In the Caribbean, an important issue has been regulation of near banks. Until recently, these were either unregulated or subject to less stringent regulation than commercial banks as they were considered outside the responsibility or supervision of the central bank. Within a framework of liberalization and deregulation, changes have been made to strengthen supervisory capability in the region. In Jamaica, the Financial Sector Adjustment Company (FINSAC) was formed in 1997 to oversee the restructuring and consolidation of problem institutions. The restructuring exercise consisted of three phases of operations: intervention, rehabilitation and divestment. The intervention phase involved the negotiation of agreements with troubled institutions with the aim of either closing, supporting or acquiring them – in some cases involving the Minister of Finance who would put the institution under temporary management under the powers provided in banking laws. Intervention sometimes involved the negotiated acquisition of the group for a token amount, with FINSAC thereafter assuming its assets and liabilities. The extent of intervention is reflected by the fact that FINSAC now has investments in over 150 companies, including 15 banks and 21 insurance companies.

The banking system in the Republic of Korea has been undergoing extreme declines in balance sheet quality since 1997. To some degree, the problems of the banking industry stem from longer term structural problems, such as low profitability, relatively undeveloped credit analysis systems and lack of independence on the part of bank management. Owing to the complex corporate structures of chaebols and extensive cross-guarantees, the number of insolvencies mounted rapidly in the late 1990s. The Government has introduced measures to reconstruct the financial system in line with practices in other OECD countries, including a thorough overhaul of institutions and practices to supervise institutions and markets. Consolidation of existing supervisory bodies led to the creation of a new agency – the Financial Supervisory Commission (FSC) – to supervise all financial markets and take charge of restructuring the banking system in 1998. Foreign ownership of up to 100 per cent became possible. As foreign owners reach the thresholds of 10 per cent, 25 per cent and 33 per cent of total equity, they will be subject to increasingly strong review by the FSC.

In May 1999, the European Commission published an action plan for implementing the framework for financial markets^[26] The document notes that, although considerable strides have been made since 1973 towards providing a secure prudential environment, the Union’s financial markets remain segmented and business and consumers continue to be deprived of direct access to cross-border financial institutions. The Commission underlines the necessity of creating a common framework to guarantee the transparency and fairness of public acquisition bids which protect minority shareholders. The proposal for a 13th Company Law Directive (takeover bids) is intended to harmonize legislation among Member States. In June 2000, European leaders were on the verge of launching a sweeping review of how to manage a single market in financial services, reflecting concerns that the supervision and regulation of financial services in Europe could not cope with radical change in the banking and insurance sectors caused by the launch of the euro, cross-border mergers and the impact of globalization. Many banks and financial services providers have urged the EU to move towards a more integrated European capital market. But banking supervision and regulation remain mostly the responsibility of national authorities. European banks argue that the rise in Internet banking will highlight the discrepancies in national legislation and that new rules for electronic commerce will leave physical banks subject to a different set of rules from their online competitors.

At the national level in Europe, bank mergers are subject to review by the banking authorities and often may even require prior government approval. In European countries such as Italy and France, all takeover bids must obtain the approval of the respective supervisory authority, which is not always forthcoming. In 1999, applications by major banks in both countries were blocked. In France the supervisory authorities often base their decision on an appreciation of the effects of the merger on the future health of the banking system, after reviewing each institution’s accounts to ascertain whether prudential rules would be respected, especially regarding the ratios between debt and capital levels. The exercise is thus focused on avoiding risk to the system and often does not concern itself with the probability that the merger might result in excess concentration. Responsibility for reviewing the competitive aspects of important non-Community mergers in France lies with the Economic Affairs Minister who may undertake an evaluation on the recommendation of the Competition Council.

