This article is part of Bain's 2022 M&A Report.
The banking industry is primed for heated M&A activity.
In an era of persistent low interest rates and economic uncertainty, it has been challenging for banks to grow their revenue organically. They rely on acquisitions to pick up attractive customers and valuable assets. Scale deals accounted for an average of 75% of all large deals (more than $1 billion) activity in banking from 2015 to 2020. Also, unlike other industries in which regulators discourage consolidation, this is one in which authorities ranging from the Financial Services Authority of Indonesia to the European Central Bank are creating conditions that favor the building of local banking champions.
This comes at a time when scale is even more important than ever as banks seek to manage margin compression caused by a host of pressures, including competition from nontraditional players; rising compliance costs; larger capital expenditure requirements for digital/technology investments; and the coming impact of environmental, social, and corporate governance (ESG) commitments. Consider that many banks have committed to net zero in 2030, which stands to significantly affect their traditional lending business.
Scale is even more important than ever as banks strive to manage margin compression.
Given all these factors, M&A is expected to rise. In our global survey of M&A executives, 72% of financial services respondents expect their company’s M&A activity to increase over the next year.
Here’s how that will play out in the market.
Local players will continue to buy competitors to build positions of scale. That was the impetus behind US Bancorp’s agreement in September to buy MUFG Union Bank as well as local portfolio deals such as AIB’s purchase of €4.2 billion of corporate and commercial loans from Ulster Bank in June.
Also, multicountry global banks will continue to reevaluate their core vs. noncore businesses and exit subscale markets. That’s what Citi did by selling most of its Asia retail business, except for the financial centers of Singapore and Hong Kong. And HSBC sold its retail activities in France and the US.
While M&A in financial services remains predominantly scale oriented, there is still space for scope deals as banks look to increase their reach both geographically and across service offerings.
Banking M&A gets more dynamic
As banking M&A continues to heat up, acquirers will need to deal with a more dynamic environment and a new set of rules.
Among the biggest changes: M&A is getting more competitive with new players entering the game. In the past, private equity (PE) firms focused on aggregating subscale, noncore banking businesses, such as payments, fund administration, and factoring. Now they have extended their reach by buying banks directly. It was PE firm Cerberus that purchased HSBC’s retail activities in France, for example. Private equity firms are well placed to absorb underperforming bank assets as they bring fresh equity, strategic focus, strong management, and are willing to make bold investments in technology and digital capabilities.
M&A in banking is getting more competitive with new players entering the game. Private equity firms have extended their reach by buying banks directly.
Meanwhile, venture capital firms’ funding of innovation at a robust pace is leading neobanks and new digital players to achieve higher valuations than those for large traditional banks (see Figure 1). For example, Europe’s Revolut is valued at $33 billion, N26 (headquartered in Berlin) is valued at $9 billion, and Brazil-based Nubank went public in an IPO that gave the company a $41.5 billion valuation. Such price tags put them out of the reach of many traditional bank acquirers—and even make them competitors for purchasing the most attractive technology capabilities. In November, Sweden-based neobanking service Klarna paid $124 million for PriceRunner, a comparison-shopping service in the Nordics and UK.
Neobank valuations grew rapidly between 2019 and 2021 while traditional bank market capitalizations saw limited growth
Further pumping up the competition, technology players are directly buying banks. That’s what happened when Shopee, Sea Group's e-commerce arm in Southeast Asia, bought Indonesia lender Bank Kesejahteraan Ekonomi.
This changing game will make it more challenging for traditional banks to grow via M&A. To succeed, many will explore alternative methods. For example, more banks will turn to strategic partnerships to build scope and scale. That’s what is happening in Asia, where many banks have entered joint ventures with nonbanks to deliver more integrated “banking inside” solutions. For example, Standard Chartered entered a joint venture with National Trades Union Congress of Singapore (NTUC) to set up a digital bank. NTUC owns the largest supermarket chain in Singapore as well as a top insurance company and businesses in healthcare, childcare, and property management. The joint venture will embed Standard Chartered banking in NTUC’s ecosystem.
In another growing trend, banks are setting up their own corporate venture funds to invest directly in technology players, as Citi has done with its Citi Ventures unit.
The changing game will make it more challenging for traditional banks to grow via M&A.
Banking’s three big imperatives
Whether they pursue integrations or partnerships, traditional banks will need to focus on delivering strong client solutions at a faster pace if they want to succeed in M&A. That means ending their reputation for being slower and more bureaucratic than technology players.
Success rests on three imperatives.
- Banks need to implement corporate development scanning and due diligence capabilities on par with private equity and venture capital firms, which have turned this into a science. Winning banks will be those able to evaluate targets and opportunities with the right value investment thesis and develop and document the business case. Investment theses will be increasingly centered on revenue generation vs. costs synergies. The best banks will anticipate disruption from the impact of technology players and ESG on the profit pool over the next 5 to 10 years so that they can anticipate long-term sources of value.
- Banks need to have a comprehensive and holistic view of all potential sources of value beyond economic value to identify how to generate the most of it. For example, in Boston Private’s acquisition by SVB, technology and talent created additional sources of value beyond growing wealth offerings. The best bank acquirers will invest to assess and identify hidden jewels that can be leveraged for sustainable value creation.
- Finally, banks need to prepare for transformation. With technology and digital accelerating the pace of change, more banks are using acquisitions as a platform or a catalyst for their own transformation. NAB bought Citigroup’s Australian consumer banking business to scale its cards platform, for example. In the past, “integrate first and transform later” was a common M&A mantra. The best bank acquirers have already replaced that with “buy and transform now.”