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Chapter 1 – Introduction_________________________________________________
The aim and objective of this dissertation is to provide an insight into the dynamics of
banking sector. The primary aim of this dissertation is to find out what motivates
financial organisations to merge with or acquire similar organisations and what the
exact degree of influence these motivations exert. Literature available on M&A activity
is primarily based on data from United States or other developed countries. Secondary,
the aim of this dissertation is to find out whether the motivations found to be behind the
wave of consolidation in the financial sector also apply to the banking sector in the UK.
The author aims to accomplish this with the help of case studies based on data from the
recent acquisition of National Westminster bank by the Royal Bank of Scotland and the
Halifax building society merger with Bank of Scotland. The effect of consolidation in
the financial sector is another area of study related to mergers and acquisitions that the
This dissertation is divided into six chapters. The first chapter provides an outline of the
aims of the study followed by the review of the literature pertaining to the topic of the
study. The second chapter starts with a definition of mergers and acquisitions, and
join. The third and fourth chapters are the apex points of this dissertation. The third
chapter provides an in-depth study of the motivations behind the wave of consolidation
in the financial sector (with a special emphasis on the UK financial sector) and
consolidation activity in the financial sector. The fourth chapter undertakes case studies
of two of the most prominent and significant mergers in the history of the banking
sector of the UK. The case studies include the acquisition of National Westminster bank
by the Royal Bank of Scotland and the merger of Halifax building society with the Bank
of Scotland, which are the pivotal points of this chapter. This chapter includes a ratio
analysis based on the figures and facts available in the annual reports of the respective
organisations. The fifth chapter evaluates the effects of consolidation in the banking
sector on the consumers, the banks themselves and the overall economy. The sixth
This section provides a brief review of the empirical literature that examines the aspect
of M&A in the financial sector. A large body of literature exists related to the topic
under consideration. Existing literature ranges from studies on the causes &
determinants of the premium paid for the target. Since the focus of this dissertation is
from which the study was undertaken i.e. theoretical studies and practitioners’ view.
the financial sector are in consensus that there are shareholders’ value maximisation
motives. On the other hand, managerial motives and external factors of technological
motives. While there is consensus on the overall motivations, the magnitude of these
motivations differs among authors. Berger, Demsetz and Strahan (1999) viewed the
causes and consequences of M&A activity in the financial industry from a static as well
as a dynamic point of view. The static analysis compared the financial organisations, as
M&A did not happen; static analysis was carried out to provide a base to compare the
results of the dynamic study. The dynamic study incorporated the changes in the
financial organisations before and after consolidation. The conclusion drawn from the
static and dynamic analysis points out that the motivations of increasing market power
and improving profits through geographical diversification are more significant than all
acquisitions. Fotios, Tanna & Zopounidis (2005) in a study which includes all
significant mergers in the financial sector of major economies till the year 2004,
emphasize on achieving economies of scale and scope and creating synergies as more
and executives related with the financial organisations engaged in M&A activity. She
found that, apart from diversifying risk, geographical diversification and improving
a financial organisation.
the financial sector. European Commission Economic Paper (2005) examines a range of
factors that facilitate integration and consolidation in the financial sector, additionally
the study assesses the level of integration both within and across national borders of the
EU. These Economic Papers are written by experts in the related field or by the staff of
the director general for economic and financial affairs. Although, the Economic Paper
the prime external motivator, because of its role as a promoter of all other motivations
behind consolidation in the financial sector. On the other hand, A Group of ten report
(2001) drafted by a working party that consisted of a task force of experts from 45
sector. The task force conducted interviews with the participants in order to ascertain
the motivations. The interviews conducted were based on a common interview guide,
which the participants were asked to give their opinions on. The final report identifies
achieving Economies of scale and increasing market power as the most important
internal factors. Deregulation and technological innovations were identified as the most
European Central Bank (2006) in order to review the motives of consolidation from an
industrial point of view, conducted interviews and surveys with bank supervisors. The
Banking Supervision Committee (BSC) prepared the report. The study concluded that
achieving economies of scale and diversification of risk through M&A are the most
In addition to the motivations behind consolidation in the financial sector, the effects of
consolidation in the financial sector are also considered in this dissertation. The
literature available on the effects of consolidation in the financial sector was found to be
based primarily on the financial sector of the United States and other developed
economies. However, results from economies having a similar financial structure as that
European nations. The results indicate that in-market mergers create positive
performance returns increasing the efficiency of the whole sector. However, it was also
found that M&A deals that occurred between securities firms and domestic or foreign
financial organisations did not gain any positive market’s expectation. On the other
hand, a study by Focarelli & Salleo (2002) concludes that mergers seek to improve
income and services, but the increase is offset by higher staff costs and other costs
involved. Focarelli and Panetta (2002) in a study on the long run effects of
consolidation in the banking sector find that consolidation generates adverse price
the long run consolidation led to prices that are more favourable for consumers.
The empirical evidence is mixed and no two studies were found to emphasize on one
central motivations behind consolidation and the effects of consolidation in the financial
sector that provides evidence from the UK banking sector is precisely what is required.
Constraints like ‘information overload’ and reliability issues are always present. The
sheer volume of data available on the topic was the first problem. The second major
issue was that the majority of literature available in books, journals and electronic
resources was found to be based on financial sectors quite different from that of the
the financial sector under consideration was a challenging task. The author had to sort
through a huge amount of data to find out relevant material for the study. Another
limitation the author faced was that the relevant material was outdated and based on
mergers and acquisitions that took place in the early 90’s. Although the field of M&A is
a very dynamic and ever-changing one, lack of relevant updated material posed a
problem. The author used recent M&A news and company financial reports to have an
updated analysis to tackle this problem. In an effort to have genuine results, only data
Mergers and acquisitions are a phenomenon, which quintessentially raised head in the
twentieth century, as the twentieth century novelist John Phillips Marquand quotes:
“Mergers are a damnably serious business. Hardly a business day passes without
Firms may expand by external as well as internal growth. Firms grow internally by
retaining earnings and using their cash flow to replace and expand plant and equipment.
(Mayo, 1995)
M&A activities are periodic in nature and come in waves. Evenett (2003) has identified
two waves of consolidation, in the years 1987-90 and 1997-2000. In the first wave,
1987-90, 63% of M&A were in the manufacturing sector, 32% in the tertiary or services
sector, and 5% in the primary sector. In the second wave, 1997-2000, 64% of M&A
were in services and 35% in manufacturing sector respectively. In both periods, within
the services sector, good percentages of M&As were between financial organisations,
The number and size of mergers and acquisitions being completed continue to grow
exponentially. Once a phenomenon seen largely in the United States, mergers and
acquisitions are now taking place in countries all over the world. (Hitt, Harrison &
Ireland, 2001) It is evident from Fig1.1 that mergers and acquisitions have become one
In the late 1990s, mergers and acquisitions in the financial sector started to get bigger
and involve even bigger financial institutions. A study of the 13 largest economies in
2001 states:
“In the 1990s there were more than 7,300 deals in which, a financial firm was taken
over by another financial firm from these 13 countries, the values of these acquisitions
being in access of $1.6 trillion. During the same period financial firms from the same 13
countries made 7600 acquisitions with a similar estimated value”. (OECD 2001)
As is evident from fig 2.1, fig 2.2 and discussion in the previous paragraphs of this
section, mergers and acquisitions have grown in popularity during the last decade. This
Consolidation activities are further fuelled by the fact that in order to stay one-step
ahead of the competition companies are squeezing hard on their resources in order to
employ them more efficiently and effectively therefore, to avoid becoming a target
themselves. Nevertheless, the most important reason for engaging in merger and
to maximize shareholders wealth in addition to other motivations and reasons that are
“Mergers and Acquisitions are tools used by companies for the purpose of expanding
In most of the western economies, the trend is towards greater consolidation of financial
firms are combined into a new legal entity. Whereas acquisition is an activity where the
control of at least one firm is bought by the financial organisation, but their assets are
not integrated and neither are they combined into a single unit. (Heffernan, 2005)
“Mergers and Acquisitions are primarily viewed as means of corporate expansion and
growth. In the past, companies have been performing ‘business combination’ in order to
Before going on to the definition part of mergers and acquisitions it is very important to
draw a line between the two activities. Acquisitions happen when the acquiring
company takes over the target company and clearly establishes itself as the new owner.