In other European countries, various supervisory authorities exercise similar roles:

in Switzerland, the Swiss Federal Banking Commission is responsible for the examination and approval of M&A proposals – each time there is a change in ownership – and all proposals are subject to review by the Competition Commission;

in the Netherlands, M&A applications require prior approval of the Minister of Finance who must consult the views of the central bank before taking a decision; however, the Minister may reject the application even if the central bank favours it. The opinions are based on three criteria: the sound financial health of the applicant; the likely viability of the new entity; and a finding that the merger would not result in abuse of dominant position;

in Spain, all banking M&As require prior approval of the Minister for the Economy who bases the decision on the report of the state banking council; the banking and financial services commission must verify that the buyer will not threaten the stability of the acquired bank;

in Italy, the Banca d’Italia has delegated responsibility in an anti-trust authority in the credit sphere, so as to eliminate “those factors which are adverse to competition and accentuate those which are conducive to it”; a 1990 Act^[27] addresses the potential negative effects of conglomerates on competition.

Bank regulation poses another obstacle to M&As worldwide. Although some current de-mutualization of previously mutual banks and insurance companies was driven by the need to expand access to capital and financial markets, many banks are unable to tap the loan and bond markets to finance acquisitions – partly because they cannot borrow as freely as industrial companies. Limits on banks’ capital ratios mean they cannot leverage their balance sheets to buy competitors.

Competition policy

Banking and financial M&As are horizontal (between competitors) and not vertical (involving supplier and customer which are frequent in industry). While there might be occasional conglomerate mergers when, for instance, a financial institution specializing in the development of products integrates with another specializing in distribution, few financial M&As result in the creation of conglomerates, which occur when the companies are not competitors and do not have a buyer-seller relationship.

The last few years have seen a number of “megamergers” between companies headquartered in different parts of the world, resulting in truly global enterprises. M&As, just like any other potential or actual anti-competition behaviour (cooperative agreements, abuse of dominant positions) are no respecters of borders. It is therefore clear that international cooperation is necessary to deal effectively with cross-border competition problems. The agreement signed in 1991 and put into effect by 1998 between the European Union and the United States is a good example of such cooperation. The agreement particularly facilitates the exchange of information and a transatlantic cooperative regime between the competition authorities and is applicable to M&As, including in banking. An example in 2000 involved telecommunications and resulted in the withdrawal of merger plans between WorldCom and Sprint. In 1999, a working group was set up to extend the areas of cooperation, especially concerning the transmission of confidential information and timely consideration of M&As. Because of laws on commercial confidentiality, European competition authorities still need the consent of the companies involved before they can communicate to their United States counterparts certain types of documents that might contain sensitive information. The aim is to eliminate the need for such consent. Similar agreements on international cooperation exist, for example, between the United States and Canada and between Australia and New Zealand. There are growing calls in various countries – including from academics, economists, trade unionists and NGOs – for strengthened international competition rules to discourage excessive sectoral concentration and to provide a counterweight to enterprises, financial or otherwise, which exploit the absence or gaps in international regulations. EU Member States have called for a multilateral framework on basic competition rules and the linkages between trade and competition policy, including on M&A policy, have been under review at WTO, UNCTAD and OECD for many years.

One issue deserving attention is ascertaining the extent to which current national competition legislation sufficiently safeguards the soundness of the international trading system in case of violation or M&A-created dominant positions on international markets. It is clearly in the international community’s interest that countries, especially the major economies, have effective competition laws that take this into account. However, uncertainty remains as to whether the ways in which they have been applied always reflect all countries’ common interests. This uncertainty arises from the fact that national competition laws, as currently applied, primarily reflect consumer-based anti-competition effects (or, sometimes, producer impacts) which fall within each country’s jurisdiction, rather than practices which affect other countries. Mergers may be approved if the resulting efficiency benefits in the country undertaking the review sufficiently offset the likely damage, but the loss for consumers and other producers outside national borders will not necessarily be evaluated. In practice, it seems that in many mergers, small countries feel constrained to accept the rules of major countries or systems, especially those of the EU and the United States.^[28]

