European banks eye acquisitions

DESTINATION INDIA

Flush with surplus capital and liquidity, European banks are increasingly looking for potential acquisition targets in India among other emerging economies which are densely populated but mostly underbanked markets, leading global rating agency Fitch Ratings has said.

"Many banks are sitting on surplus capital and liquidity and are looking for potential acquisitions to boost shareholder value," Fitch's Financial Institutions Group Managing Director Alison Le Bras said in a special report on the European banking sector.

Besides the pan-European deals, major banks are also increasingly looking for external growth towards emerging markets like India, China, Turkey, Russia and Ukraine, the rating agency said.

While operating conditions in some of these countries remain difficult, the huge lending potential makes these future acquisitions attractive to major European banks.

Within Western Europe, Italy is the most attractive market for potential acquisition opportunities and there remain few obvious significant takeover targets in other EU markets, Fitch said.

Although more major pan-European deals cannot be ruled out in 2006 and beyond, major banks are increasingly looking further afield for external growth, particularly towards more densely populated, underbanked emerging markets.

Fitch further pointed out that organic growth within mature markets would be a key challenge for major European banks, as the rapid pace of loan growth experienced over the past two years is unsustainable and margins on traditional loan business remain under intense pressure.

The expected challenges to be witnessed in the mature markets further strengthen the belief that European banks would look towards emerging markets such as India, with developed markets leaving little manoeuvering abilities.

"Although we expect 2006 to be another strong year for European banking, with major banks reporting similar, if not higher profits than for 2005, the sustainability of these high levels of profitability in the longer term is questionable," Le Bras said.

Fitch said loan growth would eventually slow down in most markets, leaving banks more dependent on other revenue sources. The key to success will lie in banks' ability to develop more sophisticated value-added loan products, improve cross-selling efforts and strengthen distribution channels.

Commission and trading revenues remain, to a large extent, dependent on capital market conditions, and will be sustained only as long as these conditions remain favourable.

The persistently high levels of profitability achieved by the major European banks over the past two years have been driven by strong loan growth, particularly in retail lending, coupled with historically low loan loss provisions and buoyant capital market conditions.

Fitch expects major European banks to take advantage of their current robust financial health to strengthen franchises in addition to expanding and diversifying core businesses through external acquisitions or organic growth.

As long as revenue growth continues to be strong, Fitch does not expect any significant fall in costs, the report added.