Bet on Banking M&A Down Under

Australia and New Zealand Banking Group's chief executive Mike Smith once again attacked the "four pillars" policy of the Australian government, a policy that prohibits mergers of Australia's major banks. He turned up the heat on the new Aussie government, calling on them to take another look at the "four pillars" policy. "The election of the Rudd government provides us with a fresh opportunity to examine this," Smith said.

With the increasing competition in the global banking industry, Aussie banking execs feel there is no rational reason to maintain the policy. The main argument here is that global competition should dictate the Aussie banking market, not domestic considerations. The "four pillars" policy is outdated and wasteful: as anyone with a basic knowledge of economics knows, an increased need for major technology investments add pressures for economies of scale. "As technology becomes more and more pervasive in banking and the spends you need become larger and larger and as margins contract, the imperatives for scale become larger," said WestPac's CEO Dr. Morgan. "(Banking) consolidation has not yet run its course in this country."

I believe we could expect a significant pickup in M&A deals in the Aussie financial sector, for the following reasons:

1) Cost savings offer a compelling argument for more M&A in Australia's banking sector. "Total expenses of the big four banks stood at $23.5 billion in 2007," says Alan Kohler at BusinessSpectator.com. "Analysts say that a rule of thumb for cost reductions from mergers is up to 20 per cent over time. That means the potential savings from allowing big bank mergers in Australia would be around $4 billion, to be shared between shareholders and customers.

2) The Australian government also has to tackle persistent inflationary pressures, and M&A in the banking sector offers an interesting way to combat price pressures. Recent economic data clearly shows that Australia has skilled labor shortages that are beginning to force wages up. Big bank mergers could free up some skilled labor, reducing inflationary pressures on the Aussie economy.

3) Competition from India and China may force mergers between Aussie banks to protect the domestic market: It has now become clear that Chinese banks are using their size to expand outside their home base. Indian banks are leading the way in the use of technology, another area in which the Australian domestic industry is lagging, raising the possibility of an Indian bank entering the Aussie market with a competitive edge. Considering these trends, it seems highly likely that a Chinese or Indian bank could take over either ANZ, Westpac, National Australia Bank or Commonwealth Bank. It is probably fair to say that if politicians don't act to abolish the policy, globalization eventually will.

4) Shaw Stockbroking analyst David McDonald said the Australian government would probably prevent a Chinese or big overseas bank from swooping in and buying a stake in a local bank. The Aussie government will try and prevent such a course of events unfolding, as they don't want to be labeled as a protectionist administration. Just last week the new Prime Minister Kevin Rudd said that he is a free trader and not interested in protectionism, and he would be keen to keep up appearances at the start of his term. The abolishment of the "four pillars" policy offers a more constructive way to prevent these foreign takeovers. Looking at the lost savings, the current system is wasteful and undermines the competitiveness of Aussie banks. If a Chinese or an Indian bank had to take over one of the big Aussie banks, they will clean up the waste. Why should Aussie politicians allow foreign banks to clean up the waste when they can get domestic banks to do it for them (by dropping the "four pillars" policy)?

This is a small market dominated by four large institutions. Some analysts suggest that if four became three there would be great pressure, in the name of equity, for three to be allowed to become two. Get ready for banking M&A down under!

Relevant tickers, ranked by market cap:

• Commonwealth Bank (CBAUF.PK) - $78.5 billion market cap
• National Australia Bank (NABZY.PK) - $62.4 billion market cap
• WestPac Bank (WBK) - $52.8 billion market cap
• ANZ Banking Group (ANZBY.PK) - $52.6 billion market cap