In practice, M&As are often a product of market shocks (for example in the financial services sector, privatization or sectoral deregulation), sharpening competition and attacks on established market positions. Higher profitability after M&As can provide not only the sought-after synergies, but eventually, in horizontal combinations of previously competing interests, increased market power. According to UNCTAD, cross-border M&As can be used to reduce or even eliminate competition, thus posing challenges for maintaining effective competition in host economies by increasing market concentration at the time of entry. Like all firms, affiliates resulting from cross-border M&As can engage in various forms of anti-competitive behaviour once established, when conditions permit. As a result of large-scale mergers among transnationals in general, these firms could end up controlling increasingly large market shares and global distribution channels, thus making it difficult for smaller-scale enterprises in developing and transition economies to compete on equal terms. In financial services, abuse of a dominant position, whether or not as a result of a cross-border M&A, can also be subject to prosecution in a country where such abuse has occurred, or within the context of international cooperation when the anti-competition effects affect other countries. Considering the inherent risks in the appearance or strengthening of dominant positions, especially in finance, attentive regulation of M&As is integral to public competition policy.

The development of Internet-based financial services poses new challenges to national and international regulators. Competition authorities must decide whether traditional yardsticks of monopoly power still apply or whether – as some companies argue – the competition issues have changed. Companies argue that the regulators do not understand that the low barriers to entry make it a very competitive environment that cannot be examined in terms of classic market shares. The fast-moving environment of the new economy means that regulators’ conclusions about the effect of a merger could be proved wrong within 18 months.^[29]

Examples in Europe include the Bank of England, which reviews banking M&A applications to ensure that they will not have negative repercussions on the operations of the institutions involved, their balance sheets or the safety of depositors’ funds. As in other sectors, the Government might also intervene if a proposed merger or acquisition could create competition problems. In Germany, banking mergers involving more than 1 billion Marks in worldwide net income or 50 million Marks on the domestic market require Federal Cartel Office approval. The Federal Office for the Regulation of Credit Institutions reviews all the prudential ratios of institutions applying for M&As.

Within the European Union, the authority to approve the most important mergers, including those in finance, is vested in the Commission under Council Regulation (EEC) No. 4064/89. The Commission must be informed if the combined aggregate worldwide of the companies involved is more than ECU2,500 million (5 billion euros) and if the aggregate turnover of each of the companies in the EU is more than ECU25 million (250 million euros), unless each of them achieves more than two-thirds of its aggregate community-wide turnover within one and the same Member State. The Commission has noted in some decisions that these thresholds have not been reached (e.g. its 1997 authorization of the merger between Crédit Suisse Group and Winterthur even if Switzerland is not an EU Member). Another example is provided by the Allianz/AGF case where, in a 1998 decision, the Commission judged that credit insurance constitutes a distinct market and that the two companies’ proposal posed the risk of creating a dominant position in it, resulting in AGF’s agreement to divest itself of a subsidiary in the same market as a condition for approval.

In the United States, since the adoption of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, the proportion of market-share in terms of deposits held are taken into consideration in cases involving bank holding companies in one state acquiring banks located in another state. The law prohibits M&As resulting in deposit concentrations of more than 10 per cent at the national level or 30 per cent in the same state. In addition, federal and state anti-trust laws are also applicable in M&As.

Following review of the financial services as a preliminary step to reforms, Canada has adopted a comprehensive sectoral policy, including the sensitive and related issues of ownership and M&As. Under this policy, the Government accepts that M&As can be a legitimate and viable business strategy for growth and success, but each merger proposal must be assessed on its own merits and those with over Canadian $5 billion in equity include a formal mechanism for public input. In addition to reviews by the Competition Bureau and the Office of the Superintendent of Financial Institutions, merger proponents have to prepare a Public Interest Impact Assessment (PIIA) for examination by the House of Commons Standing Committee on Finance. In addition to the business case and objectives of the merger, the PIIA must identify: possible costs and benefits to customers and small-medium businesses; timing and socio-economic impact of branch closures or alternative service delivery measures at regional level; international competitiveness of the sector; direct and indirect impact on employment and quality of jobs in the sector (both transitional and permanent effects); ability to develop and adopt new technologies; remedial or mitigating steps on public interest concerns, such as divestures, service guarantees and other commitments; and the impact of a transaction on the industry structure. The PIIA would also cover additional issues that the Minister of Finance or the parties deem relevant in particular transactions. Public interest remedies to address concerns raised during the review process would be negotiated with merger applicants, following which the Minister of Finance would approve the transaction with the terms and conditions reflecting those remedies.

