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Seasoned PROT

The opportunistic new CEO of BNP Paribas has made the bank a leader in the euro zone. Can he keep pace with the industry's emerging global giants without sacrificing his renowned financial discipline?

France has a tradition of grooming its leaders from a young age, using harshly competitive exams to select an elite and then parachuting the cream of the crop into senior jobs in government and industry. But even by French standards, Baudouin Prot's training stands out.

The 52-year-old banker served a decadelong apprenticeship at BNP Paribas under the tutelage of Michel Pébereau, the bank's longtime chairman and chief executive. As head of French retail and commercial banking in the early to mid-1990s, Prot helped turn around Banque Nationale de Paris's core domestic business by tightening lending standards and aggressively cross-selling consumer banking products. Then, as chief operating officer, he served as Pébereau's tactician in the 1999 battle to acquire investment bank Paribas, a deal that created an investment banking powerhouse in Europe. Prot's business acumen and financial discipline were instrumental in making BNP Paribas the euro zone's biggest bank by market capitalization when he took over as CEO last June. "Rarely," says Pébereau, "has a chief executive been so thoroughly prepared as Baudouin to take over a company."

Prot will need all his years of training -- and more -- to meet the challenges facing the bank today. Sluggish growth in the French economy will make it difficult for BNP Paribas to squeeze higher profit margins out of its domestic retail banking business, which with a modest 9 percent market share ranks third behind Crédit Agricole and Société Générale. The pressures are just as great on the wholesale side of the business, where the prospect of higher interest rates as a result of global recovery poses a threat to the investment banking arm's biggest source of profits -- the underwriting and trading of fixed-income securities.

Even more important, Prot and BNP must contend with a competitive landscape on the verge of upheaval. Buoyant global markets have given bank executives a renewed sense of confidence, even cockiness, and set off a new round of acquisitions in an industry where success increasingly demands scale. In the U.S., Bank of America's $48 billion bid to buy FleetBoston Financial in October was quickly trumped by J.P. Morgan Chase & Co.'s proposed $58 billion acquisition of Bank One Corp. in January. Top-ranked Citigroup, which has been aggressively picking up assets around the world, last month snatched control of KorAm Bank, South Korea's sixth-largest bank, out from under the nose of Standard Chartered for $2.7 billion. This came just weeks after word leaked of Citi's audacious overture to Deutsche Bank, stunning bankers across Europe.

The mergers, which aim to build capital, boost market valuations and extend the breadth and depth of product lines, pose a stark challenge to BNP Paribas and other European institutions: Either grow quickly, or risk being relegated to the second division of global banking. BNP Paribas's E45 billion ($56 billion) market capitalization may give bragging rights in continental Europe, but it remains less than half the size of the new J.P. Morgan and less than one fourth the size of Citigroup. Even within Europe, the U.K.'s HSBC Group is three times as big as BNP Paribas while Royal Bank of Scotland and Switzerland's UBS are roughly 50 percent bigger. As John Varley, chief executive­designate at Barclays, recently said, the J.P. Morgan Chase­Bank One deal was "a wake-up call to bank boards around the world."

Prot, however, shows no sign of alarm. Relaxed and confident in his wood-paneled Paris office, he allows that he is reassured rather than threatened by the J.P. Morgan­Bank One deal. BNP Paribas, he says, already enjoys the balance of consumer and corporate and investment banking business that J.P. Morgan Chase aims to bolster through its acquisition.

To be sure, Prot has big ambitions on both sides of the Atlantic. He wants BNP Paribas to be a pan-European leader in key sectors like consumer finance and to capture a growing share of the global debt market. He's also looking for acquisitions to build his presence in the U.S., where BNP owns BancWest Corp., California's fourth-largest bank. But he insists that he can fulfill those ambitions through smaller acquisitions that build on existing businesses rather than by pursuing blockbuster deals.

