Amid the turbulence and uncertainty created by Covid-19, CaixaBank and Bankia are merging in a deal that will create Spain’s largest domestic bank. The combined entity will have more than €650bn in assets and a combined market capitalisation of almost €17bn. The deal comes as banks seek to reassure shareholders.

However, from the standpoint of the Spanish taxpayer, there is much concern surrounding this merger, as it could create a larger but equally vulnerable bank. Aside from Covid-19, the banking sector faces many threats, with digitalisation one of the most significant. So, while a merger might alleviate any immediate financial shortcomings, Caixa and Bankia must employ an effective post-merger digital transformation strategy to compete with the rapidly emerging tech disruptors.

Covid has accelerated digitization

Bankia formed back in 2010 through the amalgamation of several smaller, failing entities. In 2012, Bankia needed a €25m government bailout to survive the European sovereign debt crisis. Bankia’s troubled history will be a cause for concern for Caixa. That said, the merger of the two banks appears practical in the context of the pandemic, as it will create economies of scale and allow for cost reductions.

However, Covid-19 has accelerated digitalization within banking, increasing the threat to traditional European banks. Fintech company Revolut, for example, has acquired more than seven million customers worldwide and continues to grow rapidly. Traditional banks are struggling to compete with the zero-cost currency and cryptocurrency exchange services and the simple peer-to-peer transactions and ease of use of platforms such as Revolut.

Consolidation has been coming

Consolidation amongst European banks has been likely for many years. Now, with Covid-19, looming negative interest rates, and intensified competition, the European Central Bank (ECB) has advocated for further M&A activity.

The ECB has offered guidance and flexibility on capital requirements, which could ignite a wave of consolidation across Europe. Following the ECB’s statement and news of CaixaBank’s acquisition, the share price of several direct rivals, including Banco de Sabadell, rose sharply.

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Similar patterns were seen across Europe as shares in France’s Société Générale and Germany’s Commerzbank increased by 5% and 8%, respectively. The initial activity is likely to be mostly domestic rather than international, as cross-border deals require extensive regulation and government involvement.

Investment in technology is needed

The deals have already started happening. Italy’s Intesa Sanpaolo has completed its acquisition of UBI Banca, and there is ongoing speculation surrounding a potential agreement between Deutsche Bank and Commerzbank.

However, these M&A deals could create an even larger problem if external challenges, such as digitalization, are not addressed. If European banks are to benefit from the consolidation of their fragmented banking system, they must also invest in relevant technological areas, such as digital banking or blockchain, to compete with emerging enterprises.