On Bank Consolidation in a Currency Union

IMF Working Papers, April 24, 2018

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On Bank Consolidation in a Currency Union

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Bibliographic details

• Authors: Fabio Di Vittorio, Delong Li, Hanlei Yun
• Published: April 24, 2018
• Series: IMF Working Papers
• DOI: https://doi.org/10.5089/9781484352755.001

Summary and main findings

• Focus: impact of diversification on bank performance and how consolidation through mergers and acquisitions (M&A) affects the banking sector’s stability in the Eastern Caribbean Currency Union (ECCU).
• Key finding: a lower level of loan portfolio diversification explains higher non-performing loans and earnings volatility of indigenous banks, as compared to foreign competitors in the ECCU.
• Simulation result: combining individual banks’ balance sheets to simulate bank mergers both within and across ECCU countries shows that a typical indigenous bank could better diversify against its idiosyncratic risk by merging with other banks across the border.
• Systemic risk caveat: M&A that lead to a more asymmetric banking sector may increase systemic risk.

Simulation design and scenarios

• Approach: simulate bank mergers by combining individual banks’ balance sheets.
• Scenarios considered:
  • Mergers within ECCU countries.
  • Cross-border mergers across ECCU countries.
• Outcome emphasis: cross-border consolidation provides better diversification against idiosyncratic risk for a typical indigenous bank.

Implications for bank performance and stability

• Performance indicators linked to diversification:
  • Non-performing loans: higher when loan portfolio diversification is lower for indigenous banks.
  • Earnings volatility (ROA volatility): higher for indigenous banks with lower diversification relative to foreign competitors.
• Trade-off highlighted:
  • Diversification benefits from cross-border M&A versus the potential for increased systemic risk arising from greater asymmetry in the banking sector.

Policy considerations and recommendations

• Encourage measures that enhance loan portfolio diversification for indigenous banks, including facilitation of cross-border consolidation where appropriate.
• Monitor systemic risk implications of M&A activity, especially when consolidation increases sector asymmetry.
• Balance consolidation-driven diversification gains against concentration risk and financial stability objectives.

Content in this bundle

• On Bank Consolidation in a Currency Union, WP/18/92, April 2018
  • On Bank Consolidation in a Currency Union, WP/18/92, April 2018 (Markdown version)
  • On Bank Consolidation in a Currency Union, WP/18/92, April 2018 (PDF)