At a global level, banking consolidation theme would remain, while we also expect other integrals drivers such as digitalization, low profitability concerns, push towards sustainable finance, challenged earnings, asset quality issues and regulatory intervention to reshape the banking deal landscape in 2021. Though all themes may not be prevalent for all geographies, however, these may be potential topics of discussion in board rooms of many banks.
A critical driver for deal activity in 2021 will be heightened digital engagement with customers decreasing the need for physical branches. Globally, banks are likely to place more capital investment in buying new technology and digitization.
Potential impact: Better valuation multiples of digital-savvy banks compared to traditional incumbents is another force driving digital engagements, forcing banks to infuse digital into their M&A strategy. The next wave of bank consolidation has already set-in especially in Europe. We expect progressive banks to focus on acquiring digital capabilities like AI and advanced analytics. to improve their target screening process, and build interactive customer experience dashboards.
Another key driver is the ability to generate organic capital while managing overall share count. In response to COVID-19, capital preservation has become critical and profit retention alone may not be enough. With increased impairments and even with cessation of dividend payments, it would be a challenge for banks to restore their capital ratio targets amid the prevailing uncertainty.
Potential impact: This would pave the way for banks to explore other radical options such as asset and liability restructuring, new capital issuance, and the sale or closure of portfolios and businesses which may accelerate deal activity in 2021.
Banks are in better shape in terms of capital and liquidity than during the global financial crisis. But earnings remain an on-going concern. Most global banks are seeing deposits flooding in the absence of loan demand (low consumer spending and utilization from small businesses); a lack of attractive yield opportunities will continue to put pressure on net interest margins3,4.
As per the ECB total deposits held by Eurozone banks rose 10.3 percent5 in the year to July 2020 (climbing above €12 trillion). According to FDIC data, US$2 trillion6 surge was seen in deposit accounts of US banks since January 2020.
The governments of various countries also unleashed funds to bolster small businesses and individuals via stimulus packages and unemployment benefits such as the MSME guarantee program and the unlimited bond-buying program.
Potential impact: Surplus liquidity is weighing on margins and forcing several banking institutions to pursue deals to help drive higher earnings.
This all in-turn could encourage many bank boards to include M&A in future strategic actions as they struggle to grow earnings.
Global banks are increasingly embedding environmental, social and governance (ESG) into their risk-management frameworks. As the M&A landscape starts to normalize, we expect sustainability-related M&A to open new potential revenue opportunities for the banking sector. As noted by a research paper9, exposure of European banks toward corporates with non-ESG models (particularly in sectors such as real estate, transport and brown sectors) broadly range from 5 to 10 percent, implying that lending is not concentrated in sectors which are vulnerable to climate risk.
Potential impact: Banks are likely to substitute existing business portfolios, though such portfolio transitions might take long especially for those heavily reliant on environmentally unfriendly sectors like mining. Longer term, the trend is expected to drive a 3-4 percent incremental ROE difference. Banks with asset management units can also see a substantial increase in sustainably managed assets over the next five years. It may not bring a major change in fees but would attract net new money. Climate risk-related disclosure by banks could also be a potential catalyst for further change.
Europe: Asset quality deterioration showed early signs; however, a significant impact has not emerged thanks to the loan moratoria, furlough schemes and other state support, in European markets. Despite COVID-19, investor fund-raising activity has not slowed. Due to unprecedented intervention by authorities and governments, ultimate transaction activity may decline but valuations may not fall as fast or as far as in previous crises.
Asia-Pacific: Several measures have been undertaken such as liquidity injections, special loans to affected industries and regions, and policy rate cuts by Asia- Pacific governments, central banks, and supervisory authorities to address the ramifications of COVID-19, including support for banks to provide forbearance. We estimate that Asia-Pacific in 2021 will be hit with additional nonperforming assets.
In July 2020, the ECB11 launched a new supervisory approach to promote further bank consolidation. The guidelines largely focus on the use of supervisory tools to facilitate sustainable consolidation projects and recognition of badwill to increase sustainability of business models.
Governments in several ASEAN countries such as Indonesia, Vietnam, and Myanmar are focusing on liberalizing and increasing foreign participation in their respective countries.