"The quality of people, systems and innovation really has little to do with overall size," Prot tells Institutional Investor in an interview at BNP Paribas's headquarters, an 18th-century building off Avenue de l'Opera where Napoleon married Josephine in 1796 (see box). "So if we carefully build up in areas where we are already strong, such as in European consumer finance, regional retail banking in the U.S. and global bond underwriting and structured finance, I don't think the emergence of huge banks that are bigger than us poses a competitive threat."

Such a measured approach sounds sensible, but many investors have their doubts. Consolidation has already limited the scope for domestic mergers in France -- witness last year's linkup of Crédit Lyonnais and Crédit Agricole -- just as it has in many other European countries; meantime, acquisition fever is raising the cost of

expanding in the U.S. Hence Prot is likely to face growing pressure to consider a cross-border merger, something European banks have shunned so far because of the lack of cost-saving synergies and the region's age-old cultural and political sensitivities. The pressure may be difficult to resist for BNP Paribas, given that the bank's coffers are bulging with some E7 billion in excess capital.

What's more, BNP has a recent history of bold bids. It acquired Paribas in 1999 for E17.7 billion while simultaneously attempting to buy Société Générale. And just over a year ago, it made a passing swipe at Crédit Lyonnais. The possibility that Prot will seek another big deal already has unnerved some of his shareholders, as well as investors at many banks perceived as likely acquirers. BNP Paribas's stock traded at E51.90 in late February, or only 11.2 times earnings, a 19 percent discount to the European bank multiple of 13.9.

"You've really got to wonder why they are holding on so tightly to billions of euros," says Roberto Magnatantina, the Geneva-based manager of the E170 million Lombard Odier Darier Hentsch Invest Europe fund. "Because of the potential risk for an overpriced acquisition, I don't want to buy this stock."

Clearly attentive to market fears, Prot maintains that he will resist pressures to do a big deal. He plays down prospects of a major European acquisition, saying that cost savings are "difficult, if not impossible, to achieve, given the fragmentation of everything from regulations to savings habits in Europe." He also all but rules out a renewed bid for domestic rival Société Générale because of lingering bad blood from BNP's unsuccessful 1999 takeover attempt.

Instead, he argues that BNP Paribas can sustain growth in its core businesses by cross-selling products and targeting growing markets like corporate bond underwriting. The bank ranked third among global book runners for investment-grade bonds last year, according to IFR-Thomson, up from tenth four years ago.

"I am confident our bank will continue growing profits organically in all of its businesses," says Prot. "As far as our cash is concerned, we would prefer to do nothing rather than overpay, but it is important to have funds on hand to take advantage of acquisition opportunities as soon as they arise."

Prot isn't alone in his dilemma. Other acquisitive-minded European banks, including Banco Santander Central Hispano, Barclays, HSBC, Royal Bank of Scotland and UBS, have seen their shares underperform while those of rumored targets, such as Capitalia, Commerzbank, Deutsche Bank and HVB Group, have gained. Attractive targets can inspire fierce bidding. Last July, Germany's DZ Bank won Norisbank, HVB's fast-growing consumer credit arm, by paying E447 million, E29 million more than the bank's entire consumer credit portfolio, to beat rival bids from Deutsche Postbank, HSBC, Royal Bank of Scotland -- and BNP Paribas.

Excess capital is already a drag on BNP Paribas's performance. The bank's return on equity is a pedestrian 14.3 percent, bang in line with the European average and below UBS's 19 percent and HSBC's 16.6 percent. Prot could boost the bank's return to about 18 percent by giving shareholders the excess cash, which earns interest of some 3 percent. He made a small step in that direction in July, announcing a E2 billion, 18-month share buyback, but that won't dent the growing cash pile. BNP Paribas retained 65.5 percent, or E2.46 billion, of its 2003 earnings.