Merger happens when two relatively equal companies, agree to go forward as a single
new company rather then being separately owned and operated. (Refer appendix 1)
Merger:
In a merger, two or more companies of ‘comparable size’ are brought together and
fused to create a new legal entity. Each of the companies, if the law allows, loses its
own legal identity in favour of the new merged one. (Gardner, 1996)
company. The will to do so is ‘commonly voluntary’ and may involve a stock swap or
cash payment between the two parties. Swapping of stock is the more preferred of the
two activities, as swapping stock allows the involved risk (pertaining to the deal) to be
In a merger, the corporations come together to combine and share their resources to
achieve common objectives. The ownership is transferred from the two separate groups
merger, a new entity is formed by ‘subsuming’ the merging firms. (Sudarsanam, 1995)
Acquisition:
namely the acquirer, obtains control over the net assets and operations of another
enterprise, the acquired, in exchange for the transfer of assets, incurrence of liability or
In an acquisition, the buyer normally pays full value of the target company plus a
premium. In other words, the buyer pays the discounted value of all future cash flows
from the business plus 10-50 percent more. The reason why buyers pay premium is that
they are in competition with other buyers and often they need to pay a premium to
An acquisition involves the acquiring of the assets and/or share capital (almost
invariably of both) of another business. In contrast to a merger in which both parties are
normally of equal stature, an acquisition implies that one of the companies involved is a
senior party. In an acquisition, at least half of the voting rights are passed on to the
acquiring company from the acquired company. The bought company might then
the businesses involved, how the merger is financed, or on what the resulting
market.
Market Extension Merger: - Merger of two companies selling the same products
they are carried out. There could be congenial acquisition in which all the parties
involved feel satisfied with the deal or it could be a hostile acquisition, which is
governed by the larger company. An acquisition could take place in the following ways:
When the acquirer secures a major share in the target company’s share by
When one company acquires all the assets of the target company.
good prospects buys a public company with bleak prospects, resulting to which
Other than Mergers and Acquisitions there are many options available to companies,
which want to jointly produce, to consolidate assets, to have a bigger capital base, etc.
on a corporate level.
Leveraged buyouts: - When one company buys another company with the help
of borrowed money.
Joint venture: - When two companies merge together for a specific time or to
synergies, from which the benefit is greater than those from individual efforts
are.
2.5 Summary
A merger in a broad sense is coming together of two or more companies in which each
of the companies give up their legal existence. The parties involved negotiate on the
relative value of ownership to be translated and the amount of ownership each will have
In an acquisition, negotiations take place between the acquirer and the target on the
value of the business and all the future cash flows from the business of the target.
Which are then translated into the purchase price, after paying which the acquirer will
be the owner of the whole business and the target will no longer exist.
3.1 Introduction
financial markets has blurred distinction between activities such as lending, investment
Firms have reacted to intelligent competition by cutting costs and expanding in size,
often by merging with the competitors or taking them over. For a long time financial
However, due to deregulation in the financial sector, it has now become a sector with
the highest number of mergers and acquisitions taking place. Technological innovations
financial industry all over the world. The wave started in the United States in the
Until the late 1970s the growth in the UK financial sector was anything but fast paced
or exciting, it was rather steadily paced in an unremarkable way. This growth in the
financial sector was primarily due to modernisation of the wages and salaries payment
system. This was being carried out more efficiently and securely by having a bank-to-
bank transfer instead of dealing in cash. Such transfers were made possible by the
adopting them early to speed up account processing and settlement (Leyson and Pollard,
2000).
This period of slow development and greater stability, ended in the early 1980s when
the UK’s financial industry went through a sea of changes in its regulatory framework
that controlled the activities in the sector. In particular, from the mid 1980s onwards the
old system of structural regulation was dismantled on the grounds that it discouraged
competition and failed to properly serve the consumer. In its place, a new system of
‘prudential’ regulation was installed; one that would allow firms from different parts of
the financial sector to directly compete with each other, bringing about efficiency gains
With new regulations in place, terms like ‘bankassurance’ came into existence. The
financial institutions that were involved in their own secluded activities were now free
to move around into each other’s territories. This increased the competition in the
financial sector and new products started to come out at a very fast pace. The financial
institutions were now being distinguished from competition based on product offerings.
This pace hit rock bottom in the early 1990s with the financial sector and the economy
overall being ‘overheated’. With the interest rates going up in the late 1980s, everything
ranging from, basic necessities to luxuries became dearer. Pertaining to which the
unemployment rates went up and a situation of ‘debt crisis’ arose in the financial sector
In order to keep their heads above water, financial organisations started looking into
new ways to cut costs and increase revenues. The best way to do that was to provide the
customers with new products and services, which led the wave of consolidation in the
financial sector of the UK. Figure 3.1 presents some evidence supporting this notion.
Source: - http://www.kpmgtci.tc/news.asp?unid=41
The increase in geographical reach, ability to lend money from a bigger pool of money
and various other motivations led the merger wave in the UK’s financial sector. This
wave was second only to the number of consolidations going on in the US financial
financial sector.
synergistic benefits from engaging in M&A and believes that the benefits achieved will
be enough to pay for the activity and a premium to the shareholders, then attaining
Synergistic activities are comprehended when the combined efforts of the two
organisations involved produces a greater effect than the summation of efforts of the
“The operation of a corporate combination is more profitable than the individual profits
of the firms that were combined. M&A deals are often justified based on the anticipated
Fotios, Tanna & Zopounidis (2005) have formulised an equation to better understand
the concept of Synergy. They argue that Synergies might allow the combined firms to
Equation 1 contains the synergistic effect in the square brackets. The effect should be
greater than the adding together of P and E as shown, otherwise the equation will have a
negative value. This will mean that the merger or acquisition has not had a positive
affect and the bidding company has paid in excess for the target. Often synergy is
expressed in the form 2+2=5. The equation for net present value simply expresses the
“Although many merger partners cite synergy as the motive for their transaction,
He advocates that there are two types of synergies that arise out of mergers and
acquisitions: synergies that are derived from cost economies and synergies that flow
from revenue enhancements. The notion that cost economies are easier to achieve as
The main approach behind creating synergies is to bring up the management of the
target firm to the standards of the parent firm. The key areas that are affected by
The figure above clearly depicts that reductions I costs is the main area from which
synergistic benefits flow. In order to reduce cost and enhance revenues, management of
3.3 Economies of Scale: - The term ‘economies of scale’, or scale economies, is a long
run concept, applicable when all the factors inputs that contribute to a firm’s production
Economies of Scale are achieved when increasing the number of products brings down
the average cost of production. Procuring inputs becomes cheaper as the organisation
demands bigger volumes of inputs due to enlarged size. Due to which the demand for
inputs increases which evokes bulk discounts. These bulk discounts easily make the
manufacturing process much more economical and in terms efficient than before. The
benefits do not stop in the manufacturing process, they might concern research,
development, and even departments like sales and marketing. Often these benefits are
reaped across many departments and have far-reaching effects in respect of improving
Consider the case of a simple bank, which has three factor inputs:
The bank yields one product- loan. The economies of scale in this particular case will
exist when the factor inputs mentioned above are utilised more efficiently. The potential
takes place, because neither the property (in the form of branch network) nor the labour
(in the form of bank employees) are utilised as intensively as they could be. Therefore,
when a merger or acquisition takes place, redundant branches are closed down. This
leaves one or two branches in a particular locality. By doing this, the bank saves up on
property and labour costs. The main purpose of doing this is to reduce the overhead cost
per unit of output, in this case the loans. As the cost of producing loans goes down the
bank is able to make more profits. Thus, by engaging in M&A activity the shareholders’
However, considerable benefits from economies of scale can only be achieved when all
the factor inputs can be varied, which is not entirely possible in a realistic situation.