In Japan, the Fair Trade Commission is mandated with guaranteeing anti-monopoly laws. Its competence covers the whole economy, including banking and financial services. Japan has traditionally been seen as a hostile environment for M&As, such activity being considered almost immoral, with the result that previous M&As in Japan were invariably friendly, often resulting from third-party initiatives such as those of government agencies interested in bringing about sectoral adjustments. Following its “Big Bang” drive to deregulate the financial markets, Japan’s enterprises, including banks and other financial services operators, have developed a taste for M&As. Restrictions on M&As, takeover bids and business transfers are nevertheless included in the country’s Commercial Code, the Anti-Monopoly Act and the Securities and Exchange Law. The Stock Exchange and the Securities Dealers Association have their own self-regulatory controls on takeover bids.

Resistance at the national level

There have been long-standing predictions – so far unrealized – that the present wave of in-country consolidation, mainly in Europe, would be followed by regional consolidation in which big banks would buy institutions in other countries. In 1999, only $50 billion of $225 billion in European financial institution deals represented intra-European mergers.^[30] So far, cross-border consolidation has taken place only along Europe’s periphery, in regions with close historical and cultural links – Spanish banks buying banks in Portugal, Belgian and Dutch groups linking and pan-Nordic consolidation. At Europe’s core, no German bank has bought its way into the Italian market and no French and Spanish banks have merged.

Cross-border M&As are sometimes seen as eroding the national enterprise sector and, more broadly, economic sovereignty. Concerns of this kind are not new and, in the past, were particularly associated with the natural resource sector. Although banks are cross-border, moving outside their home base involves sensitive cultural issues and such moves rarely produce comparable cost-savings as in-market consolidation. Indeed the promise of minimizing job reductions and maintaining significant local autonomy are often the price foreign bidders have to pay to succeed in cross-border acquisitions. However, there may be economic gains from cross-border M&As if they help to strengthen the capabilities and competitiveness of acquired firms, or simply save them; the risk of “denationalization” may therefore need to be balanced against possible gains in economic restructuring and competitiveness.

Ultimately, banking analysts suggest that the lack of synergies across borders means that pan-European institutions are likely to be created through big mergers of equals. Banks will merge when they are so big that no one else can intervene to break up the deal.^[31]

With increasingly nomadic capital, countries are torn between the necessity of mergers or partnerships between financial institutions beyond national borders and the maintenance of the independence of domestic financial organizations. In 1999, Portugal opposed a merger proposal between its largest financial group, Champalimaud and Spain’s BSCH, the parameters of which had to be renegotiated after European Commission intervention. Scandinavian countries are similarly strongly reluctant to allow foreign institutions to take substantial interest in national banking institutions, even though the region has seen the highest number of consolidations. The Norwegian regulatory authorities have not supported several M&A operations, including that proposed by the Finnish-Swedish group, Merita Nordbanken for Christiania Bank.

Legal status of financial institutions

Mutual and cooperative banks continue to play an important role, especially in continental Europe. A product of national social and economic history, their legal status, which prevents stock exchange listing, constitutes an obstacle to M&As. These institutions, which generally include savings funds or agricultural banks, have resisted adopting purely capitalist structures and thus modifying the balance of internal power for fear of losing their historical and local rationale. While consolidation has happened among this category of institutions at the national level, cross-border tie-ups are much more difficult because the purchase of a foreign institution of comparable size could only be envisaged through market financing or the exchange of shares. Nevertheless, the status of this type of institution does not prohibit them from minority holdings – sometimes quite considerable – in foreign financial institutions. Neither does it prohibit alliances and other partnership arrangements, including in bancassurance. The merger announced in October 1999 between mutual banks in the Netherlands and Germany, joined by a major credit cooperative in Italy, will serve as a trial run in this type of consolidation.