Underlying profits also face growing strain. The bank last month reported a 14.1 percent increase in net profits in 2003, to E3.76 billion, but revenues grew by just 6.8 percent, to E17.94 billion. Slightly more than two thirds of the growth came from the bank's corporate and investment banking division, where pretax profits surged by 58 percent last year, to E1.88 billion. Analysts estimate that the division derived more than half of its profits from bond underwriting, which hit record levels in the past three years as corporations rushed to take advantage of falling rates. If, however, rates rise this year, as many economists expect, companies could reduce their bond issuance significantly.

"The move up the book runner table was the direct result of combining the old BNP's commercial banking client roster with Paribas's bond expertise," says Guillaume Tiberghien, a banking analyst at Fox-Pitt, Kelton in London. "That kind of natural fit is played out at the bank, and it may not be that easy to grow ahead of the market now."

For all the potential pitfalls, however, Prot holds some powerful cards. BNP Paribas is the third-largest bank in the euro zone, with E783 billion in assets. It boasts 2,900 branches, more than 20 million retail customers and 71,000 corporate clients. Prot's success in integrating Paribas after the 1999 merger and wringing synergies of more than E800 million from the deal testify to his ability to drive growth.

"Before you start doubting BNP Paribas's capacity to cross-sell and successfully market a broad range of retail and investment banking products under Prot, you should consider his history," says Benôit Vincenzi, a banking analyst at Lehman Brothers in London. "Focusing on the danger of him overpaying for an acquisition is really missing the point, which is that Prot could be just the man to secure BNP Paribas's future as the euro zone's most financially solid bank."

BAUDOUIN PROT AND MICHEL PÉBEREAU HAVE been working hand in glove at the top of BNP Paribas for the past decade; their offices, in fact, are connected by a door. The regal Pébereau, 61, prefers elegant Louis XVI decor, while Prot has filled his office with modern design classics by the likes of Charles Eames, Eero Saarinen and Jean Prouvé. Both men are énarques, as graduates of the Ecole Nationale d'Administration, the training ground for France's elite, are known. But for all their similarities, Prot has a more commercial heritage than Pébereau, who spent 15 years as a senior civil servant, rising to deputy director of the Treasury before being appointed CEO of then-state-owned Crédit Commercial de France in 1982.

Prot was born in Paris in 1951, the son of a perfume maker who sold the family business, Parfums Lubin, to French drug company Sanofi in the 1970s. He spent only seven years in the civil service after graduating from ENA in 1976. "By both temperament and family background, I was better suited to business than to government," says the soft-spoken Prot. "What I like about a career as a banker, as opposed to being a civil servant, is that your decisions usually have a more immediate and more measurable impact than they do when you are putting government policies into effect."

Still, it was during his civil-service years in the late 1970s and early 1980s -- working first as an inspecteur des finances at the Treasury and then as deputy director of energy policy at the Ministry of Industry -- that Prot developed his pragmatic approach to problem solving. He also forged close relationships with fellow bureaucrats who have since risen to the top of French industry, including Serge Weinberg, head of retail group Pinault-

Printemps-Redoute; Charles de Croisset, who retires this month as chairman of CCF (now owned by HSBC); Jean-Charles Naouri, who controls supermarket group Casino, and Michel de Rosen, chief executive of U.S. biotech company ViroPharma.

These men collaborated with Prot on a series of six influential public policy books that focused on such subjects as how to privatize, how to lower taxes and how to get young people into the job market. Case histories rather than ideological tracts, the books outlined how economic reforms had been carried out in a variety of countries, including Germany, Japan, Spain, Sweden, the U.K. and the U.S. "The idea was to bring French decision makers a good résumé of what could be seen in other countries that had addressed the problems that we faced in France," says Prot. "We wanted to open people's eyes to how things were done elsewhere, rather than drive home theory."

Among this group of supposedly insular French bureaucrats, "Prot was the most modern since he was the most interested in how things were done abroad and in business," says Naouri. De Rosen, a friend from Prot's ENA days, describes the banker as "obsessed with gathering the facts, focusing on reality and trying to find the truth, as opposed to relying on prejudices or ideological intuitions."

