Shortly after John Varley took over as chief executive of Barclays in 2004, the bank’s top managers started using a new term to describe the scale of its ambitions, writes Peter Thal Larsen in the FT. The idea, which they dubbed T5, was that Barclays should think and compete as if it were one of the top five banks in the world.
If Barclays succeeds in buying ABN Amro of the Netherlands, Mr Varley and his team will need a new target. Based on current share prices, the combined group would be worth around $177bn and would displace JPMorgan Chase as the fifth largest bank in the world. The merged group would be a rival to Citi and HSBC as one of only a handful of truly universal banks.
But is this a good idea, asks Thal Larsen. Most banking executives implicitly assume that big banks are better than small ones – but that case is unproven. Despite a decade of banking mergers, there is no evidence that big banks are any more efficient or profitable than their smaller rivals. This is reflected in their share prices. In the past few years, the world’s largest banks have tended to trade on lower earnings multiples than smaller institutions. “When it comes to asking the stock market whether bigger banks are better, the current answer is a resounding ‘no’,” analysts at Citigroup wrote in a study published last year.
Far from spawning a host of imitators, global universal banks like Citi remain a rare breed. Though other US banks such as JPMorgan Chase and Bank of America have made big acquisitions, they remain predominantly focused on their home market.
The history of ABN Amro also offers a cautionary example that building a universal bank does not always work It has failed to deliver any sustained growth in profits in recent years. It was not until TCI last month launched its campaign to shake up ABN Amro that the bank’s shares rose above the level they stood at in the spring of 2000.
ABN Amro’s performance is often blamed on poor management – and there seems little question that the bank could be better run. Stuart Graham, an analyst at Merrill Lynch, calculates that if ABN Amro’s ratio of cost to income were in line with that of its peers, profits would be 37 per cent higher.
Barclays’ management team would be likely to improve performance. But an alternative argument is that ABN Amro does not make sense in its current form and should be broken up, with its various subsidiaries sold to banks that could manage them better, Thal Larsen says. Investment bankers are trying to assemble consortia that could offer to buy the whole of ABN Amro and, if successful, carve up the businesses among themselves.
In this context, Barclays’ talks with ABN Amro mark a critical moment in the development of the industry. If the deal goes ahead and is a success, it could transform the banking landscape, triggering a string of similar deals among European institutions as they rush to bulk up. Yet if Barclays is outbid by a rival that splits ABN Amro into different parts, investors could rethink the value of large banks – and increase the pressure on those institutions that have done big deals in the past to prove they really are worth more than the sum of their parts.
Whatever the arguments, the data suggest there is no evidence that big banks are better. Last year analysts at Citigroup measured the efficiency and profitability of a large group of banks relative to revenues and the size of their balance sheets and concluded there was no relationship between the two. They also calculated that big banks’ earnings were no less volatile and that, while they were better able to diversify risk, this applied to any bank with a market capitalisation of more than $20bn.Despite all this, bank executives seem unlikely to lose their interest in getting bigger anytime soon. Faced with the threat of being taken over by larger rivals – particularly those from the US – many European banks will continue to explore cross-border deals as a way of getting bigger.
As for Mr Varley, he has everything to prove. If Barclays takes over ABN Amro, he will be under pressure to prove that big global banks really can work. But if Barclays’ tilt at ABN fails, it may be the beginning of the end of the idea of the global universal bank.
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Click here for a video comment by Peter Thal Larsen on consolidation in the banking industry.