Inadequate assessment of
cultural aspects of M&As

Interest is concentrated almost exclusively on the economic benefits of M&As, with scant attention being paid to “soft” cultural and organizational considerations. Though merger proponents and some research in the United States and the United Kingdom argue for increased efficiency gains and employment generation throughout the economy resulting from domestic mergers (thereby compensating in some measure for immediate job losses), as well as increased pricing power which the institution can translate into improved margins, augmented domestic market power does not automatically transform the merged organization into a global force. Influence at the global level requires a corresponding global presence. Although the sector easily lends itself to globalization, cultural differences have often been the root cause in the disappointing experience of extracting efficiencies in cross-border M&As. Following its acquisition of the United Kingdom’s Morgan Grenfell Group, Germany’s Deutsche Bank at first allowed the company to maintain its autonomy, but had to revise the strategy as the arrangement would not permit efficiency maximization. Deutsche’s attempts to imbue its acquisition with its own organizational culture and ways of work almost totally nullified the value of the acquisition. Examples of similar problems in cross-cultural integration are legion and few financial services organizations have found the model approach to overcoming them. The wider the cultural divide, including distinctly different languages, the greater are the sometimes insurmountable barriers to effective integration into transnational M&As.

According to the KPMG study cited in Chapter 1, M&A deals were 26 per cent more likely than average to be successful if they paid satisfactory attention to cultural issues and those acquirers who left cultural issues until the post-deal period severely hindered their chance of deal success, compared with those who dealt with them early in the process. Early emphasis on cultural assessments and communications plans are particularly important. The results also underline the challenge acquirers face in undertaking cross-border deals where there is a significant cultural and linguistic disparity between participants. The authors note that full integration requires the best aspects of both legacy organizations to be incorporated into a single new company culture focused on achieving future business growth. Where the companies are to be run as two separate entities, close links to ensure mutual cooperation between two separate cultures will be essential. The survey results also suggest that a company increases its chances of success if it uses reward systems to stimulate cultural integration or cooperation, as opposed to more informal methods.

Cultural aspects therefore constitute a significant obstacle to cross-border combinations even though the differences continue to ease with time, education and training. Any merger or acquisition is a complex process taking up more time than usually expected: it requires integrating very different organizations, blending often very diverse cultures and dealing with complex questions of dissimilar work organization. This requires high levels of managerial capacity in change management, the constitution of effective teams and network integration – all demands for which many managers are ill-equipped but which can lead to an accumulation of critical errors and misunderstandings and ruin what, at least on paper, might look like a highly promising deal.

Neglecting the human factor is
a frequent cause of failure

Cultural and symbolic elements in M&As are typically framed in terms of the distinction between the merging firms, thus leading to an “us versus them” dualism. The creation of formal, internal communications mechanisms as early as possible in the process is necessary to limit the anxiety that will otherwise be fuelled by rumour, the grapevine, or even outside news reports. Employees complain that their first knowledge that their employer is involved in a merger or acquisition is often from the morning news before setting off for work.

According to a Hewitt Associates executive, the fact that the human factor is taken into account in only 5 per cent of M&As explains why more than half of them in all sectors fail. Teams are usually put together to oversee merger and acquisition operations. These teams almost always comprise specialists in legal and financial issues as well as experts in strategy but rarely do they include human resource directors. One possible explanation is the fact that speed is generally considered of capital importance for success. While the integration phase of merging enterprises may cover between three to five years, the first 100 days after the announcement of the transaction are the most crucial for success or failure. It has become common practice to prepare and communicate to staff and shareholders a programme of integration activities to cover this period, when the feelings of fear, apathy, demotivation and the classical “victor” and “vanquished” syndromes are at their highest. Since a majority of mergers end up with the elimination of overlapping functions and positions, the first 100 days are likely to be those when staff are most uncertain about jobs, career prospects and the disappearance of their own corporate culture.