Prot is intensely curious about other cultures and speaks English and German fluently. "He is much more international than I am and thus fits the age of globalization better than I do," says Pébereau, who speaks halting English. Prot's outlook reflects the influence of his wife, Viviane, a Freudian psychoanalyst from a Hungarian-Jewish family whose relatives are scattered throughout Europe, North America and the southern hemisphere. He says that traveling with his wife and their two children to visit far-flung relatives is one of his principal pleasures outside of work, along with sailing and tennis.

While at the Ministry of Industry in 1983, Prot was wooed by Réne Thomas, Pébereau's predecessor and yet another énarque, to state-owned Banque Nationale de Paris. After a three-year stint heading the then-tiny European retail division, Prot rose rapidly through the domestic ranks and was appointed head of French commercial and retail banking in July 1992.

One year later new conservative prime minister Edouard Balladur appointed Pébereau chief executive of BNP with the mission of privatizing the bank in 1993. Pébereau succeeded, in large part because of Prot. A severe recession was causing an alarming increase in nonperforming loans at BNP and other French banks. Prot responded by establishing France's strictest loan criteria for small and medium-size companies; loan growth shrank, but provisions dropped sharply. He also increased profit margins in the consumer banking network by introducing groundbreaking retail packages that encouraged French consumers to buy several products at once -- offering advantageous rates to clients who opened a savings account while taking out a mortgage, for example.

"What impressed me was Baudouin's ability to lower the costs of the bank while rapidly modernizing our sales approach and product line," observes Pébereau. Annual group net profit rose from E155 million to E588 million between 1993 and 1996, in large measure because of Prot's retail banking reforms. The accomplishment marked him as a potential successor to Pébereau.

After overhauling the retail network, Prot proved his diplomatic skills in the mid-'90s by negotiating the successful financial restructuring of Walt Disney Co.'s troubled, Paris-based EuroDisney. The main representative of a 63-bank lending syndicate owed Ff20.3 billion ($3.5 billion) by EuroDisney, Prot spent most of 1994 crafting a complex arrangement that reduced the park's net debt to Ff10 billion in exchange for Disney's forgoing royalty and management payments for five years at EuroDisney, which it controlled with a 49 percent interest. Prot notably persuaded recalcitrant Japanese banks to go along with the deal by getting Disney to also extend a ten-year, Ff1.15 billion credit line to EuroDisney. Prot's next big test came in 1999 when he served as Pébereau's chief tactician in the seven-month, three-way bidding contest for Paribas and Société Générale -- a landmark for hostile takeovers in France. Société Générale, France's second-largest retail bank, initiated the contest by making a friendly offer for Paribas. Fearful that the deal would put the smaller BNP at a serious disadvantage, Pébereau and Prot countered by launching twin bids of E17.7 billion for Paribas and E18.3 billion for Société Générale. SocGen was their prime target because it offered greater potential for synergies, but the bid failed in large measure because they refused to increase their offer. Pébereau and Prot did succeed in foiling SocGen, however, and walked away with Paribas, a deal whose upside has subsequently surprised analysts and investors. In calculating their offer, "we benchmarked against the experience of others and didn't theorize" on price, says Prot. It was a lesson in "how to pragmatically improve position, which is what we always try to do at BNP Paribas."

Prot worked with Dominique Hoenn, who had run Paribas's capital markets unit and was appointed co­chief operating officer after the takeover, to integrate the two banks. Within six weeks Pébereau named the new bank's 650 key executives, all proposed by Prot and Hoenn. Over the next year those executives formed 200 working groups and achieved E800 million in annual synergies with remarkably few defections. BNP Paribas has seen its annual revenues rise 15 percent since the merger, and net profit is up 54.4 percent. Over the same period the cost-to-income ratio has fallen to 62.9 percent from 68.1 percent. That ratio is the best in France, where the average remains close to 70 percent, but lags behind the European average of 59.4 percent. Rigid labor laws, generous wage agreements and dense branch networks make retail banking an expensive proposition in France.

