MacroScan - International Finance: Consolidation Increases Systemic Risk

During the 1990s, the three-decade long process of proliferation and rise to dominance of finance in the global economy reached a new phase. On the one hand, evidence was growing that the rise of finance, and the financial liberalization it encouraged and enforced, was resulting in financial instability of a kind that was undermining the real economic gains registered in different parts of the world since the Second World War. On the other hand, the international financial system was being transformed in directions that were substantially increasing systemic risk, and rendering the system more crisis-prone. Central to this transformation was a growing process of financial consolidation that is concentrating financial activity and financial decision making in a few economic organizations and integrating hitherto demarcated areas of financial activity that had been dissociated from each other to ensure transparency and discourage unsound financial practices.

Concerned with the consequences and implications of this process Finance ministers and Central Bank Governors of the Group of 10 commissioned a study of financial consolidation, the recently released results of which are quite revealing. The study covered besides the 11 G-10 countries (US, Canada, Japan, Belgium, France, Germany, Italy, Netherlands, Sweden, Switzerland and UK), Spain and Australia. It found, as expected, that there has been a high level of merger and acquisition (M&A) activity in the study countries during the 1990s, with an acceleration of such activity especially in the last three years of the decade.

As Chart 1 shows, The number of acquisitions by financial firms from these countries increased from around 337 in 1990 to over 900 by 1995, and has more or less remained between 900 and 1000 a year since then. What is more the size of each of these acquisitions has increased substantially since the mid-1990s. The total value of financial sector M&A initiated by firms in these countries, which stood at $39 billion in 1990 and $53 billion in 1994, rose three-fold to $154 billion in 1995 and $299 billion, $499 billion and $369 billion respectively in 1997, 1998 and 1999 respectively (Chart 2). This was because the average value of the M&A instances covered rose from just $224 million and $111 million in 1990 and 1994, to touch $504 million, $793 million and $649 million respectively during the last three years of the decade (Chart 3). As a result the annual value of M&A transactions, which stood at less than 0.5 per cent of the GDP of these nations in the early 1990s, had risen to as much as 2.3 per cent of their GDP in 1998. Clearly, M&A in the financial sector is creating large and complex financial organizations in the international financial system (Chart 4).
Chart 1 >> Chart 2 >> Chart 3 >> Chart 4 >>

The banking sector tended to dominate the M&A process in the financial sector, accounting for as much as 58 per cent of the value of M&A during the 1990s as a whole, as compared with 27 per cent in the case of ‘securities and other’ firms and 15 per cent in the case of the insurance industry (Chart 6). However, a closer look at the evolution of M&A activity through the 1990s suggests that while the instances of M&A in the banking industry were rising rapidly during the first half of the 1990s, they have tended to stagnate, while instances of M&A among securities and insurance firms have been on the rise. As a result, by the end of the 1990s, the number of instances of M&A among non-banking financial firms was almost as large as those among banking firms. The process of concentration is clearly sweeping through the financial sector as a whole (Chart 5). However, given the large size of the banks as financial institutions, the banking industry dominates financial sector merger activity in value terms (Charts 7 and 8).
Chart 5 >> Chart 6 >> Chart 7 >> Chart 8 >>

Over the 1990s as a whole the evidence seems to be that M&A activity was largely industry-specific, with banking firms tending to merge dominantly with other banks (Charts 13 and 14). However, matters seem to be changing here as well. While in 1994 there was one instance of cross-industry M&A for every five instances of intra-industry mergers, the ratio had come down to one in every three by 1999. The merger and acquisition drive within the financial sector is not merely creating large and excessively powerful organizations, but firms that straddle the financial sector. Exploiting the process of financial liberalization these firms were breaking down the Chinese Walls that had been built between different segments of the financial sector.
Chart 13 >> Chart 14 >>