This article originally appeared on Forbes.com.
Europe’s large banks can’t get enough capital, even after approximately €1.5 trillion of bailouts in 28 countries since September 2008. That huge sum of taxpayer money has put pressure on banks to improve their balance sheets and their performance. Now Europe’s countries want the bailed-out banks to exit state ownership so governments can get their money back.
Who will buy the stressed business units and ailing loan portfolios from struggling banks? The most likely acquirers, other banks within or outside Europe, have been building up their capital reserves to comply with regulations, but many lack the funds to chart a path to sustainable growth by purchasing underperforming assets.
One group of buyers with ample capital and expertise stand ready: private equity firms. PE funds currently have plenty of “dry powder”—capital raised and waiting to be invested—as well as experience turning around ailing banks’ strategy and operations. After the typical holding period of about five years, PE investors will be looking for a return on their investment. During that time, European banks will build enough muscle into their balance sheets to absorb the revitalized assets. Alternatively, the banks owned by PE funds would be in a stronger position to continue standalone operations through an initial public offering.
The private equity solution has a firm foundation. Several funds have invested in banking over the past five years, and the prospects so far look sound. For example, AnaCap Financial Partners has expanded in small and midsize enterprise (SME) banking through investments in Aldermore Bank in the U.K. and FM Bank in Poland. Advent International and Bain Capital deepened their expertise in payments through investments in ICBPI, Nets and Worldpay. During their Worldpay ownership, Advent and Bain Capital built its value by £3.2 billion over a five-year period—an 11% compound annual growth rate in underlying earnings during a challenging period for financial services.
Besides experience growing the value of financial services companies, PE funds have other characteristics that make them logical buyers. Since 2013, PE funds raised $500 billion annually worldwide, and dry powder today stands at a record $1.3 trillion globally. The past year saw the best environment for fund-raising since the pre-crash boom. By one definition, that’s smart money waiting to be put to work.
Private equity also depends on transitional ownership. Funds held their buyout investments for an average 5.5 years as of 2015. Over the past decade, their ability to deliver results to investors has depended less on financial engineering than on turning around businesses, improving operational efficiency and putting companies back on a growth path to ready them for sale or IPO. General partners have the flexibility to act quickly if the situation calls for speed. When a government or a bank needs capital fast, PE funds can mobilize faster and with more confidence than most other sources of capital. They can quickly narrow the decision criteria to the few key decisions that will generate the most value.
Just as important for Europe’s economy generally, private equity ownership of banks promotes competition. By contrast, selling one bank to another bank results in one fewer competitor in the market. Lending volumes to SMEs, for example, fell by almost half during the financial crisis. The elevated borrowing costs created a demand/supply gap that persists, even after the creation of a number of smaller banks and peer-to-peer lending firms.
Private equity buyers will select a strategy designed to realize the full potential of their acquired bank. Although that strategy might involve a sale to a larger bank, in many cases the smaller bank can thrive on its own, as illustrated by Aldermore. Alternatively, a PE fund will orchestrate a merger between two subscale players, such as the merger of PBP Bank and FM Bank in Poland. In either case, competition is preserved through a new, revitalized bank.
As governments and regulators press banks to resolve capital shortfalls and exit state ownership, private equity offers a logical path to recovery. Deep pockets combined with the capability to turn around assets are in high demand. Private equity firms thus could serve as a bridge between today’s capital-constrained banking market and tomorrow’s more solid financial system. An expanded role for private equity in European banking could not be better timed, with potential gains for all parties: banks, PE funds, governments and the customers that depend on banks in their financial lives.
João Soares is a partner in Bain & Company’s Financial Services practice. Tim Cochrane is a partner in the Financial Services and Private Equity practices.