In addition to handling the integration, Prot and Hoenn set new risk parameters that favored client-generated fee income over proprietary trading profits in the investment banking division. By putting an emphasis on structuring and origination capabilities in fixed income and derivatives rather than trading, the pair increased margins and reduced capital requirements in the division.

With Paribas fully digested, Prot's next strategic coup was the opportunistic purchase of a government-owned 10.9 percent stake in Crédit Lyonnais in 2002. The government had wanted to use the shares to orchestrate a merger between Lyonnais and Crédit Agricole, France's largest retail bank in French banking. But after months of dithering by Agricole over price and management structure, Finance Minister Francis Mer announced a snap 24-hour auction on a Friday evening in November. Prot immediately pounced, phoning Pébereau, who was traveling to London on the Eurostar, to get his backing for a bid on the stake. Prot worked all night on the offer, and the next day BNP Paribas trumped Crédit Agricole with a E2.2 billion bid.

"Baudouin determined there was very little downside," says Pébereau.

The purchase allowed BNP Paribas to surpass Crédit Agricole's long-held 10 percent stake in Crédit Lyonnais and put Pébereau and Prot in the running to either acquire all of Crédit Lyonnais or to negotiate a higher price for their stake from their rival. Jolted, Crédit Agricole fired its chairman, Marc Bué, and later won all of Lyonnais for E20 billion.

Although Prot didn't land the prize, his tactics earned BNP Paribas a cool E100 million profit on its Lyonnais stake and forced Agricole to pay a steep 40 percent premium for the acquisition. The bold calculation convinced Pébereau, if any further convincing was needed, that Prot was a worthy successor.

TODAY PROT IS WALKING A FINE LINE IN HIS effort to sustain growth. On the one hand, he is determined to pursue acquisitions and has resisted calls to increase the bank's share buyback. But in a bid to reassure investors, he says any purchases are most likely to be small.

The one possible exception -- and the one that has investors increasingly anxious -- is in the U.S. Prot wants to build his retail banking presence there in order to benefit from the faster U.S. growth rate and to smooth earnings by diversifying beyond the European economic cycle. BNP Paribas has controlled San Francisco­based BancWest since 1980. Two years ago BNP Paribas paid $2.5 billion to acquire the 55 percent of BancWest it didn't own, then purchased United Bank of California for $2.4 billion, nearly doubling the size of BancWest. The banking group, with 351 branches, 2.3 million clients and $38.4 billion in assets, now controls the fourth-largest bank in California and the largest in Hawaii.

Prot acknowledges that U.S. bank valuations are "high if not inflated" in the wake of the J.P. Morgan Chase­Bank One and Bank of America­FleetBoston deals, but he insists that it's still possible to find suitable targets. "The fact that we already have a large base in the U.S. will allow us to extract significant cost synergies when we acquire and means that not everything there is expensive. We've just got to wait for the right industrial case at the right price."

One potential target is UnionBanCal Corp., whose 63 percent owner, the troubled Bank of Tokyo-Mitsubishi, is believed to be receptive to offers. The bank, which has 295 branches in California and $27.5 billion in assets, traded at a modest 10.6 times estimated 2004 earnings in September. But since Bank of America paid almost 16 times estimated 2004 earnings for FleetBoston, UnionBanCal's stock has risen nearly 18 percent, valuing the bank at $7.7 billion, or 12.5 times estimated earnings. "If Prot paid any kind of meaningful premium on that price, he would be unable to hit his criteria for acquisitions," says one London based investment banker.

Back in France, Prot denies any plans to make another run at Société Générale. Market speculation about a merger of the rivals persists because of the potential for cost savings. Société Générale has roughly 11 percent of the French retail market, compared with BNP Paribas's 9 percent. Certainly, BNP could use the synergies. The bank's domestic network, with 2,200 branches and 10 million customers, accounts for 26.4 percent of group revenue but only 21.4 percent of profit.

