A V Rajwade: European banking blues

WORLD MONEY

Banking integration is more rapid in smaller European countries

In the general process of European economic integration, unlike the capital markets, cross-border bank mergers have not made much of a headway. The only recent major case has been the takeover, about a year ago, of the British bank Abbey National, by a Spanish one.

The previous comparably large transaction occurred more than five years ago. Ironically, within a couple of weeks of the defeat in France and the Netherlands of referenda to approve the new EU constitution, UniCredito, Italy's largest bank, announced a merger with HVB Group, Germany's second largest bank.

The resultant bank would become Europe's fourth largest in terms of size. HVB, itself the product of a merger of two regional banks, has been hobbled by huge non-performing assets, particularly from the property sector. (German banks have aggregate problem debt estimated at €300 billion plus.)

A corollary of the mountain of bad loans is that private equity and hedge funds have been active in Germany, in buying them at deep discounts. Many of these are managed from London and New York and readily arouse European suspicions of Anglo-Saxon practices and "finance capital".

One US-based private equity fund, which made a killing in the takeover of a weak Japanese bank, was rebuffed when it tried to purchase a troubled German bank. It has now founded a joint venture with two German state banks to buy distressed assets.

But coming back to cross-border mergers in Europe, an interesting question is whether after the UniCredito/ HVB transaction, the Italian authorities will take a more benign attitude towards foreigners trying to buy Italian banks, now that an Italian bank has taken over a German one.

In many ways, the Italian market is likely to prove to be a magnet for foreign banks: many banks are small and relatively undercapitalised and trading at comparatively low multiples.

Not much may happen in the two major economies, Germany and France, where more than half the industry is still in state hands. Banking integration has progressed much more rapidly in smaller European countries like Belgium, the Netherlands and Luxembourg, and Nordic countries such as Sweden, Denmark, Norway and Finland.

So far the Italian authorities have not been too supportive of foreigners' attempts to take over Italian banks. A test case is the ongoing bid of ABN Amro to buy an Italian bank. The offer expires later this week.

Citibank's bond trades
In the last week of June, UK's Financial Services Authority fined Citibank 14 million pounds, thus bringing to an end a 10-month investigation in the bank's bond trading activities in the European market. To recapitulate, on August 12, Citibank first purchased eurozone government bond futures to drive up the prices; then, in 200 separate trades executed within minutes, it sold €12 billion worth of bonds.

Later in the day, it bought back bonds worth €4 billion, making a profit of $17.5 million in the process. Some internal memos leaked later suggested that the objective was to "turn the European government bond market into one that more closely resembles the less transparent US Treasury bond market", and "kill off some of the smaller dealers".

The set of transactions became a subject of inquiry not only by the FSA, but also by prosecutors in Frankfurt and the German regulatory authorities. The prosecutors did not find enough grounds to launch proceedings.

Germany's financial market watchdog, Bafin, however, concluded that the bank traders had manipulated the market. The crux of the issue was that orderly functioning of the order-driven MTS bond trading platform depends on the participants co-operating.

As game theorists argue, in many situations, while co-operation is in the long-term interest of all participants, a defector can make large gains in the short term. Citibank seems to have preferred the short-term gains, ignoring in the process, the longer-term impact, also on its credibility and reputation.

As the FSA said while announcing the fine, "Citigroup....planned, authorised and executed a trading strategy without having due regard to the risks and likely consequences of its action for the efficient and orderly operation of the MTS platform."

Citibank's own respect for its professed commitment to "the highest standards of moral and ethical conduct" is exemplified by the reinstatement of the traders, perhaps, after a mild rap on the knuckles.

Last month, Citibank also settled a claim by investors in Enron paper for its role in the fraudulent deals of the failed company, by paying $2 billion.

More or less simultaneously, it has been barred from participating in the overseas IPO and listing of the China Construction Bank, for having gone back on a pledge to become a shareholder of CCB.

Citi is obviously not having a good year, at least in reputational terms; profit is of course another matter!

Email: avrco@vsnl.com