Under what conditions would it make sense to merge the two big Swiss banks? Finance Professor Teodoro Cocca has agreed to write for finews.asia and this is his first contribution.

Teodoro D. Cocca is a professor for banking at Johannes Kepler University in Linz and adjunct professor at Swiss Finance Institute.

The language of the stock exchange makes for plain reading: the shares of the big universal banks are not the flavor of the time. Only carmakers have an even less attractive valuation than European banking shares, which says it all about of their less than glorious outlook.

The failure to merge Deutsche Bank and Commerzbank, as well as speculation involving other banking groups point toward an imminent wave of consolidation in European banking. This wave won’t stop at the big two Swiss banks, UBS and Credit Suisse, both of which have a low valuation on the stock.

Mergers Don’t Generate Added Value

The question is whether investors profited when banks merged in the past. The extensive research on this topic suggests that bank mergers within a country led to an increase in value. Acquisitions across European borders also created value, under certain circumstances. Mergers across the Atlantic ocean, however, are seen more critically, as have shown the experiences of the big Swiss banks.

A megabank created through a takeover can indeed profit from economies of scale in production, but will also be faced with diseconomies of scale in the governance of the complex structure. The former typically is overestimated, the latter underestimated.

Far-Reaching Changes

It is tempting to toy with the idea of UBS and Credit Suisse in the context of a possible wave of consolidation. Looking at the probability of its integration, such a «United Bank of Switzerland» would stand quite a fair chance, because the cultural fit seems more of a given compared with any combination with a foreign bank.

So far, when individual investors demanded far-reaching changes to the corporate structure of the big banking two, the consideration rather was to split off a division. A complete merger no doubt would be met with heavy regulatory opposition: at least one of the two banks would have to split off its Swiss business to avoid being held back by the competition commission on concern of market domination.

Too-Big-To-Fail Issue

The merged bank would also strongly exacerbate the «too-big-to-fail» issue in Switzerland. Valid points for sure. But because regulatory reasons stand in the way of such a merger doesn’t mean that a merger would make little strategic sense.

The strategic assessment should, however, focus more on synergies in both cost and income. The economic logic of a merger of both the investment banking and asset management units to create synergies of cost and of the private banking units to generate growth opportunities can’t be disputed.

Swiss Powerhouse

The result would be a Swiss powerhouse focusing on wealth management (which is the core competence of both companies), with a very strong presence in the biggest private banking markets and selective investment banking services. From a business point of view, this vision has quite a lot speaking in its favor, even though the implementation would present many hurdles.

One central aspect would be the capital requirement by the combined firm. The unbroken trend to higher capital requirements in investment banking means that cross-subsidization by wealth management becomes a major advantage for the funding of the business. A merger may be advantageous, but only if the two banks do their homework.

Creating a United Bank of Switzerland

The real challenge lies in the complexity of the operative and technical merger. Put simply, the bank would have to choose one of the two platforms and readdress all the production and distribution processes. A herculean task. The more integrated the business, the more sense it makes to make an acquisition of distribution (private banking), to generate more volume for the existing technology platform.

It would be simpler to do so by buying a slightly smaller Swiss rival.  I doubt whether this would constitute the necessary quantum leap though. If the two big Swiss banks really strive for the big deal, creating a United Bank of Switzerland would be a giant project but in many ways more sensible than merging with a foreign bank.

Teodoro D. Cocca is a professor for asset and wealth management at Johannes Kepler University in Linz. Before joining the university in 2006, he worked in investment and private banking at Citibank for a number of years. He was a researcher at Stern School of Business in New York and a lecturer at Swiss Banking Institute in Zurich. The Swiss, who has Italian roots, is adjunct professor for private banking at Swiss Finance Institute (SFI) in Zurich. He advises financial firms and government bodies in Switzerland and abroad. Since April 2011, Cocca has been a member of the board at VP Bank in Vaduz and heads the bank’s strategy and digitization committee. A new book, «Digitization in Private Banking» (in German) is out now at Frankfurt School publishers.