But Prot contends that the risks outweigh the potential benefits of what would be a huge deal, given Société Générale's E30 billion market cap. "We won't bid on Société Générale because the execution risks that would come with a merger are simply too big to be taken," says Prot. "That will be the case whether or not there is new management, either here or there, for the foreseeable future." The consolidation of the French market has undermined the logic of a deal, other executives say. "Since we acquired Paribas, and since Crédit Agricole purchased Crédit Lyonnais, the market has become more consolidated, improving profitability," says Jean Clamon, COO in charge of retail banking and financial services at BNP Paribas.

Prot also throws cold water on talk of a large cross-border takeover in Europe. "We want to be a pan-European bank, but we think there are better ways to create value than by acquiring a sprawling retail network in another European country," he says. "With much less risk, we can achieve real synergies building up in focused businesses like consumer credit, leasing, online brokerage and custodial services, all of which are areas where, unlike most of our competitors, we already have a pan-European presence and a leading position."

A prototype of the CEO's style of deal making was the 2002 purchase of German online brokerage Consors from struggling SchmidtBank for E485 million. That price represented only one tenth of Consors' value at the peak of the Internet bubble in 2000 -- just the sort of reasonable price that Prot finds attractive. Analysts expect that Consors, now merged with BNP's own online brokerage and fund management arm, Cortal, will fulfill Prot's requirements that acquisitions be earnings accretive after one year and achieve at least an 8.5 percent return on investment within three years.

Similar opportunistic deals include the E800 million purchase of PHH Europe, Avis Group Holding's European auto-leasing and fleet management arm, in 2001; the E869 million purchase of French consumer finance bank Facet from heavily indebted Pinault-Printemps-Redoute in 2002; and in the same year, the acquisition of British custodian and mutual fund administrator Cogent Investment Operations for E363 million.

On these and other deals, BNP Paribas has a good track record. Its return on the Paribas purchase has averaged more than 9 percent a year, and on seven smaller acquisitions since then -- all made for less than E2.5 billion -- its average return on investment is in excess of 8 percent and rising. The acquisitions have made BNP Paribas's international retail division -- which includes Cetelem, Europe's largest consumer finance company, with E29 billion in loans outstanding -- the group's second-largest division, generating 27.3 percent of revenue and 31.4 percent of profit.

The question for Prot is whether he can maintain that acquisition record at a time when the competition for financial companies in both Europe and the U.S. is getting fiercer. "There is clearly a big danger that banks will pay too much in the scramble to acquire," says Niklaus Pöhlmann, the Frankfurt-based manager of DWS Investments' E155 million Finanzwerte fund, which has an undisclosed stake in BNP Paribas. "BNP Paribas's least risky option from our point of view would clearly be to return their cash to investors, but we take comfort from the fact that the team of Pébereau and Prot have proven that they are one of the few managements in European banking able to successfully manage acquisitions."

Prot also is looking to direct his bargain-hunting skills at asset management, an area where BNP Paribas lags behind many of its European rivals. Fund management generates 13.8 percent of the bank's revenues and 11.7 percent of profits. The bank's French retail and institutional fund arm has E180 billion under management, of which roughly two thirds is in fixed income. BNP's private bank, France's largest and Europe's fifth biggest, manages a further E95 billion in assets, while BNP Paribas Security Services is the world's biggest cross-border custodian, with foreign securities accounting for 77 percent of its E2 trillion in custody assets.