Even if the financial organisation is able to become more efficient, there is always a
problem of ‘indivisibilities’, which states that some resources like labour and property
In addition to the problems discussed above, there is also the question of what
constitutes output of the financial organisations. The views of various academics and
Moreover, empirical evidence and studies, like Short (1979) carried out on data from
the United States, indicate that motivations of achieving economies of scale are more
prominent in M&A involving small and medium sized banks. Larger banks that are
highly diversified may be unable to detect economies of scale, because scale economies
might be restricted to particular product lines and may not appear in aggregate. A study
on European banks in ‘The Economist’ (18th May 2006) advocate the notion that
relatively modest size. According to the study, diseconomies of scale start to creep in
when the size of the bank grows bigger than an optimal size. (‘Thinking Big’
Economist, 2006)
“Management will find it harder and harder to aggregate and summarize everything that
is going on in the bank, opening up way to the duplication of expenses, the neglect of
concealed risks and the failure of internal controls.” (‘Thinking Big’ Economist, 2006)
Even with the adversaries discussed above, employing economies of scale are still one
M&A activity.
3.4 Economies of Scope: - Economies of scope are achieved when the average total
being produced.
rather than specialize in just a handful of products. Expanding the product range to
exploit the value of existing brands is good way of exploiting economies of scope”
(Refer appendix 4)
Economies of Scope motivate mergers and acquisitions in the financial sector because it
becomes possible for the organisations involved in consolidation to cross sell the
products and services from the merged or acquired financial organisation. Economies of
scope are achieved by selling this added range of products and services through the
combined branch network of the organisations. This increases the number of products
and services available for the customers of the financial organisations. However, this
does not increase the related cost of production or the cost of Research and
Development, which the financial institution would have incurred, if they had not
engaged in M&A. Heffernan (2005) points out, if the banks can supply all the products
and service of the resulting organisation more cheaply through a joint production
process, they are said to enjoy economies of scope. It can be said that Scope economies
are mainly achieved by offering the customer more products on which there is a fixed
cost incurred. Due to the number of products increasing, the profits of the organisations
also increase.
cross selling products and services. For example, if the target bank has an insurance
conglomerate and the acquiring bank also owns a similar conglomerate. Then in case,
they engage in M&A activity. The best suitable insurance conglomerate from the
existing two is made as the principal and the product lines of the other conglomerate are
replaced by that of the principals. Thus, the more profitable products from the better
conglomerate are now sold through both of the conglomerates, and because the products
“Many mergers or acquisitions, particularly in the banking sector of the UK have been
By engaging in mergers and acquisitions, costs can be lowered if scale and scope
overlapping inputs such as labour and property are removed within the consolidated
organisations can incur lower costs if a single organisation can offer several products at
3.5 Market Power/ Competition: - Studies in the past; Fotios, Tanna & Zopounidis
(2005), Berger (1999), Demsetz & Strahan (1999), have reviewed and tested the
hypothesis that the wave of M&A in the financial sector of Europe has been motivated
In order to gain additional market power, financial organisations engage in merger and
sector, which provides these organisations more power to set prices (deposit rates, loan
rates, etc.), in order to achieve higher profit margins. The easiest way to achieve
substantial market share rests in the hands of a couple of banks. A small bank with
considerably small market share is certain to be acquired by one of the major banks in
the market. The assets of the small bank then become more valuable, because they are
now associated with a major force in the market and inherit the goodwill of the parent
organisation. This enables both the target and acquirer to benefit from the acquisition.
The smaller bank after consolidation is managed more efficiently and effectively by
employing the managerial expertise of the parent bank. The parent bank gets to increase
its market share, which allows it to set prices that are more in favour of the bank than
Although the example above might depict a win-win situation for the parties involved, it
Barriers to entry: - a major bank might not be allowed to enter the market by the
might not be suitable for the market in which the target is positioned, and to
Market share: - the market share held by the target may not be worth
Legislative problems: - the regulators of the market in which the banks are
located may be concerned about the future of the organisation; it might become
To sum it up, to achieve maximum value for their shareholders through increasing
order to become a ruling force in the market and to earn monopolistic profits. Although
there are many barriers and checks in place by the regulators in order to keep
concentration in the financial sector below a certain level, there have been studies like
Berger (1995), Gilbert (1984) which found evidence in support of the theory of gaining
lowers the systematic risk of the combined entity. Nevertheless, this can only
happen if the cash flow streams of the financial organisations involved are not in
perfect correlation with each other. Due to little or negative correlation the risk
“Consolidation may affect systematic risk in part because it changes the risk of
M&A activity facilitates the extension of the government safety net for the
status, the government cannot afford them to fail and employs all resources
Conversely, this fact in spite of lowering the risk may increase the risk taking
ability of the financial organisation. The problem of ‘Moral Hazard’ may arise.
This problem states that when the financial organisations are aware of the fact
that in case of serious problems the government will rescue them, they are
diversifying risk through M&A has found mixed results. Either M&A could
In a broader sense, banks and financial institutions want to minimize the risk of
Fail it acts as a further reason to engage in M&A activity, although it has been
motive.
major motivator of M&A activity in the financial sector. Firstly, because the
negatively correlated. Secondly, a product that is not very popular in one market
conglomerate. The term ‘Bancassurance’ originated from the want of the banks
distribution network. It is a service that fulfils both banking and insurance needs
Another market sector into which financial organisation like banks are keen to
acquire or merge is the mortgage sector of the financial sector. The mortgage
sector has been dominated by building societies in the UK. In order to capture a
huge market share in the mortgage sector and to take advantage of an already
societies. This is evident from the fact that many mergers or acquisitions, which
took place in the UK during the early 21st century; involved a bank and a
Financial organisations are able to add services and products to their existing
range at a nominal price and therefore attain the goal of wealth maximisation.
Geographical diversification also has a down side to it. It may lead a financial
Results from studies like Gardner (1996), Berger (1999) & Strahan (1999),
3.7 Capital Growth: - Capital growth pertains to the fact that the combining of capitals
capital deposits, capital gains will certainly be present. The gains from capital growth
motivate mergers and acquisitions particularly in the financial sector, for the following
reasons.
sector this requirement is influenced by the ‘Basel II accord’ under which the
dictated under the accord (refer appendix 10). If a financial organisation has a
low CAR and there is a prospective target having a higher CAR, then acquiring
or merging with that particular target will improve the overall CAR of the
the organisation will enjoy a better capital to asset ratio. Additionally, it will also
be viewed as a less risky venture, which will allow the financial organisation to
raise capital easily from financial markets at a lower cost, which will further
reduce costs.
capital base enlarges and they are able to lend larger loans. Combining the
capital base increases lending abilities. In some cases, this combination allows
sheer size of these loans. These types of loans are also called ‘Jumbo loans’. The
3.8 Managerial Motives: - A study by Milbourn (1999) into the managerial motives
behind an M&A decision has lead to the conclusion that “CEOs of larger or more
diverse banks enjoy higher reputation and possibly higher monetary compensation in
equilibrium”.
