Why European companies should stick with European investment banks Thursday, 14 April 2016
“US investment banks tend to focus on the immediate transactional value of a deal. This makes them risk-conscious and as a result less loyal.”
Investments banks from the USA are gaining dominance in the European market. They can be powerful partners for companies in mergers, acquisitions and loans. But relying too much on these banks creates a strategic risk for European companies, according to Prof. Dirk Schoenmaker from Rotterdam School of Management, Erasmus University (RSM). He argues that companies should always have at least one European banking partner to build long-term relationships to see them through in times of need.
How dependent are European corporations really on US banks?
“We studied how market shares of investment banks in Europe changed over the last 10 years. We found that investments banks in the USA have indeed significantly increased their shares in investment activities in the EMEA region during that period, from 37 per cent to almost 45 per cent. The share of European banks slid from nearly 55 per cent to 46 per cent. Unfortunately, we only had the numbers for the whole EMEA region, but the lion’s share of those investments go to European companies.”
So did banks in the USA become larger or did the European banks become smaller?
“With new regulations after the banking crisis, Europe has effectively caused banks to become smaller. In England for example, the large banks were forced to separate their retail activities from their investment activities. After the Liikanen report in 2012, European banks were also forced to downsize their risky trading divisions. All in all, this left European banks with less investment capital. So it’s rather unsurprising that American banks then filled the gap in the capital market and became more active in investment banking in Europe.”
US banks apparently also have a better capital position than their European counterparts, allowing them to invest more. Why is this?
“After the economic crisis, the U.S. Department of the Treasury forcefully imposed rules on US banks to increase their equity within a very short time span. The Treasury Department is a federal and very powerful institution, and as a result these banks recapitalised with government help much quicker than in European countries. In Europe, recapitalisation of banks was a lengthy, incomplete and sometimes rather messy process. While the European banking sector was still running stress tests until 2014, US banks became a ‘source of strength’ to the economy in 2009 already.”
Ah, so US banks are more important now to companies looking for capital in Europe, but we live in a globalised world. Why does it matter who supplies the capital?
“Indeed, on the short term it does not really matter where companies get their financing from, but in the long run it does. In times of economic downturn, companies still need financing and typically every round of financing comes with unknown factors and risks. Banks that have a longstanding relationship with a company based on mutual trust and loyalty will probably make a different risk assessment of those uncertainties. Those banks know they will be involved with this client for some time to come, so they will look beyond the quick gains and judge their chances. US investment banks tend to focus on the immediate transactional value of a deal. This makes them risk-conscious and as a result less loyal. It is harder for European companies that find themselves in trouble to attract investments from those banks.”
But didn’t we see that the loyalty European banks had for their clients had its limits during the last economic crisis? Didn’t their willingness to invest also decline sharply in those years?
“True, the economic crisis made all banks slower to invest, but this reasoning goes beyond large systemic crises. Just look at Ahold. When the company got into trouble after the accountancy scandal in 2003, their trusted Dutch banks were the ones to pick them up again and provide the company with additional finance. This happened against a higher than usual interest rate. This shows it definitely was not a charity operation, but it was because of their long investment relationship that they stepped up at that point. It’s questionable that a consortium of anonymous banks would have done the same.”
Many US investment banks set up a branch in Europe to serve European clients. Can they not develop the same kind of relationship with companies?
“These banks establish a presence in Europe, but the real power and mandate to make decisions stays in London or New York City. So you might get to know the country manager really well, but when you need a big credit line you will still need to talk to the bank’s headquarters, which will often judge the deal on its transactional qualities.”
What’s your advice to companies?
“The take-away here for European companies trying to attract financing is to look beyond the cheapest interest rates and reputation of the big name US banks. Don’t discard the power of long-term relationship banking. Be willing to share the profit with the bank in good times and it just might see you through bad times. When working with a banking syndicate, as is often the case with larger companies, my advice would be to always include at least one European bank.”
Can I describe you as an optimistic European when it comes to the future of banking?
“Yes, you can. I realise I’m part of an increasingly rare breed, but I feel we have a lot to gain by the European co-operation between banks and co-operates.”
Read the paper: The United States dominates global investment banking: does it matter for Europe? by C. Goodhart, D. Schoenmaker, Bruegel (2016).
Watch what Dirk Schoenmaker has to say about the European deposit insurance on RSM Discovery.