Given the market-timing scandals hitting the U.S. fund industry, "it could be a good time for BNP Paribas to assess the issue of whether it is attractive or not to buy an asset manager," says Georges Chodron de Courcel, COO in charge of corporate and investment banking as well as asset management services. Some analysts speculate that the bank may buy a big U.S. equity manager -- "something like Amvescap or Janus could be very interesting for BNP Paribas," says Merrill Lynch & Co.'s European bank analyst, Jacques-Henri Gaulard. But de Courcel repeats the Prot mantra that smaller is better. "Our clear inclination would be to look for smaller, less risky acquisitions in U.S. equity asset management," he says. "We don't rule out anything, but we are looking more for expertise that we can build on rather than a large group that might prove difficult to integrate."

Although Prot has a handsome kitty for acquisitions, he insists that his first priority remains organic growth. "By putting a heavy emphasis on cross-selling our products, we can grow faster than the market, even without acquisitions," he contends. BNP Paribas's domestic retail network, for example, already sells an average of more than seven products per client, more than double the European average. The typical BNP Paribas client has a checking account, two savings products, a debit card, a mortgage and three specialized fee-generating services, which include overdraft facilities, detailed quarterly breakdowns of investments and investment advisory products.

This year, in one of its newest initiatives, the bank will roll out 25 retail branches devoted exclusively to servicing small and medium-size businesses. Known as the Nouvelle Approche Entreprise project, it is supposed to step up cross-selling between the retail network and the corporate and investment banking division.

"We think that we can significantly boost growth by supplying a full range of corporate and investment banking products to midcap domestic customers who have traditionally only borrowed from our retail bank," says Prot.

Some analysts question BNP Paribas's ability to grow strongly if interest rates rise, given the heavy reliance of its corporate and investment banking division on bond underwriting. That is no small concern considering that the division is the bank's largest, generating 32.4 percent of group revenues and 35.5 percent of profits. Fixed-income underwriting and trading accounts for more than two thirds of the division's revenue. The bank was the third-largest underwriter of euro-denominated, investment-grade bonds last year, acting as book runner on 164 issues that raised E42.7 billion, according to Thomson Financial.

Prot and his team play down the concerns, asserting that they can make up for any fixed-income slowdown by pushing other products. "If interest rates start to climb, it is unlikely to have a big impact on our revenues and profits because on the flip side swaps activity will increase," says de Courcel. The bank is one of Europe's largest originators of structured-finance products as well as equity and fixed-income derivatives, businesses that de Courcel maintains will expand if corporate bond issuance declines.

For all the importance of investment banking at BNP Paribas, the disciplined Prot is not about to pursue growth at any cost. In December he agreed to merge the bank's small, unprofitable equity sales and research operation -- Europe's 12th largest -- with Exane, the widely respected French broker. (Its analysts were No. 1 in France in this year's All-Europe Research Team [Institutional Investor, February 2004].) The new company, Exane BNP Paribas, is owned 50 percent by the independent firm's managers and investors. BNP Paribas owns the other half but holds only 40 percent of the voting rights. The merger allows BNP Paribas to cut its exposure to an area that racked up an estimated E100 million loss last year, while gaining access to an independent equity research and sales network. Exane BNP Paribas is the largest institutional brokerage in France, with an estimated 15 percent market share, and analysts forecast that it will make a profit of E50 million this year.

At a time when investment banking conflicts are under a spotlight in France, following LVMH Moët Hennessy Louis Vuitton's E30 million judgment against Morgan Stanley analyst Claire Kent, the move was politically astute. It also suggests that Prot may be even more exacting and bottom-line-oriented than his predecessor.

"Building up a significant operation through further investment was not realistic, given the size of our brokerage unit, falling margins and new regulatory concerns regarding the separation of research and investment banking," says Prot.

By stanching its losses on equities, BNP Paribas has freed up funds to hire investment bankers selectively. Prot is not aiming for the bulge bracket -- BNP Paribas ranked 12th in the European M&A league table last year, advising on 41 deals worth E38.8 billion, according to London-based Merger Market. But he does believe that the bank can develop a bigger European advisory business by exploiting relationships in its fixed-income and derivatives businesses. So far the bank has hired bankers in Germany, Italy and the U.K. specializing in banking, chemicals, health care, insurance and telecommunications. That is just the kind of carefully focused expansion that Prot hopes will drive growth and reassure jittery investors.

