The Consolidation of Boutique Banks
The process through which banks take over and merge with other ones is called bank consolidation. This operation is not very frequent due to the huge costs and legal practices related to it. The main reason why this phenomenon takes place is that banks need to achieve power globally in order to remain profitable and sustainable.
Thus, the main advantages that these institutes benefit from after completing such a move, are the higher ability to compete against major rivals and the ability to offer increasingly more services to please a wider range of customers.
The creation of bigger banks is not only an advantage for single institutions, but it could also bring additional security for the users of bank services. The reason is that the notorious economic saying “too big to fail” is an accurate statement. As a matter of fact, the biggest banks in the market are less likely to fail since, in case of near bankruptcy, Governments usually do all that is in their power to avoid it. Thus, this change of scale would be a guarantee for inventors and customers to store and underwrite their money in these institutions.
Among the banks that emerged from consolidation in the United States of America, we can quote the following: JP Morgan Chase, Citi Group, Bank of America, and Wells Fargo.
The first one, for instance, is a financial institution that, at its base, consists of 13 different smaller banks. Using this tactic, JP Morgan Chase has become both one of the world's largest asset management firms and the world's third-largest hedge fund, managing $45 billion.
Figure 1: US Banks' Consolidation Process
Before Covid there was a strong motivation of transformation in the banking sector, including consolidation through M&A. The need for investment in technology and digital capabilities has increased the importance of scale in investment banking. Coupled with regulatory changes, increased consolidation emerged, exceeding the values before the great recession crisis in 2019.
Exhibit 1: Consolidation Rates Recently Reurned To Historical Highs, But What's Next?
During the first months after the COVID-19 pandemic spread the level of uncertainty in the market, combined with low business optimism and confidence, there was little M&A activity. The total shareholder return (TSR) and the valuations of the companies took a hit. Therefore, many sellers preferred to wait before selling, unless forced by severe capital pressure or material risk of failure. On the other hand, buyer’s might be concerned over capital flexibility or the quality of target credit portfolios. However, generous government support programs, including support for employees and payroll, as well as creditor forbearance schemes, have allowed many companies to weather the storm through 2020.
There is also a growing need for consolidation. Unprecedented credit losses and low interest rates are just some of the causes that put pressure on banks. After the crisis and this period of inactivity in which expectations and valuations further stabilize, consolidation will continue and to return to rates seen just before COVID-19, possibly with some acceleration. There will be a finite window for banks to maximize this opportunity. Thus, some banks will emerge from the crisis stronger than others, because of greater resilience in their existing books or better responses to the crisis. Banks with higher relative valuations or financial resilience should be ready with clearly articulated strategies and plans. Contrarily, banks with a relatively high fixed cost base or those that do not adapt with new capabilities will struggle to respond to the new reality. Following the acute phase of the COVID-19 crisis, scale, the ability to invest and transform to capture advantages from digital data and analytics will be even more important than before the crisis.
Exhibit 2: Lower-risk Models Are Holding Up Better in the Crisis; Higher RWA/Assets Ratios Are Bringing Significant TSR Declines
Consolidation for BBs
Boutique Banks cannot really be dealt with as typical investment banks. First because the main characteristic of these entities is that they are often small or medium-sized banks that focus only on a specific niche, service or industry. Thus, it is interesting to wonder: “would it make sense for a boutique to consolidate?” Many may say that most of the time it would not, unless the institution decides to change the whole perspective of the company and its core structure.
On one hand, during the consolidation phase, the boutique would stop existing since the result of such action would be the creation of a typical round investment bank. On the other hand, if this is true in the case of an acquisition, it is not in the case of a merger. Indeed, boutiques can merge and still keep their main focus unchanged, while it would impact the culture of the firm. In our opinion, by consolidating, the boutique could lose part of its identity and independence, but it wouldn’t necessarily change its core activities.
This process could result in the loss of leverage when it comes to being trusted by clients to manage their deals, but it could also broaden the number of customers interested in the bank’s services. Some elite boutique banks such as Rothschild or Lazard have successfully accomplished a consolidation process. Lazard, for example, in 1999, had decided to merge all its three investment banks into a single partnership to compete better with such banks as Goldman Sachs or Morgan Stanley. This move gave, at the time, a strong competitive advantage to deal with its rivals. Moreover, this was also done to integrate all functions that the boutique bank was offering to be able to provide them to all users around the world. Nevertheless, what usually characterizes boutiques is their profound knowledge of the sectors in which they operate. This is what gives them credibility and the strength to go after any type of need and concern of their customers.
Figure 2: The Idea Behind Consolidation
The knowledge they have on specific sectors allows them to find efficient solutions and develop very efficient perspectives on problems that their users may face.
Consolidation, in most cases, would not make this process easier and it would probably lead these banks to not be able to fully satisfy the consumers.
The spontaneous question that comes to mind is: “after all this discussion, is consolidation effective for Boutiques or just hurtful?” The only answer we can give, as of now, is the worst one anyone can think of: it depends. In fact, Boutique banks that consolidate are different from other banks since they mostly merge in order to offer broader services, toward bigger audiences, still operating in the same niche of the market’s segment in which they are specialized.
As we have seen, bank consolidation is a growing trend. Economies of scale in the production of financial services, sophisticated (and costly) risk management techniques, customers’ preference for one-stop-shopping, and the related bank’s need to diversify into different lines of business (and sources of revenues) are just some of the causes. Small banks seem to be threatened, which is shown by the number of banks of this size that have shrunk in the last years.
In Europe many banks have low profits and high costs. This compromises the resilience of the banking sector and therefore the stability of the financial system. Consolidation can help by enabling investment, unlocking economies of scale, and allowing diversification. It should also help banks to prepare and face long-term challenges. But also, the most immediate ones posed by the pandemic, or the longer-term ones that will emerge as digitalization, irreversibly changes customers’ preferences, and with them the banking landscape.