Euro area bank profitability and consolidation

Abstract

Consolidation in the euro area banking sector has been slow since the end of the global financial crisis, despite the persistent weak bank profitability. The coronavirus (COVID-19) pandemic has reinforced profitability risks in the euro area banking sector, and coincided with worse performance of some banks, notably those burdened with legacy non-performing loans. Consolidation among banks may bring benefits from both a micro- and a macroprudential perspective by generating cost synergies, increasing revenue diversification and strengthening the resilience of the banking sector. However, it comes with attendant execution risks, which need to be properly managed by banks. Consolidation may give rise to competition concerns, although empirical evidence suggests that there is room for further domestic concentration in some euro area countries and for greater cross-border integration of the European banking market. Bank mergers also increase the systemic footprint of the resulting institutions, which might be addressed by the existing macroprudential and resolution frameworks. The European Central Bank assesses consolidation from a prudential perspective, focusing on the current and future ability of the combined bank to comply with prudential requirements. To this end, it published a Guide in January 2021 in which it clarified its expectations and approach to three key prudential issues arising in the context of consolidation: setting Pillar 2 capital requirements, treatment of badwill and use of internal models.