M&A decisions in the financial sector. Financial organisations tend to have weaker
(1999) points out that in the case of weak corporate controls, managers might be
increase the size of the organisation, because their remuneration is directly proportional
“Most large firms set compensation by looking at the compensation of peer group
executives, and size is the main determinant of which firms are in a peer group”.
Fotios (2005)
Heffernan (2005) further supports the notion that compensation is directly linked with
“Compensation is found to rise with size, and mergers may be seen as a quick way of
However, at least in some cases it has been found that higher compensation does
reward the extra skills and efforts of the managers that they employ in going forward
engage in M&A activity in order to reduce risks to a level beyond which the financial
organisation will not be declared insolvent. This leads to higher job security for the
However, many banks have tried to avoid this kind of situation by increasing the
managerial stock holdings, but again increasing the stock holdings for the managers
might make them more hesitant towards M&A, therefore the managers might favour
maximisation benefits that flow through engaging in M&A, if the managers are deep-
In case of the UK banking sector, being in charge of a bigger organisation improves the
status and power of the CEO and this highly increased status and power in addition to
Finally, the CEOs may be motivated to engage in M&A to build an empire, as it has
been well documented and observed that most of the mergers or acquisitions in the
financial sector take place between a large and a small organisation. Therefore,
managers may want to merge or acquire in order to enlarge the organisation and avoid
becoming a target themselves. While doing so, they secure themselves and not the
interest of the shareholders. Empirical literature reviwed points to the fact that M&A
decisions are indeed influenced and motivated by managers own motives rather than
emphasizes on three major external factors that encourage consolidation in the financial
services industry.
“In Sum, Technology, Deregulation and Globalisation have eased or removed entry
barriers and paved the way for increased competitive pressures” (OECD, 2001)
The ‘External Factors’ mentioned above might have a direct or indirect relationship
with the wave of consolidation in the financial sector. However, they have been
associated with the reasons of increased pressure on the managers to improve efficiency
institutions operated during the last twenty years has been drastically changed.
The Group of ten report on consolidation of the financial sector identifies the
following to be the major demarcations that depict the changes in regulations for
financial organisations.
transactions;
III. Through limits on the range of permissible activities for service providers;
In case of the UK’s financial sector, regulatory changes made by the European
fact that the changes made by the European commission in order to deregulate
and harmonise the financial sector of Europe (which are said to be based on the
changes in the US regulatory system (ECB, 2000)) has two essential tools. To
provide financial organisations with the freedom of capital movement and the
single banking licence, implemented these tools and the Second banking
financial services anywhere else in the EU with the permission from the home
state. The author’s aim behind including these changes in regulations in the
European Union under the motivating factors behind the wave of consolidation
in the financial sector is that in the past due to the regulations competition was
the sector. Due to the restrictions being lifted on the barriers to entry it served as
efficient in order to keep the shareholders happy and sustain themselves. The
acquire domestically.
Fotios, Tanna & Zopounidis (2005) have identified five periods of change
The major change from the above mentioned, that motivated the merger wave in
authorities in the UK followed suite with other EU countries, the financial sector
opened up to the international market, which led the merger and acquisition
wave.
Although the regulators opened up the financial sector in the UK, they still
acceptable to a certain limit and to give too much power in the hands of a couple
of financial organisations was not a favourable decision for the overall financial
sector and the economy. The notion discussed above is supported by the fact that
While the regulators have acted in the best interest of the public, they have also
provided financial aid to banks in distress, which have further encouraged the
“The main influence of deregulation appears to be that it enlarges the set of legal
across sectors and across borders, and thereby gives institutions flexibility to
invention of the 20th century; it might as well be seen as the biggest invention
including the internet. One of the major technological innovations that affected
the financial sector has been the advancements in information technology. It had
a major impact on the processing of information, which is at the very heart of all
among financial organisations are far reaching and numerous. These influences
financial products and services like credit cards, asset management etc. The risk
bank guarantees etc, is better diversified because they are now being produced
With the innovation of ATM and online banking, financial organisations benefit
Most of these new services and products have high technology investment costs
attached to them, and they generate less significant revenue margins. Financial
institutions, in order to provide these services at a lower cost, have to spread the
cost over a larger customer base and to have a large customer base they engage
the financial sector, at both the production and the distribution level, and have
However, there are concerns about these products and services not being easy to
use by people with less or no access to technology, in addition to the fact that in
the light of these innovations many financial organisations have closed branches
financial sector.
The innovation in technology and the changes in the regulatory structure have
very effectively aided the integration of the international financial system (IFS).
“Globalisation of the IFS has been associated with a shift from bank-centred to
With the ease of entry, because of deregulation and the fact that technological
innovations have made global reach more economical, financial institutions are
Globalisation has turned the world into a global village in which various
reach financially feasible. It can be said that although globalisation may not be
one of the primary drivers of M&A activity in the financial sector, it certainly
3.10 Summary
spans all over the globe. Factors motivating the wave of consolidation in the financial
sector vary from country to country. Each financial sector of the world is different in
terms of rules, regulations, structure, products, services and so on. Thus, the internal and
the external factors that influence major decisions in each financial sector are different.
influence these motivations exert on consolidation activity in the financial sector differs.
Figure 3.5 shows the significance of each motivation listed in figure3.4, according to
Technological Globalisation
Advancements Synergies
2%
15% 15%
Deregulation
7%
Economies of Scale
Managerial Motives 18%
2%
Capital Growth
6%
Figure 3.6 sums up the results from the study, the author embarked on in order to find
out the fundamental motivations behind consolidation in the financial sector. In addition
to the studies listed in figure 3.5, these results also depict the amount of influence all the
other studies reviewed by the author (having relevance to the subject) exert on the
According to figure 3.6 achieving economies of Scale is the most important motivation
behind the wave of consolidation in the financial industry. Whereas, creating synergies,
achieving economies of scope, having higher market power, diversify risk, diversifying
geographically and the external factor of technological advancement are the second
Furthermore, the author also came across some less documented motives behind
increased shareholder pressure and macro economic motivations that influence the rate
imminent, as the ones mentioned in figure 3.4, they still play an imperative function in
some cases.
4.1 Introduction
In line with the findings detailed in the previous chapter, the author will perform a
financial analysis on the pre and post merger financial reports of the financial
organisations involved in two of the most influential in-market consolidation that took
By testing various ratios based on the financial data of the organisations, the author
aims to ascertain whether the findings from the previous chapter can be applied to the
UK banking sector.
Ratio analysis is an accounting technique used to compare figures. For example if the A
business is twice as big as the B business we could represent the ratio of the sizes of the
Ratios help us to instantly check whether a business is sound, and to compare ratios
over a period in time. In business, we also use the term ratio to apply to other measures
Although ratio analysis is a powerful tool to analyse and interpret financial statements,
it has certain limitations to it. The accounting procedures of the companies involved
might be very different and may have a noteworthy impact on the analysis.
