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OPINION

Cost of equity is the new answer to banks' low profits

Debate around the UniCredit-Commerzbank merger will centre on its impact on European banks’ share prices as Eurosceptic populism makes cost cutting more difficult.

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A merger of UniCredit and Commerzbank would be the biggest bank M&A deal since the 2008 crisis. It is about the riskiest thing you could imagine a chief executive choosing to do. So how would it square with UniCredit CEO Jean Pierre Mustier’s insistence that his share price can rise, because he can do more to convince investors his bank is safer than before?

If you discount, for a moment, the idea that UniCredit might bid for Commerzbank, you can see where Mustier is coming from. After all, banks (especially UniCredit) have done the easy bits of cost cutting. Bank-bashing populists will increase the collateral damage of more aggressive staff reductions and branch closures. Future cuts may come more from technology, much of which is still under development.

At the same time, the populists have weighed on growth so much that European banks have to come to terms with the reality that the ECB is not going to help their interest margins any time soon. So what else can they do to boost their sorry share price performances, other than by trying to reduce their perceived risk?

Targets

Ultimately, banks must reach their profitability targets, which they set by looking at their cost of equity.