OREANDA-NEWS. Mergers and acquisitions among mid-tier EU banks are more likely than large-scale deals such as between Deutsche Bank and Commerzbank, whose recent discussions were reported in the media, says Fitch Ratings. This is because many of the larger banks, traditional acquirers of other banks, are capital constrained, making it more difficult to fund sizeable deals. Convincing board members and shareholders that consolidation is a sound choice at a time when returns generated by many EU banks are poor is likely to be tough.

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

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

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

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

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

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

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

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