The year 2023 may well be remembered for bank failures: First Republic Bank, Silicon Valley Bank, and Signature Bank in the US; and Credit Suisse in Europe. And the specter of troubled banks set the tone for M&A in banking throughout the year.

Deal activity was muted compared with 2022 because of high interest rates, low valuations, and regulatory barriers. But the year saw many banks divesting noncore assets while healthy players made opportunistic acquisitions of troubled banks (that otherwise may not have passed regulatory approval). Other banks shored themselves up by making scope deals for fintech capabilities or capital-light businesses such as wealth management.

The activity came in three small waves.

The first wave of deals was the direct result of bank failures. First Citizens BancShares bought Silicon Valley Bank’s US commercial and private banking business, JPMorgan Chase purchased First Republic, and UBS acquired Credit Suisse. All of these deals were expedited to maintain stability in the banking system. This wave signaled a warning sign to the industry: Get healthy now to ensure viability in the future.

Banks then looked to M&A to prepare their portfolios in two subsequent waves.

Following this turbulence, some banks divested noncore businesses to clean up balance sheets. For example, PacWest Bancorp sold its property lending division and other assets before later merging with Banc of California after weeks of declining share prices and large deposit outflows. Danske Bank has a pending sale of its Norwegian consumer business to Nordea to streamline its portfolio.

Other banks turned to M&A to strengthen positions by opportunistically expanding growth areas or adding new capabilities. Deutsche Bank purchased investment bank Numis to expand overseas. Crédit Agricole’s Indosuez Wealth Management acquired a majority stake in Bank Degroof Petercam, a European wealth manager, to access growth without relying on costly and scarce capital. Dubai Islamic Bank purchased a 20% stake in TOM Group, a digital bank operator in Turkey.

As of the end of the third quarter of 2023, overall deal value in banking fell by 36% while volume dropped by 21% (see Figure 1). And now the factors causing this depressed activity remain. Lowered valuations mean that acquiring firms have less leverage and that sellers are more reluctant to sell. The deal math remains difficult. For example, high interest rates depress many banks’ held-to-maturity portfolios, which need to be marked to fair value in a transaction.

Figure 1

And then there are the regulatory mixed messages. US Treasury Secretary Janet Yellen signaled an openness to deals in the aftermath of bank failures, yet the US Department of Justice indicates tougher scrutiny for bank deals, with possibly more onerous regulatory/capital requirements for banks that have assets greater than $100 billion. Toronto-Dominion Bank’s inability to obtain regulatory approval for its planned $13.4 billion acquisition of First Horizon, the largest US bank deal termination ever, may spook others from embarking on large tie-ups.

Indeed, the number of scuttled US bank deals keeps climbing as financial institutions grapple with uncertainty, and heightened regulatory scrutiny may lengthen approval processes. Eight US banking deals were canceled within the first nine months of 2023, approaching the 13 terminated deals in all of 2022 and surpassing the total of 4 terminations in 2021. This represents $13.9 billion of lost value in the US in 2023. Similarly, in Europe, cross-border requirements for ring-fencing capital and liquidity may discourage cross-border mergers.

What can we look forward to in 2024?

In the US, we don’t expect more big bank consolidations given the double whammy of regulatory barriers and economic uncertainty. The big caveat could be a continuation of first-wave deals intended to prevent stress or failure. With elevated interest rates, macroeconomic headwinds, and emerging commercial real estate issues, more troubled banks are likely to surface over the next 12 to 24 months in the fragmented US banking system. If this happens, expect more deals to be allowed as regulators prioritize soundness and safety over usual regulatory concerns.

In Europe, domestic concentration levels are generally sufficient, so we don’t anticipate a lot of in-market scale M&A. Nor do we see a rise in the number of cross-border scale deals as long as regulatory hurdles prevent banks from sharing liquidity across borders. Yet this is one issue to watch closely since potential progress toward greater banking union could shift the calculus. While full banking union may still be distant, recent European Central Bank discussions indicate an appetite to increase incentives and reduce barriers to cross-border mergers. If this happens, we could witness a new wave of cross-border M&A as Europe’s banks aim to improve their scale and profitability.

In Asia, expect banks to remain opportunistic and open to cross-border deals, although they’ll be cautious on value dilution and regulatory constraints.

We also believe that 2024 will bring more second-wave activity to sell assets to strengthen the core and free up capital. Some of the buyers might be stronger banks that see an opportunity to gain scale and find synergies. But some of these asset sales will be to nonbank lenders, the so-called “shadow banks” that recently have found themselves in the regulatory crosshairs. Increased regulation could dampen appetite from this sector.

Finally, 2024 could bring with it a rebound in M&A for new engines of growth or to acquire new capabilities—namely, third-wave deals. Despite the potential for near-term dilution associated with capital-light businesses, we believe that banks will act on opportunities to purchase assets such as fintech businesses to build new capabilities. As many fintechs struggle with profitability and face challenges accessing capital, more will be available at lower valuations than in the past. Banks can capitalize on emerging stressed situations to acquire valuable technology assets. Buyers will be those looking to make step changes in their capabilities—for example, banks with lagging tech systems and innovation.

What should banks do?

Banks have not historically relied on M&A as a steady source of strategic growth. But now is the time to reconsider that stance and to begin building the fundamentals for successful deals.

That means having capital ready to do deals. Banks can start by taking a hard look at existing businesses that could be cleaned up via divestitures ahead of problems and also taking actions to improve costs, efficiency, and productivity. It’s imperative to get costs in check before problems emerge; the market has been punishing, and the speed of liquidity events has been unprecedented.

Banks with a strong balance sheet can prepare in advance to act quickly for the moment when scale or scope opportunities present themselves. They should define their growth ambition so that they are clear on the types of acquisitions they need. They can perform early due diligence to understand what businesses and assets might be valuable if a distressed bank needs to engage in a fast sale. The best bank acquirers develop their playbook for robust diligence by drawing on insights from private equity. They come armed with a value creation plan and post-merger integration capabilities.

And as part of adopting a new M&A posture, banks can learn from other industries. For example, the top consumer products companies have succeeded in using a “string of pearls” approach to M&A as a source of growth. They’ve perfected their ability to identify and integrate smaller deals without destroying value. In these uncertain times, banks could consider a similar strategy.