Mergers and acquisitions have boomed in the banking and capital markets (BCM) sector since August 2020, reflecting management teams' heightened realization of how customers' expectations have changed in recent years. The pandemic's digital migration has supercharged this shift.
Banks are taking things into their own hands: in the 2021 EY Global Corporate Divestment Study, 85% of banks describe their most recent divestment as proactive, up from 64% pre-pandemic.
The ongoing re-evaluation and pivot are likely to bring further divestment activity. Besides classic sales and joint venture/industry utility deals, this includes disposals of nonperforming loans.
In this environment, management teams could look to revisit portfolio review criteria to help identify potential divestment candidates.
Embracing structural transformation
In general, banks globally are exiting markets where they lack scale and are redeploying capital in areas where they are at or close to scale. Examples include exits from certain business lines or from geographies.
The trend reflects pressure on profitability and returns across the banking sector that the pandemic has only intensified. Businesses in the portfolio that do not have a sustainable long-term cost transformation journey (see Six strategic levers to optimize long-term cost transformation) are likely candidates for divestments that could help lift cost-income ratios.
To prepare for this buyer pool, management would examine the broader capabilities and stronger growth outlooks that businesses within their portfolios could potentially take on as stand-alone companies.
Streamlining the remaining organization through a divestment of non-core businesses may enable large-scale structural transformation.
Digitalization as the key driver
The scale of investments required to digitalize banking — the customer experience and banks' internal processes — means that many lenders are likely to deploy a significant proportion of their divestment proceeds on technology. In the 2021 EY Global Corporate Divestment Study, 90 percent of banks invested funds raised by their last divestment in this way.
The EY Capital Confidence Barometer (CCB) further highlights how this has emerged as a key pillar of banks' strategies. More than three-quarters of banks expect technology and digitalization to drive increased M&A activity in the sector.
Management could redouble efforts to determine where capital can be freed up to fund technology transformation.
Factoring in transaction certainty with TSAs
Increased M&A is boosting focus on transitional service agreements (TSAs) in the banking sector. The key issue is product migrations if the bank's core platforms are not within the deal perimeter. Developments like current account switching, modularization of core banking platform technologies and moves to modern third-party vendor platforms have helped to accelerate these migrations.
Regulators' push on banks to enhance resolution planning since the global financial crisis also plays into this. This national and international focus has enhanced banks' understanding of how they would carve out and divest subsidiaries and business lines in a recovery situation or resolution event.
Strategically, TSAs are highly relevant for potential buyers as they support execution certainty and speed. This is particularly the case for the higher proportion of banks that emphasize transaction speed over value (28%, compared with 16% in insurance and 17% in wealth and asset management).
Buyers that can demonstrate migration expertise and that have a target technology platform with limited product gaps are particularly attractive. This includes PE bidders, who may be able to integrate the divested entity into an existing portfolio company.
Exploring the potential of ecosystem partnering
As part of their ongoing portfolio review, which the pandemic has only accelerated, banks are focusing heavily on leveraging strategic partnerships to improve service.
More banks should now look to ecosystem approaches. These involve engaging with software companies, FinTechs and other collaborators to innovate and raise margins while reducing costs. Benefits include strategic clarity over enhancing the portfolio, as well as accelerated speed to market, access to innovative technologies and a level of scale they could not achieve alone.
The sector appears receptive to this. The vast majority (86%) of EY CCB respondents report being open to partnering with competitors.
Several banking groups have recently entered into partnerships with technology players to co-innovate new products and services with start-ups and FinTechs or to jointly expand into the banking-as-a-service space.
Further examples exist across a range of banking product areas and types of partnership.
The views expressed by the authors are not necessarily those of Ernst & Young LLP or other members of the global EY organization.