Ratio analysis on the annual reports of the financial organisations under consideration
Profit Margin: - profit margin ratio is very useful when organisations in the
same industry are compared. This ratio is calculated by dividing the net income
provides us with the actual earnings that the company retains out of the sales
made during the respective period. A higher profit margin reflects a good
performance by the company. Increased profit margin tell us that sales of the
company have shown a greater increase than the costs attached to the sales and
Sales Growth: - as the name suggests this ratio compares the percentage growth
in sales between the said periods. A steadily increasing sales growth ratio is
what the institutes’ desire. Sales growth ratio indicates that the company’s prices
are keeping up with the increases in the overall costs of production. If the ratio is
declining then the company needs to revamp prices in line with costs
Return on Equity (ROE): - return on equity measures the ability of the managers
said period.
Earnings per Share: - EPS calculates the profit allocation of the company to its
Earnings per Share: - Net Profit after Tax and preference dividends x100
No. ordinary Shares in issue
All the figures and graphs derived from the figures, used in the analysis, are taken from
the annual reports of the respective financial organisations (refer appendix 8).
The Royal Bank of Scotland Group is one of Europe’s leading financial services groups
with a reputation for acquiring other financial institutions and integrating them
profitably. The formal structure in 2006 was that RBS had eight ‘customer-facing’
divisions:
Wealth Management;
Retail Direct;
RBS insurance;
Citizens (US);
On 6th March 2000, Royal Bank of Scotland took control of National Westminster Bank
with a winning bid of £21bn.RBS’s winning bid had promised the shareholders that it
will “create a new force in banking” with the scale and strength to exploit new
opportunities in the UK. In order to deliver on the promise, RBS had an ambitious plan
cutting redundancies could result in annual cost reductions of £1.1bn by the end of three
years. In addition to the promise mentioned above, RBS acquisition was also seen as a
benefits from the integration of the entrepreneurial spirit of RBS. Overall, the benefits
and gains arising out of the acquisition will help Natwest to move forward in a highly
Figure: 4.1 Geographic extent of Royal Bank of Scotland and National Westminster
bank before the acquisition
From figure 4.1, it is evident that RBS was motivated to diversify geographically
through acquiring Natwest, as RBS had moderate or low presence in England, and areas
around England. In contrast to RBS, Natwest had a very strong presence in England and
surrounding areas. In short, there was a very low overlap of branches. In the words of
RBS group Chief executive Sir Fred Godwin, “By combining the branch networks of
Profit Margin
This ratio depicts the profit generated from sales by the company. As there is an
increase in the profit margin, it portrays that resources are employed more efficiently
thus achieving economies of scale or scope. Profits can go up when costs are reduced or
revenues are increased, in any case, economies of scale and scope are achieved.
RBS YTD 31/09/99- 29.4% YTD 31/12/00- 28.2% YTD 31/12/01- 29.3%
Natwest YTD 31/12/99- 29.7% YTD 31/12/00- 38.7% YTD 31/12/01- 40%
The above table shows the profit margins of RBS and Natwest before and after the
acquisition. By looking at the numbers it becomes clear that Natwest with its huge
resources and infrastructure was not, performing as well as it could (refer appendix 11).
On the other hand, RBS a much smaller bank than Natwest was almost equal when
target. After acquiring Natwest, RBS employed the same practices and values, which it
had already tried and tested, onto Natwest. This triggered efficiency gains and cost
reductions, which is evident from figure 4.2, which shows a substantial increase in the
45.00%
40.00%
35.00%
Source: - RBS & Natwest annual reports, various years
RBS was aware that Natwest was underperforming, and that it could be elevated to a
30.00%
new high by employing the practices and values of RBS. Thus achieving economies of
25.00%
Sales Growth
This ratio measures the growth in sales as compared to last year. It can be both negative
and positive. A positive figure will mean that the cost of production is in accordance
20.00%
with the prices of the products, and the factors of production are being employed
efficiently.
15.00%
Royal Bank of Scotland & Natwest (Pre and post merger)
RBS YTD 31/09/99- 10.1% YTD 31/12/00- 19% YTD 31/12/01- 18%
Natwest YTD 31/12/99- (-)1.6% YTD 31/12/00- (-)0.25% YTD 31/12/01- 1.75%
10.00%
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5.00%
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As is clear from the table above, Natwest had a negative sales growth figure before and
Various factors of production were evaluated, and major cost reductions were planned
25.00%
20.00%
15.00%
RBS
10.00%
Natwest
5.00%
0.00%
1999 2000 2001
-5.00%
bring Natwest sales growth out of the red, which is evident from figure 4.3. Although
RBS’s sales growth saw a little dip, it was due to the dilution in the resources
(managerial time, training time etc.) that were employed for Natwest instead. Thus, the
Return on Equity
Returns on equity are a major motivation for investors, as they are generally higher
when compared to other similar investments. Looking at the figures in the table below,
a slumping ROE for Natwest shows that the returns were nose-diving; this is never a
good indicator of the company practices. This also makes the value of share capital to
Banks Return
The dip in the value of shares of Natwest motivated RBS to acquire it. Additionally in
order to substantially increase its market share, RBS was motivated to acquire Natwest.
25.00%
20.00%
15.00%
RBS
Natwest
10.00%
5.00%
0.00%
1999 2000 2001
By acquiring Natwest, which was a major competitor, RBS made it an insider rather
than a competitor. This helped RBS to capture a huge market share while reducing
competition. The acquisition brought gains for Natwest to, as it is depicted in figure 4.4,
ROE of Natwest went down by 8.5% the year before the acquisition, and only a
This ratio is concerned with shareholders value. Value maximisation motives are citied
as the most important motivation for financial organisations to engage in M&A. EPS
However, the graph shows that the EPS was not maximised or substantially increased in
the last few years before the acquisition in 2000. Conversely, Natwest enjoyed a higher
EPS than RBS because of its vast resources. In order to boost the earnings and
maximise value for its shareholders RBS was motivated to acquire Natwest.
By including, the EPS of Natwest to its own, RBS was able to attain a higher average
RBS YTD 31/09/99- 53.6p YTD 31/12/00- 66.6p YTD 31/12/01- 67.6p
Natwest YTD 31/12/99- 96.7p YTD 31/12/00- 66.6p YTD 31/12/01- 67.6p
Although the EPS was not as high as expected, probably because the acquisition costs
were very high for RBS, RBS was still able to maximise its shareholders value.
4.3 Halifax building society merging with Bank of Scotland to form HBOS
Before the merger of Halifax and Bank of Scotland (BOS), Halifax was the largest
mortgage lender in the UK, and Bank of Scotland was seen as a major banking power in
the UK banking sector. Peter Burt, the CEO of Bank of Scotland, had suffered
considerable disappointments with failed merger attempts in the past. This situation was
further aggravated with the loss of a takeover battle to Royal Bank of Scotland for
National Westminster Bank. This strings of failures made Bank of Scotland a possible
takeover target. On the other hand, Halifax being a major force in the mortgage sector
As a merger wave swept across the UK financial sector, every institute in the sector was
aiming to challenge the big four (Lloyds TSB, HSBC, RBS and Barclays). In a situation
like this when BOS was in need of a merger and Halifax was looking to diversify, it was
Critics and analysts saw it as an ‘excellent strategic fit’. According to a statement in the
Halifax annual report, the potential gains from the merger would arise from the
complementarities of the businesses of the two organisations, also from the fact that
Profit Margin
Analysing the profit margin ratio gives us the measure to gauge the performance of the
company. In the case of Halifax, profit margins were showing a downward trend,
however it was not a major issue for the management, as the drop was very small. On
the other hand, Bank of Scotland was showing a considerable downfall in profit
margins.
