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* Regulatory "banking nationalism" not dead despite ECB role
* Capital protection, secrecy, company law among obstacles
* Cross-border bank mergers rarely work, offer few synergies
By Paul Taylor
PARIS, Oct 12 (Reuters) - Health checks on Europe's banksmay reveal takeover targets, but because protectionistregulation across the region has yet to be addressed, anypost-"stress test" tie-ups are likely to be along national linesand could make a splintered industry more so.
The European Central Bank takes direct authority over thecurrency area's 120 top banks on Nov. 4 after publishing theresults of its review of their balance sheets on Oct. 26.
But prospects for subsequent cross-border mergers have fadedsince Europe has yet to address national regulators' power tostop capital moving across borders, company law requiringsubsidiaries to be run independently and secrecy laws.
All have a chilling effect on cross-border investment.
"There are two key obstacles," said a senior bank executivewith long experience of cross-border operations, who spoke oncondition of anonymity to avoid antagonising regulators.
"One is fragmentation that takes various forms - capital,liquidity, legal and structural. The other is that it isinherently more difficult to generate synergies withcross-border mergers."
Bank mergers prompted by the launch of the euro in 1999 havestalled since Lehman Brothers collapsed in 2008 - an event thatprompted then Bank of England governor Mervyn King to observethat "global banks are global in life but national in death".
Data compiled by Reuters show cross-border banking mergersand acquisitions in the euro area peaked in 2007 - the year aconsortium led by Royal Bank of Scotland bought ABN AMRO of theNetherlands in a deal that turned disastrous for all parties.
Deals have since dwindled to barely $1.5 billion in value inthe first nine months of this year as bankers were put off bythe cost of unwinding soured mega-deals and new rules which makemajor banks more expensive to run.
(http://link.reuters.com/fuj23w)
Nonetheless, some European banking experts are optimisticthe obstacles will diminish over time, once the ECB settles intoits role as single supervisor and gets to work.
The European Commission, which polices the EU's singlemarket, is working with the European Banking Authority to try tocurb restrictions on the free movement of capital. And DanielleNouy, the head of the ECB's supervisory board, has pledged tostop countries "ring-fencing" their banks.
"There may not be a wave of pan-European consolidationimmediately, given the uncertainties that will continue to weighon the European banking sector after the balance-sheet review,but it is likely within three to five years," said NicolasVeron, a specialist at the Bruegel economic think-tank and thePeterson Institute for International Economics.
"Beyond accelerating the creation of pan-European bankinggroups, banking union should also strongly favour the internalintegration of banks that are already active in several eurozone countries such as BNP Paribas, Deutsche Bank or UniCredit."
Bankers with experience of the constraints are less sure.
BANKING NATIONALISM
The introduction of a single supervisor is arguably thebiggest leap forward in European integration since the launch ofthe euro in 1999. But putting the ECB at the head of a networkof country regulators seems unlikely to end the "bankingnationalism" demonstrated in a series of regulatory spats.
Early in the financial crisis, Polish regulators restrictedItaly's UniCredit from shifting funds from its wellcapitalised subsidiary Pekao SA to Italy, fearing retrenchmentby foreign banks could drain their economy of liquidity.
At the height of the crisis in 2011, Germany's financialregulator BaFin took similar action, banning Italy's UniCredit from transferring billions of euros from its Germansubsidiary back to its Milan headquarters.
BaFin feared Italy might need a euro zone bailout and thetransfers could leave German depositors exposed to supportingUniCredit, Italy's largest bank by assets.
Following Germany's move the Bank of Italy increased itsscrutiny of Deutsche Bank's Italian operation - an apparent actof retaliation - and pushed it to become financiallyself-sufficient.
The dispute was eventually settled after talks between theBank of Italy and BaFin, with UniCredit agreeing to a smallertransfer, sources familiar with the case said.
"Ring-fencing is a European problem. It happens in all thecountries not just Germany," said UniCredit chief executiveFederico Ghizzoni.
"The indication from the ECB is that in the euro zone thisproblem of liquidity should no longer exist once the ECB takeson the single supervision. We just have to wait and see."
While the crisis has blown over - and UniCredit no longerneeds to move capital - German regulators say the rules stillapply despite the European Commission's introduction of thesingle supervisory mechanism (SSM) that put the ECB in charge.
"The law that requires any German bank to have a certainlevel of capital and liquidity will still exist after theintroduction of the SSM," a German regulatory source said.
"Regulators have to avoid a German bank parking liquidityovernight at its parent abroad and bearing the risk of notgetting it back."
The Polish Finance Ministry said the advent of jointsupervision should reduce barriers to the flow of funds withinmultinational banks although some regulations would remain.
It's not hard to find other examples of nationalisticregulatory decisions: Britain's Financial Services Authority haspressured large euro zone banks operating in the City of Londonto set up subsidiaries that would be subject to Britishregulation, rather than branches, which are not.
And Austria introduced rules that set tougher conditions forits banks to lend in central Europe than at home, although iteventually backed down after they complained to the EU.
From a multinational bank's perspective, such obstacles andother national legal constraints make it hard to achieve costsavings that are a key attraction of mergers in other sectors.
TEST CASES
Aware of the problems, the European Commission launched asurvey of national practices in January 2013. Some measures"raised questions about their proportionality", a Commissionspokesperson told Reuters in response to detailed questions.
The unpublished report showed that in certain cases"national supervisors decided to take action unilaterally,without consulting the other supervisors concerned, even whenthey were obliged to cooperate under EU banking legislation,"the spokesperson said.
EU executives hope new harmonised rules on how muchliquidity banks should hold to see them through any crisis willpromote confidence and cooperation among national supervisors -to whom the Commission has written urging them to act "toprevent the risk of unduly restrictive practices.
The first test cases of the M&A climate could arise if bankssuch as Italy's number three lender Monte dei Paschi di Siena or Germany's number two, Commerzbank, areforced to look for a partner by the stress test results.
Commerzbank said in August it felt "well positioned to passthese tests". MPS's chief executive has said the bank's capitalraising efforts put it on a stable footing but a big shareholdersaid late last month it was uncertain whether the health checkswould result in further capital requirements.
Lawyers and bankers specialised in M&A say Britain'sBarclays, France's BNP Paribas and Spain'sBanco Santander might all be interested in bidding forCommerzbank, but regulatory problems make such a deal unlikely.
Any foreign bank trying to take over Commerzbank would beshackled by German company law, which requires a Germansubsidiary to have a supervisory board independent of the parentcompany, the senior bank executive noted.
Then there are the legal constraints to consider. Forexample: Directors of foreign-owned German banks are criminallyliable for up to 10 years after the event for decisions deemedto have been counter to the interest of the bank in Germany.
"I just don't see any game-changing, bet-the-bank M&A," oneLondon-based lawyer said. "We're seeing national retrenchmenteverywhere. Political, regulatory headwinds just aren'tconducive to big M&A."
More likely, lawyers and bankers say, banks may divestnon-core activities and sell off loan portfolios, mostly todomestic rivals but with Chinese and Japanese banks potentiallygetting involved in small deals. (Additional reporting by Matthias Sobolewski, Andreas Kroener,Alexander Huebner and Arno Schuetze in Germany, Anjuli Davies,Steven Slater and Laura Noonan in London, Alessandra Galloni inRome, Pawel Sobczak in Warsaw, Jan Strupczewski in Brussels andCarmel Crimmins in Dublin; Editing by Sophie Walker)
