Wednesday, May 02, 2007

Breaking up large banks

The fate of Dutch bank ABN Amro hangs in the balance. Barclays of the UK first made a Euro 66 bn with a provision for selling ABN's Chicago bank, La Salle to Bank of America for $21 bn. Now a consortium of Royal Bank of Scotland, Santander of Spain and Fortis, a Dutch-Belgian group, has come up with an offer of Euro 72 bn but this is contingent on ABN not selling La Salle to BofA.

Whichever way the bidding goes, two things are clear. One, both bidders are banking on huge cost savings, partly from outsourcing of operations to countries like India (one report said an estimated 10,000 jobs could move to India). Two, ABN Amro is almost certain to be broken up. This means that the constituent parts are more valuable than the whole contrary to the earlier wisdom that banks stood to gain by integrating various types of businesses.

Important investors (one of which has led the campaign to break up ABN) are not buying this at all. They do not think it is true for many European banks and they think it may not be true for the biggest behemoth of all, Citibank.

The American bank's management is under pressure to prove that the bank is worth more than the sum of its parts. Citibank's stock has been an underperformer in recent years and it has moved to address investor concerns by slashing 17,000 jobs worldwide. But it is yet to convince sceptics that the whole is greater than the sum of its parts.

In Europe, inefficiencies in large banks such as ABN Amro have been hidden by the protective regime in most countries that frowns on cross-border acquisitions of banks. But this is breaking down under relentless pressure from the European Union. The prospects are that many national sacred cows in banking will soon cease to remain so.

As somebody who has long been sceptical about bank mergers, especially those aimed at creating financial supermarkets, I am inclined to believe this marks an important retreat from the hitherto prevailing wisdom, namely, that bigger is better.

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