Halifax YTD 31/12/98- 54% YTD 31/12/99- 53.7% YTD 31/12/00- 50%
Bank Of Scotland YTD 28/02/99- 47% YTD 29/02/00- 38% YTD 28/02/01- 37%
HBOS YTD 31/12/01- 35.1% YTD 31/12/02- 38.6% YTD 31/12/03- 42.1%
Falling margins and the feeling that the scale of operations was not large were enough
reasons for Bank of Scotland to find a financial partner that could help its position.
Halifax on the other hand, was looking to diversify. It was already the leader in
mortgage services and has reached the apex now as the profit margin dipped slightly.
Halifax made a friendly nil premium offer to Bank of Scotland, which was duly
accepted. The capital base of the combined organisation became much larger and
facilitated lending on a wider scale. The market power of both the organisations
drastically increased which promoted growth, which is evident from figure 4.6 that
shows that profit margin of HBOS increased from 35% in the first year to 42% in the
44.00%
42.00%
40.00%
38.00%
HBOS
36.00%
34.00%
32.00%
30.00%
2001 2002 2003
Thus, the motivations of achieving superior market power and increasing the capital
base were two of the most important motivations that promoted the creation of HBOS.
Sales Growth
Sales growth figures of the financial organisations show similar patterns, i.e.
Halifax YTD 31/12/98- 6.8% YTD 31/12/99- 4.3% YTD 31/12/00- 4.6%
Bank Of Scotland YTD 28/02/99- 13.5% YTD 29/02/00- 10% YTD 28/02/01- 10.8%
HBOS YTD 31/12/01- 4.6% YTD 31/12/02- 15.5% YTD 31/12/03- 18.6%
The organisations were well established in their own respective sectors. Then why were
The answer was, as it occurred to the managers, that the range of products and services
was not diversified enough. Halifax was a building society specializing in mortgage
loans and Bank of Scotland was a major bank specializing in banking products and
services.
20.00%
18.00%
16.00%
14.00%
12.00%
10.00% HBOS
8.00%
6.00%
4.00%
2.00%
0.00%
2001 2002 2003
The products of the two organisations were uncorrelated. By merging with each other,
they not only diversified their product and services but also were able to diversify the
associated risk. After the merger, the sales grew, as is shown by figure 4.7, from 4.6%
to 18.6% in a span of just 2 years. Anticipating this growth, it can be said that managers
of both the organisations were not wrong in getting motivated to merge in order to
diversify.
Return on Equity
Return on equity (ROE) measures the returns that flow from equity. Looking at the
figures of Halifax and Bank of Scotland it can be said that Halifax was seeing a steady
increase in ROE as it rose from 16% to 18% in a period of two years before the merger.
On the other hand, Bank of Scotland had seen a slump in the ROE in years before the
merger.
Banks Return
Halifax YTD 31/12/98- 16% YTD 31/12/99- 17% YTD 31/12/00- 18%
Bank Of Scotland YTD 28/02/99- 11.9% YTD 29/02/00- 10.7% YTD 28/02/01- 8.6%
HBOS YTD 31/12/01- 12% YTD 31/12/02- 13% YTD 31/12/03- 14.9%
The reason for the slump in ROE for BOS was said to be the incompetence of BOS to
compete with the bigger banks in the sector. In order to survive BOS required a capital
boost. On the other hand, Halifax viewed BOS as a perfect target because BOS was
16%
14%
12%
10%
8% HBOS
6%
4%
2%
0%
2001 2002 2003
However, after the merger, as is evident from the ROE figure of HBOS the desired
trend in ROE was achieved. The ROE figures of HBOS may not be better than those of
Halifax’s but they still outpace the growth percentage which is supported by the fact
that ROE figures for HBOS grew by 2.9% in two years as compared to Halifax ROE
growing by 2% in the last two years before the merger. Although there might be some
external factor encouraging the growth that might not be present in the past, still the
Earnings per share (EPS) are an indicator of the companies’ performance. It is clear,
from the table below, that the trend for both of the organisations were on a steady
increase
Halifax YTD 31/12/98- 47.5p YTD 31/12/99- 46.1p YTD 31/12/00- 52.5p
Bank Of Scotland YTD 28/02/98- 42.1p YTD 29/02/00- 44.3p YTD 28/02/01- 45.8p
HBOS YTD 31/12/01- 40.5p YTD 31/12/02- 50.6p YTD 31/12/03- 63.6p
However, when the EPS for HBOS is examined it shows a higher increase rate
compared to both Halifax and BOS. The EPS increased by 20% for HBOS in the first
Although HBOS started with a lower EPS of 40% for the first year, which might be
blamed on the merger cost, it showed a healthy trend in the following years. Halifax and
Bank of Scotland both were managing to achieve what can be said to be a steady EPS
figure. The comparison of EPS figure before and after the merger highlight that HBOS
delivered higher EPS. This substantial growth in EPS shows that by merging to form
HBOS, both the organisations realised their aim of maximising the shareholders value.
70.00%
Source: - HBOS annual reports, various years
Thus from the figure 4.9 it can be concluded that the merger of Halifax and Bank of
Scotland resulted in a new force in the banking sector of the UK. The aim and motive of
4.4 Summary
The primary motive of analysis presented in this chapter was to find out whether the
central motivations behind the wave of consolidation in the financial sectors around the
world, discussed in the previous chapter, can be applied to the banking sector of UK.
In the case of the acquisition of National Westminster bank by Royal Bank of Scotland
(RBS), .RBS seems to have achieved the goal of generating economies of scale and
scope and the overall goal of increasing shareholders’ value by creating synergies,
diversifying geographically and by increasing market power. However, the result of the
analysis also show that the gains are increasing, but at a slow rate. This may be due to
the sheer size of the acquisition, as Sir Fred Goodwin has aptly put it:
“Natwest is a super tanker. You will not be able to turn its performance round quickly”
Although results may not be as good as desirable, they are still headed in the right
direction.
In the second case, the merger of Halifax and Bank of Scotland to form HBOS, the aim
was to create a bank that could challenge the big four in terms of geographic reach,
product offering, market power and Capitalisation. The results of the analysis show that
the motivations and reasons behind the merger have been successful in challenging the
dominance of the big four in the UK banking sector. HBOS has shown a sustained and
profitable growth from the very beginning. Furthermore, HBOS is now the fourth
the big four has been renamed the big five to accommodate HBOS in the league.
The newspaper the Scotsman (April 2004) in its business review section during the time
“This is a merger in which everyone is a winner. The outcome of the merger looks
encouraging for the banks as well as for the customers and shareholders”
The results of the analysis, along with other facts, depict that the motivation of creating
a bigger bank in terms of capitalisation, market power and having an unrivalled product
range have benefited both the organisations. Thus resulting in prosperity for the
Beside the motivations discussed above, there are always managerial motives that have
been questioned repeatedly. During the analysis, the author has noticed that the
managers of the banks do tend to benefit from M&A activity. The gains might be
significant in some cases and not so great in others, but they are still present.
Besides that, recent profit declarations by banks in the UK’s banking sector (£9.2bn for
RBS) have raised some eyebrows about the banks charging high penalties from their
customers and not giving back enough to the customers, in form of interests and other
benefits. Research and analysis to find answers to these questions have been successful;
they have found that banks do charge customers’ high penalties. (Refer to appendix 9)
To discuss all the results from the studies, will be out of scope for this dissertation; this
This chapter has provided an in-depth financial analysis into the two most prominent
cases of consolidation in the banking sector of the UK. The results from the analysis
provide concrete evidence supporting the results of the previous chapter. Thus, it is
concluded that the fundamental motivations (refer pg 41) that drive consolidation in the
financial sector around the world, are indeed the motivations fuelling the consolidation
5.1 Introduction
There are many direct and indirect consequences and effects of consolidation in the
banking sector. Direct consequences include increased market power in the hands of
performance of banks and related organisations due to fiercer competition, and many
small customers in rural areas, cultural clashes or turf battles inside the banks, etc.
