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Strengthening Europe’s banking sector through consolidation

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The European banking sector is facing three key challenges: a prolonged period of negative interest rates, the pace and scale of the digital transformation of the sector, and increased competition from established and new entrants.

The sector has grappled with negative interest rates for more than five years, but the economic crisis caused by the Covid-19 pandemic has reduced the likelihood of them being raised imminently. Indeed, many economic indicators point to this macro backdrop continuing for the foreseeable future.

For example, while eurozone inflation crept up to 2% in May and is expected to continue rising this year, markets are pricing in a negative 12-month Euribor until October 2024. This will likely have a knock-on effect on profitability, considering the average return on equity of eurozone banks was standing at 5.4% between 2016 and 2020, according to the European Banking Federation. This will force many entities to rethink traditional banking models, focusing more on fee earning activities at the expense of deposit taking.

Meanwhile, the sector is also facing a technological revolution which affects all elements of the banking sector, from infrastructure to distribution channels, including a bank’s relationships with its customers. Banks are having to overhaul their legacy systems and migrate to new technologies to benefit from the various efficiencies generated by moves such as migrating from data warehouses to the cloud and adopting forms of artificial intelligence and machine learning.

The pace of technological change and innovation has given rise to new competitors in the form of shadow banking and fintech, which are subject to less stringent regulations and unencumbered by legacy technologies. Data from the European Systemic Risk Board (ESRB) highlights this issue – at the end of 2019, 40% of European financial assets, equivalent to €45 trillion, were under the management of non-bank financial institutions, compared to €17 billion in 2005.

We now have an excellent platform, a new and more robust CaixaBank that enables us to face the future from an unrivalled starting point
José Ignacio Goirigolzarri, chairman, CaixaBank

These challenges are well understood and, as a result, the consolidation of the European banking sector has been a hotly discussed topic as traditional banks strive to reach a critical size in an increasingly fragmented marketplace. However, with a preferred solution of cross-border mergers within Europe difficult due to the lack of a true EU capital markets union, banks have focused on their domestic market for consolidation and scale.

Going from discussion to action, however, requires an alignment of purpose as well as a financial rationale. As one of the major consolidators of the Spanish banking sector in the past decade, CaixaBank continues to build on its track record to create Spain's leading financial group thanks to its latest merger with Bankia.

The merger means CaixaBank now has close to 20 million customers in Spain, a 25% and 24% share in loans and deposits, respectively, and assets of more than €620 billion in Spain, which makes it the largest bank in the country.

A stronger more agile bank

CaixaBank has, through this merger, anticipated and addressed the wider sector challenges, allowing it to reach a critical size, and ensure financial stability and sustainable profitability.

An example of this is the merged bank’s balanced portfolio mix which has a strong capacity to generate more income and savings, with around €1 billion in synergies, and a better efficiency ratio than the averages in Spain and Europe. In addition, cost savings will emerge from a streamlining of overheads and the structure and operating costs of the merged entity will be smaller than the sum of its parts.

In essence, the merger has created a bank which is able to generate sustainable profitability despite continued low or negative interest rates. This will also strengthen its ability to make the necessary investment in new technology and innovation.

Indeed, the merger has made CaixaBank an institution large enough to be able to deploy the new business models emerging in the digital era. These new models are based on economies of scale that require the largest possible customer base to develop cost-effective platforms and digital ecosystems, allowing the bank to roll out digital financial services at scale.

The deal has also given CaixaBank the financial muscle for the investment needed to build an attractive project that ensures talent retention. The bank’s robust balance sheet and capital position has also reinforced its financial stability, allowing it to replace legacy systems. Furthermore, given CaixaBank’s strengthened position in long-term savings products, mutual funds, and insurance, the new balance sheet is well-provisioned and well-capitalised, with a non-performing loan ratio that is the lowest among the big four banks in the country and a coverage ratio above Spain’s average.

However, a successful merger can only be achieved with a common culture, shared values and a clear vision on management. CaixaBank and Bankia both have deep roots stretching back to their inception based on a differentiated banking model, excellent corporate governance and a clear commitment to society. From day one, the management structure was clearly set up and aligned in its mission, seamlessly mitigating implementation risk inherent to every merger, and giving the merged bank the foundations it needs to ensure the future sustainability of the project.

Huge challenges are forcing established banks to make important strategic decisions. For CaixaBank, consolidation through the merger with Bankia has given it a solid foundation to face these challenges and become a hugely flexible organisation, capable of responding to a changing environment with enormous speed. As José Ignacio Goirigolzarri, CaixaBank's chairman, pointed out during his speech at the CaixaBank’s General Shareholder Meeting in May 2021: “We now have an excellent platform, a new and more robust CaixaBank that enables us to face the future from an unrivalled starting point”.

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