To reduce the possibilities of failure in M&As, some management experts have recommended that human capital be placed at the centre of the process, or at least be given equal attention to that assigned to economic and financial considerations. According to this school of thought, such a redirection would enable acquirers to select the most compatible acquisition targets from a human resource perspective and make integration that much easier.

Frank communication on a daily basis between management and staff helps to dispel some of the uncertainties of M&As and avoid organizational drift. Employees should be informed in good time about the manner in which redundancies, if there are to be any, will be decided and about the role of their trade unions or representatives in the process. It is also important for staff from the acquired organization to be assured that the rights and entitlements they had with their previous employer are to be respected; otherwise there is a high probability of conflict. Merger uncertainties are also frequently blamed for the loss of talent from target companies, which can destroy the very basis for the merger. The failed merger plans between the Deutsche Bank and Dresdner Bank in April 2000 demonstrate how staff resistance can undermine corporate strategies and management wishes. Integration of teams from the respective investment banks of the two parent banks posed a risk to the balance already achieved between staff in Deutsche Morgan Grenfell and the previously acquired Bankers Trust.

3. Employment effects of M&As

Regional overviews

Africa

Financial market liberalization in Africa has often outpaced the reform of weak financial institutions. Years of liberalization, restructuring and other reforms have strengthened the sector. However, many observers believe making the sector competitive will require further privatization and consolidation. Bank privatization has been slow although some large divestures are planned once the banks have been restructured, troubled loan portfolios provisioned for and staffing and branch networks re-evaluated. Most M&A activity in the 1990s was implemented in a reform context.

The Central Bank of Nigeria (CBN) and the Nigeria Deposit Insurance Corporation (NDIC) report that, of the 115 banks in operation in 1997, 47 were in varying states of distress, with an average ratio of non-performing assets of around 82 per cent. The restructuring of distressed banks starts with their being put under joint control through “acquisitions-in-trust” by the NDIC and the CBN for eventual sale to private operators. Six mergers between 1996 and 1998 resulted in 88 net job losses out of a total workforce of 1,860. Without the mergers, many of the banks would have been closed by regulators with the loss of all the jobs involved. Bankers warn that, although the worst of the crisis may be over, only 30 of the 82 remaining banks are serious operators. Recovery does not mean an end to restructuring as the industry is expected to shrink in both the number of institutions and active branches, although the latter already declined from nearly 2,500 to 2,200 between 1997 and 1999. Employment in the sector dropped from 78,514 workers in 1990-91 to 54,292 in 1999-2000, though this can be attributed to bankruptcies and closures and not wholly to M&As.

Given the preponderance of its economy in Africa and its financial operators’ relatively substantial resources, South African interests have been active in acquiring banking and other financial sector enterprises from governments. The four big South African banks (Absa, Standard Bank, Nedcor and First National Bank) are not huge by global standards but tower above rivals in other African countries. In efforts to reduce costs and improve profitability, most major South African banks are examining possibilities of merging with assurers or other banks, while many others are expanding into other African countries. Standard Bank (Stanbic) expanded into 14 African countries in the 1990s, believing this would allow it to be the financial services provider for industries wishing to tap African markets. An attempted hostile takeover of Stanbic by Nedcor was blocked by the Minister of Finance in 2000, partly because of competition concerns, fears of increased systemic risks and the possible loss of up to 10,000 jobs in a country with extremely high unemployment. In arguing its case to the regulatory authorities, Nedcor advanced the need for South Africa to have a “national champion” to compete on a global scale. It claimed t

The employment impact of mergers and acquisitions in the banking and financial services sector

Report for discussion at the Tripartite Meeting on the Employment Impact of Mergers and Acquisitions in the Banking and Financial Services Sector

Geneva, 5-9 February 2001

International Labour Office Geneva

The employment impact of mergers and acquisitions
in the banking and financial services sector

Report for discussion at the Tripartite Meeting on the Employment Impact of Mergers
and Acquisitions in the Banking and Financial Services Sector