M&A: Navigating the opportunities and challenges of inorganic growth

Over the past few decades, consolidation in the banking industry has become a familiar story. Earlier this year, Capital One announced its proposed acquisition of Discover Financial Services for $35.3 billion. In 2023, the failures of Silicon Valley Bank, Signature Bank and First Republic resulted in those entities being absorbed by larger institutions.

And going forward? A regulatory environment that is increasingly challenging for community banks and credit unions to navigate, a voracious appetite for growth among larger financial institutions (FIs) and pressure to deliver shareholder returns are all factors currently driving banking industry M&A.

Deal activity in the banking space also tends to increase following elections due to the political and policy changes implemented when a new administration takes office. With the 2024 U.S. presidential election looming, leaders at financial institutions need to consider the implications of a consolidating market—whether they’re in the position of potential acquirer, or potential target.

Considerations for FIs pursuing inorganic growth opportunities

For FIs contemplating an acquisition strategy to expand their operations, inorganic growth isn’t just about achieving a larger geographic footprint. Banking’s “Starbucks moment,” when large FIs opened a retail branch on seemingly every corner, has faded in favor of serving customers through digital banking channels. In the modern banking landscape, FIs are focused on locating branches strategically, where they can serve as community hubs or meet specific local needs. For example, access to a nearby branch can significantly impact customer retention and growth in agricultural communities.

Beyond strategic branch placement, acquisitions can enable FIs to expand business opportunities. Inorganic growth can be a means to accelerating digital transformation and enhancing specialized offerings. Technology capabilities to look for in an acquisition include:

• Core – the target’s core banking vendor is important. It doesn’t need to be the same one the acquiring FI uses, but the core systems need to be interoperable. The target’s core should ideally also be open, accessible, have the right access to data, and possess open infrastructure and architecture.
• Payments – frictionless instant payments are more important now than ever. With the increasing number of bad actors and advanced fraud attempts, having an end-to-end solution beginning with a core for managing instant payments is a non-negotiable for financial institutions in 2024, especially the ones poised for growth.
• Tech structure – unless the acquiring FI is extremely tech-forward, an acquisition that lacks a similar tech structure will entail a more difficult integration, leading to delays in cost savings benefits and branding.

How smaller FIs can resist acquisition

Inorganic growth can deliver significant value to acquiring FIs—but not every smaller FI is eager to be gobbled up by a bigger fish.

The proliferation of Amazon-like customer experiences has permanently altered consumers’ expectations and behaviors. To thrive in this competitive marketplace, and to avoid becoming acquisition targets for larger FIs, smaller banks and credit unions need to adopt technology that enables them to keep pace with shifting customer demands. Leaders at these institutions should take measures to foster a culture of innovation and double down on efforts to stay abreast of industry trends. Demonstrating that the organization is not only keeping up, but is setting the pace among its peers, will reduce the likelihood of becoming an acquisition target.

In addition, community banks and credit unions can resist being acquired by shoring up their own defenses. This can mean fortifying their internal structures, operations efficiency and technology prowess, implementing streamlined operations and advanced cybersecurity measures, and more. The bottom line: FIs that run faster and operate better than competitors are in a stronger position in a consolidating market.

Lastly, strategic alliances with like-minded institutions can deter potential acquirers—and today’s advanced technology can help FIs turbocharge these efforts. Sharing resources, establishing joint ventures, and participating in collaborative initiatives can position community banks and credit unions as substantial entities that are less susceptible to being absorbed by a larger enterprise.

Understanding the potential benefits of being acquired

For some FIs, being acquired is a positive outcome. This may be the case when the initial investors or leaders of a smaller, locally owned institution are preparing to retire and looking to maximize the payout from their book of business. M&A deals may also make sense for small FIs that are not equipped to adapt to changing customer expectations or recover from market events, or that lack the technological capabilities to keep up with the evolving banking environment.

Finally, it’s not uncommon for a potential acquirer to make shareholders an offer that’s simply too good to turn down.

In the current banking environment, consolidation is inevitable. For leaders at community banks and credit unions, it’s imperative to understand the implications of inorganic growth trends for their institutions and determine how to respond—whether that means seizing the opportunity to expand their institutions, taking steps to fortify themselves against the threat of acquisition, or negotiating a mutually agreeable deal with a potential buyer.

Peter Longo is Vice President, Product, Platform and Technology at Finastra.