These direct and indirect consequences may be good or bad for the consumers, the
economy, the banks, and other organisations involved, and for the overall financial
sector. To find out whether consolidation had a good or bad effect on these elements,
the author carried out a detailed study on the direct and indirect consequences of
consolidation. The study is focused on the UK banking sector and the results are
presented hereunder.
prove to be disadvantageous. The results rely on the viewpoint that they are being
analysed from; however, this study includes an analysis from the viewpoint of the
• Consumers
• Macroeconomic effects
The effects of consolidation among banks, on the consumers of financial services and
products, can be analysed from the viewpoints of the corporate consumers and small
customers.
Corporate consumers tend to benefit from the increase in consolidation in the banking
lending rates. This being one of the primary factors affecting demand for financial
Empirical literature points out that if consolidation takes place between a small and a
large financial organisation, then over a long period after the consolidation deposit rates
also have shown a propensity to increase. However, conversely the rates may go up
involved increases significantly, the reason behind this rise is possibly the associated
Moreover, the increased size and market power of the financial organisations due to
increased concentration in the sector directly affects the small consumers. With the
increase in market power, financial organisations now have greater power to influence
prices of financial products and services, and may set prices that are less favourable for
the small consumers. Relationship banking is another service that is affected by the
increased size of the organisation. A study by Berger et al. (1999) suggests that the
increased complexity of the financial organisations might hinder them to provide locally
based services to small consumers, as it might not be financially viable to do so. The
study also suggests that the larger banks might not reduce the availability of services
and products to all small consumers. Moreover, high net worth individuals might have
the same products and service offered to large customers extended to them as well.
However, if the parent financial organisation recasts the target into its own image, the
services and products offered to small consumers will depend on the portfolio that the
parent organisation had before consolidation. In other words, if the parent bank had a
healthy part of its portfolio consisting of small investors and consumers, it is very likely
that the new consolidated bank will also have small investors and consumers as a good
availability of services and products offered to them by large banks in case of financial
stress. Empirical evidence supports that larger banks are more capable of handling
tend to withdraw products and services from small consumers during financial stress.
the supply of financial products and services, which are affected due to external factors
5.3 Effects of consolidation in the banking sector on banks and the banking sector
itself
organisation mergers or acquires an inefficient one, and brings it up to its own level.
consolidated financial sector, conversely too much concentration in the sector might
subject to other forms of characteristic risks, which undermine the financial system such
constitute a rescue operation in order to save an organisation under financial stress. The
supervisors of the sector might also initiate this kind of M&A. These rescue operations
through consolidation are better than using the government safety net because a lot of
taxpayers’ money is saved by doing so. Thus, taxpayers’ money is saved and the
conglomerates from within the sector new range of products and services are added.
This diversifies the associated risks, which in terms makes the organisations involved,
more stable and with increasing number of this kind of consolidation, the whole sector
With increased consolidation in the financial sector, the payment system also witnesses
involved. This improvement in the payment system in terms improves the efficiency of
the overall sector. Similarly, the back office operations in consolidated financial
organisations also enjoy increased scale efficiencies, as the scale at which the operations
However, Heffernan (2005) points out that a marked increase in the cost efficiencies of
being geographically adjacent. That brings out the question on the efficiency of
domestic and international mergers. Large amounts of literature and research papers are
available on the question of which of the two; domestic or international mergers are
more beneficial? Answering this question will be out of the scope of this dissertation,
but it has been found that in-market mergers and acquisitions are much more successful
One area in which M&A certainly produces efficiency gains is by the elimination of
“Failed banks are significantly less efficient than their peers; consolidation can be a
Consolidation in the financial sector affects the macro economy. These effects can be
measured in terms of market power, safety net subsidies and systematic risk. In a
developed economy like the UK, a financial sector merger that crosses international
borders seldom takes place. That means the fate of the whole economy and the financial
sector enclosed in the economy are knitted together. In other words, an economic
downturn will affect the profitability and stability of the countries’ financial sector,
With the financial organisations becoming much bigger in terms of capitalisation and
geographic reach, the regulators of the financial sector are under more pressure, as there
are now more organisations under their safety net compared to the situation earlier.
With more financial organisations attaining the status of Too-Big-To-Fail, the financial
sector incurs an added cost of expanding the safety net. With the financial organisations
becoming bigger and more industries depending on them, the regulators cannot afford
tend to be much more severe and widespread. This in terms may motivate larger
organisation to take undue risks. Financial organisations have been know to explain by
increased risk taking by quoting that they are taking the advantage of the safety net to
maximise shareholders value. However, the risk taken by larger organisations might
“The conclusion seems to be that financial sector integration results in reduced business
volatility and enhanced overall macroeconomic stability” (EU Economic Paper 2005)
5.5 Summary
The empirical literature reviewed and analysed generally concludes that in-market
may harm the interests of consumers. Conversely, there is evidence supporting that the
long run effects might be the opposite, i.e. in the long run efficiency gains dominate
over the market power effect, leading to a favourable price for the consumers.
Consolidation in the financial sector has encouraged the development of very large and
complex financial institutions. The trend is not showing any signs of slowing down in
the near future. Consolidation has also led to greater concentration of payment and
settlement flows among fewer parties (due to increased concentration) within the
technologies the larger institutions created are better able to invest in new and imminent
technologies that in terms makes the organisations more efficient and the sector overall
benefits from the increased efficiency. On the macro economic level, consolidation in
The consequences and effects of consolidation in the financial sector are far-reaching
and numerous, ranging from creating new jobs and new avenues of investment, to
include and detail the most important in this chapter, but due to various restrictions, the
scope of this chapter is limited. The topic of consequences and effects of consolidation
in the banking sector is a vast and spontaneous research area. A whole study can be
based on this particular subject, taking into account the static and dynamic nature of the
consequences that may not have come into existence yet. The far-reaching effects after a
number of years may prove to be entirely divergent from those studied in current and
previous literature.
Chapter 6 – Conclusion___________________________________________________
stimulants behind this wave of consolidation have been discussed and reviewed by the
author (chapter 3). It appears internal factors that transpire within the financial
organisation motivate M&A decisions more than external factors affecting these
and Scope are decisive for an M&A decision. The presence of these three factors is
critical because they indicate that the decision would be profitable, all else equal, to
jointly produce different financial products and services. Furthermore, it appears that
decreasing costs rather than increasing revenue drives much of the consolidation
activity in the financial sector. Most of the financial organisations that engage in M&A
justify their decision by quoting that the combined organisation would create
In line with reducing costs and increasing revenues, diversifying risk and geographical
diversification were also recognized to influence M&A decision in the financial sector.
The Geographical expansion into markets that the individual institutions had not
previously had a presence in has been referred to directly or indirectly in almost all
geographical expansion, the financial organisations are also able to decrease various
risks and increase sales, thus increasing overall gross revenue. Several cases of mergers
and acquisitions in the financial sector were also found to be motivated by the fact that
the combined asset base of the involved organisations will allow the consolidated
In addition to enlarging the asset base and being able to provide new products to
organisations to offer the products that their associate offered before the organisations
were fused together, thereby increasing sales and boosting revenue growth. Financial
organisations also benefit from an enlarged asset base in terms credit rating. These
motivations all come under the shareholders value maximisation motives. In addition to
them, non-value maximisation motives behind an M&A decision were also found.
motivation. The fact that new and upcoming technologies are expensive in terms of
capital, time and other resources makes it difficult for some organisation to update
circumstances due to which they themselves are looked upon as prospective targets.