"We've reached the critical size to be profitable in cash equities, yet at the same time, we've found a way we can capture market share," says Prot. "We've always delivered prudent expansion to investors whether we are speaking about organic growth or acquisitions, and that will continue."

Prot on scale and 'faux amis'

Many observers believe that giant banking mergers in the U.S. could change the competitive equation in the global industry, but Baudouin Prot, the new CEO of BNP Paribas, remains relaxed and confident about an expansion strategy that doesn't include major, transforming mergers. With a diverse spread of businesses, BNP Paribas -- the third-largest bank in the euro zone -- has a solid base for organic growth and selective acquisitions, says Prot. He recently discussed the challenges facing his bank with Staff Writer David Lanchner at BNP Paribas's Paris headquarters.

Institutional Investor: What conclusions, if any, do you draw from the recent $58 billion merger between J.P. Morgan Chase and Bank One Corp.? Will it redefine banking, as some claim?

Prot: I don't see it that way. Interestingly, it is largely an attempt to copy what most people regard as the Citigroup formula of combining corporate and investment banking earnings with more consumer banking profits. Although we've never copied them, we have exactly the same business portfolio as Citigroup. I see the deal as an affirmation of our strategy.

Is the merger wave forcing your hand in terms of finding U.S. acquisitions that can give you critical mass?

Certainly not. We already have a strong presence in California and in most neighboring states through BancWest Corp. There are still more than 7,000 banks in the U.S., and none of them are dominant on a regional level. The three main reasons to acquire in the States are attractive demographics, good pricing of financial products and our ability to extract cost synergies through our large existing base. Acquiring in the U.S. is a rational move for us, but it is not a necessity that has been imposed upon us.

You are looking for relatively small bolt-on acquisitions in Europe, but so are many others. How can you avoid paying too much?

First, by not being obliged to acquire anything. Second, by being able to target a broader range of businesses than our competitors. We have five businesses that are leaders, active in at least ten European countries and which get more than half of their revenues from outside of France. All of them can grow either organically or by acquisition, depending, at any given moment, on what is the best trade-off between the two. Other banks have a strong presence in specific areas and markets outside of their home country, but none have the sheer range of pan-European businesses that we've got. Generally speaking, the more options you have when it comes to expansion, the more discerning you can be in terms of price.

If you are not obliged to acquire, why not boost your return on equity by giving your E6 billion in excess cash to shareholders?

That would increase our return on equity in the short term, but it would severely limit our ability to maximize the value of BNP Paribas in the medium to long term. Using any kind of yardstick, whether it is return on equity or something else, we have complemented good organic growth and sharply increased the value of BNP Paribas through acquisitions. It is always a challenge to find the right buying opportunities in terms of pricing, fit and risk. But we have succeeded in the past, and we believe we can continue to do so.

Don't the balance sheets of your bigger U.S. and European competitors represent a competitive threat for BNP Paribas in corporate and investment banking?

I don't think so. Scale is often what we call in French a faux ami, or false friend. It is important for taking on risk, but bankers tend to overrely on it, often to the detriment of focus and customer relations. We are convinced that we can continue to take market share from competitors in areas like bond underwriting, structured finance and derivatives.

When do you think Europe will be ready for major cross-border mergers between retail banking groups?

It is impossible to say. But I think the success of such mergers will depend on better harmonization of rules, regulations, taxes and banking practices between euro-zone countries. What is important at BNP Paribas is that we have a strategy of focused, pan-European growth -- both organically and through acquisition -- in specific areas like consumer finance, mortgage lending or online brokerage that will work with or without greater harmonization. These are operations that can share the same information technology platform and marketing strategies, thus achieving real pan-European economies of scale. This is expansion based on what works, not on theory.