Better-than-expected earnings announcements and the prospect of rising profits in 2004 and 2005 have helped push the shares of large Greek banks to levels considered unattainable by many pundits a year ago. Many analysts believe that current share price levels have incorporated all the good news. There are good reasons to believe a new round of M&A activity is likely to take place in 2004/2005 with general elections on March 7 acting as a catalyst. Signs in the same direction from the major European banks should help speed up developments. Although there is good reason to believe that we will see a revival in M&A activity in the Greek banking sector in the 2004-2005 period, it will be very difficult to match the kind of mergers we saw back in 1999. During that year, Alpha Bank acquired a 51 percent stake in Ionian Bank sold by Commercial Bank of Greece and EFG Eurobank merged with Ergobank. Alpha Bank moved to absorb Ionian Bank later on, boosting its market share and becoming the second largest commercial bank in the country. This move, however, is widely thought to have hurt its earnings and its stock during the 2000-2002 period. The merged EFG Eurobank Ergasias also saw its market share enhanced, especially in consumer and mortgage loans as well as loans to small and medium-sized companies. However, it also took quite some time to make the operations of the two banks fully compatible. Of course, the climate during the late 1990s, when most mergers and acquisitions took place in the local banking sector, was different. A number of foreign banks with a relatively small number of branches sought to leave the Greek market either because they realized that the era of hefty profits from capital market operations in the drachma and drachma-denominated debt instruments was coming to a close, or because of a strategic decision at parent level to withdraw from the Greek retail market. Some other foreign banks chose to trim their operations, others chose to rationalize them and stay. Only two, namely Citigroup and HSBC, continued to clearly beef up their branch network since then. Another reason explaining the consolidation bout seen in the late 1990s was the privatization of a number of small and mid-sized banks. EFG Eurobank was able to grow faster by acquiring Bank of Athens and Cretabank in 1998 and 1999 respectively and Piraeus Bank by acquiring Macedonia-Thrace Bank in 1998. Of course, some other moves, such as the absorption of the National Mortgage Bank and ETEVA by parent National Bank of Greece in 1998 and 2002 respectively, were part of a strategy to rationalize the parent-subsidiary relationship. The stock market rally which sent bank shares to skyrocketing highs also played a role in promoting M&A activity. Most analysts believe it is difficult to see a repetition of the late 1990s consolidation binge among banks, especially large ones, for a number of reasons, most prominently the country’s rigid labor laws. Although competition regulations pose no major obstacles and politicians have taken either a positive or a neutral stance when a major bank merger issue came up, such as the effort to merge National Bank of Greece and Alpha Bank in 2001, which failed due to disagreements between the two management teams on a number of issues, the major hurdle of the inflexible labor market remains, they say. «This limits potential cost synergies and heightens integration risks,» according to one of them working for a well-known foreign investment bank. Undoubtedly, this is a valid argument and is frequently cited even by top bankers to support the same position. One may argue this did not stop Societe Generale from seeking to control Hellenic General Bank and may not stop France’s Credit Agricole from increasing its equity stake in Commercial Bank of Greece provided a solution is found for the uncovered liabilities of Commercial’s employee pension fund. Moreover, the supposedly rigid labor laws have reportedly done little to dissuade some small to medium-sized banks from seeking an alliance with other banks of a similar size. Although it may not be politically feasible for the new government to be elected on March 7 to seek to relax some labor laws, one should not completely rule it out, especially if the conservative New Democracy party wins. This, coupled with an already favorable tax law giving tax breaks to merging entities, may turn the things around. Even if no major changes to the existing labor law are made, there are arguments in favor of increased M&A activity in the sector this year and next. With most banks having succeeded in either repairing or improving their balance sheets, and focusing on profitability on the back of a better equity market, the next step is size. Top bankers, who are likely to be called to assume leadership roles in large Greek banks after the general elections, say in private that local banks have no option but to go for size if they want to play a role in the pan-European banking sector. To them, organic growth is not enough and size should be obtained through M&A activity. Asked if this means they should go for size even if it means subdued profitability for a few years given difficulties in obtaining cost synergies due to existing labor laws, their answer is «yes.» This kind of thinking should not surprise. Starting in the USA a few months ago, merger speculation in the European bank sector has slowly but steadily picked up. More and more analysts see that the pressures for large deals are building as the economy recovers and banks seek ways to make better use of their growing capital surpluses. Though Greek banks are small in a pan-European context, some bankers seem to be getting the message and preparing for a pick-up in M&A activity. Greece has one of the more concentrated banking sectors in Europe. But even the large Greek banks are small to medium-sized banks by European standards. With the case for a pick-up in M&A activity in the European banking sector rising and Greek elections coming, there is good reason to believe the local banking landscape will be different a year and a half from now as size again becomes the key word.