Moreover, deregulation in the financial sector and globalisation of the sector has
organisations were discouraged to engage in M&A, but after some radical changes in
the regulations initiated by the European Commission in the late 1980’s the financial
sector was opened up and competition started flooding into domestic markets all over
the world. The affects were more prominent in developed economies such as the UK.
world changing into a global village, it became much easier for financial organisations
to control and command the flow of resources around the world. With this happening,
organisation to become more efficient or else they risked becoming a target of M&A. In
order to become more efficient over a short period domestic financial organisation
compensation and empire building were also reviewed and studied by the author, but no
responsible for an M&A decision. Researchers and Economist question this motive
often following mega mergers. Not a single study or research was found to present hard
evidence proving that the managers were entirely motivated by their personal motives
for engaging in M&A. Further analysis and research on this particular motivation will
lead to even further insight into this matter, and can prove to be a rewarding avenue for
future research.
The 1980s was a period of real deregulation in the UK banking sector. In late 1980’s a
wave of consolidation swept across this sector, and two of the most prominent
outcomes of this wave were the acquisition of National Westminster bank by the Royal
bank of Scotland and the merger of Halifax and the Bank of Scotland. The fundamental
motivations argued by the author to be behind the wave of consolidation in the financial
sector are absolutely applicable to the banking sector of UK, evidence from the
The effects and consequences of consolidation in the financial sector range from the
effects on consumers to managerial compensation. Consumers may lose in the short run
but in the long run i.e. 10 years or more, the overall effects are positive. Systematic risk
could increase with the increased market share of the organisation due to M&A, but one
fact that stands out is that the authorities often block M&A deals if they pose a serious
threat to the customers or if the systematic risk gets higher than a certain level. The fear
Appendix______________________________________________________________
Appendix 1
http://www.investopedia.com/terms/m/mergersandacquisitions.asp
Appendix 2
http://www.investopedia.com/university/mergers/mergers1.asp
Appendix 3
Journal of Finance volume 7 issue 3, Journal of Banking and Finance volume 24 issue 9
Appendix 4
http://www.tutor2u.net/economics/content/essentials/economies_scale_scope.htm
Appendix 5
Types of Mergers
Horizontal integration- the union of two companies who are in the similar line of
business sell the same service or product to a customer within a matching geographical
area.
Vertical integration- two firms may decide to link up, although they are at different
stages. Their motive is to gain benefit from the integration of activities and greater
control over distribution channels.
Conglomerate merger- When a company is acquired by another from a completely
different and unrelated sector.
Appendix 6
http://www.etinvest.com/microsite/icicilombard/new_what_bancassu.jsp
Appendix 7
The competition Commission in UK blocked Lloyds TSB’s 18.2 billion hostile bid for
Abbey National in July 2001, because the new bank would have dominated the segment
of current accounts, with a 27% market share, and would have increased to 77% the
Appendix 8
Bank of Scotland
Ten year Summary Profit & Loss account 28th Feb 2001
Bank of Scotland
Ten year Summary Balance sheet 28th Feb 2001
Summary consolidated profit and loss account for the year ended 31 December 2000
2000 1999
£m £m
Reconciliation of movements in shareholders' funds for the year ended 31 December 2000
2000 1999
£m £m
Profit attributable to shareholders 1,168 1,064
Dividends (591) (538)
577 526
Return of capital to shareholders - (1,509)
Goodwill reinstatement on disposal/closure of estate agency branches - 124
Issue of ordinary shares 2 1
Repurchase of shares - (39)
Foreign currency translation difference on subsidiary undertaking - (4)
Other movements - 6
Net addition to/(reduction in) shareholders' funds 579 (895)
Opening shareholders' funds 6,254 7,149
151.6 137.8
Long term assurance assets attributable to policyholders 30.9 24.3
Total assets 182.5 162.1
Liabilities
Deposits by banks 16.5 11.9
Customer accounts 92.1 87.8
Debt securities in issue 25.4 23.5
Other liabilities 6.5 4.7
Subordinated liabilities 3.4 2.9
Minority interests (equity and non-equity) 0.9 0.7
Equity shareholders' funds 6.8 6.3
151.6 137.8
Long term assurance liabilities attributable to policyholders 30.9 24.3
Appendix 9
Having failed to get even a rough indication from any of the major banks about how
much it costs them to process their customers' defaults, we decided to set up a
commission of experts to try to answer the question.
Instead, we chose two eminent business academics Prof Philip Molyneux of the
University of Wales, Bangor, and Prof John Struthers of the University of Paisley, and
an experienced banker, Ian Jarritt, formerly a senior executive with NatWest.
We asked them to work out the highest costs they thought banks could possibly justify
for dealing with defaults, taking every relevant expense into account.
Our commission began work in October and met in London a month later to reach their
final conclusion.
They decided that the highest cost banks could justify for bouncing cheques (the most
labour-intensive procedure) was £4.50.
For other items, such as bouncing direct debits or dealing with unauthorised overdrafts,
the commission judged £2.50 to be the highest cost banks could reasonably justify.
Both figures are vastly lower than the average £30 penalty banks have been charging for
defaults.
Appendix 10
Capital adequacy rules set down the amount of capital a bank or credit institution (CI) must
hold. This amount is based on risk.
There are all sorts of financial instruments available by which credit institutions can guard
against risk (risk mitigation), such as derivatives, futures, corporate bonds and asset-backed
securities.
The rules are enforced by supervisors who check on how much risk is being run (risk
weighting) and gauge how much capital is required to underwrite (insure) that risk. Once each
bank has been assessed by the supervisors it is given a “risk profile”.
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Internationally, rules are set by the Basel 1 Committee, part of the Bank for International
Settlements (BIS). On this committee sit representatives from Belgium, France, Germany, Italy,
Luxembourg, Netherlands, Spain, Sweden, Switzerland, UK, Canada, Japan and US. The first
set of international rules was known as Basel I.
In June 2004, the Basel committee agreed updated rules - Basel II. These had to be applied in
the EU and in July 2004, the Commission set out proposals for a new Capital Requirements
Directive (CRD), which would apply Basel II to all banks, CIs and investment firms in the EU.
The new EU regime is contained in two directives: Directive 2006/48/EC on the “taking up and
pursuit of the business of credit institutions” and Directive 2006/49/EC on the “capital adequacy
of investment firms and credit institutions”.
Issues:
• Three different levels from which institutions can choose (Pillar 1): standard,
foundation and advanced;
• supervisory review process (Pillar 2): CIs do an internal assessment which is then
checked by supervisors and the minimum required amount of capital is set (capital
charge);
• public disclosure (Pillar 3): CIs must make certain information public to allow the
market to judge their risk worthiness and react accordingly (market discipline);
• single market passport: mutual recognition system allowing banks and CIs to operate
throughout the EU once approved by their own national regulatory authority, and;
• Consolidating supervisor: a new national banking supervisory body responsible
for cross-border issues. It must ensure harmonisation across the single market.
Appendix 11
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Annual Reports
Royal Bank of Scotland Report and Accounts for the year ended 30th September 1999
Royal Bank of Scotland Report and Accounts for the year ended 30th December 2000
Royal Bank of Scotland Report and Accounts for the year ended 30th December 2001
Natwest Report Accounts for year ended 30th December 1999
Halifax Consolidated Report & Accounts year ended 31st December 2000
Bank of Scotland Ten year summary reports year ended 28th February 2001
Halifax Bank of Scotland Five year summary report for year ended 31st Dec 2001