Making generalisations about European banks – as about North American or Asian banks, for that matter – is always rather unfair. Each region, each entity, each business model faces wildly diverse circumstances, such as the degree of progress made along the path of digital transformation, the regional setting or the range of products and services on offer.
Nevertheless, there are aspects common to most banks that indicate that European banks are having a very difficult time of it.
Objectively, most European banks are experiencing problems of lack of profitability, the origin of which is the subject of discussion.
On the one hand, banks and the associations that represent them claim that the source of the problem is essentially the European Central Bank's (ECB) policy of lax money and negative interest rates that, as we recently learned, are set to continue for some time due to the weakness of the eurozone economy. ECB spokespersons at the highest level have repeatedly contested this claim, arguing that the real source lies in an excess of installed capacity and the attendant need for countries that have not yet undertaken restructuring and streamling processes, to do so – and soon.
Combined with this perceived lack of profitability comes the pessimism of analysts and institutional investors about any improvement in the short term, given that the lack of economic growth can slow down the rate of growth of credit demand.
Sure enough, the global economic context and, particularly, trade tensions between the US and China, on the one hand, and between the US and Europe, on the other, are affecting European economic growth and slowing it down, as both the European Commission and the ECB have previously stated. Obviously, other political factors such as Brexit and the uncertainty it has created have also played a part in the lacklustre performance of the economy compared to that reported some months ago.
Against this backdrop, the general outlook for the European financial sector is one in which the beneficial effects of digital transformation on efficiency are still nowhere to be seen. New players (singularly, the Big Techs) are moving in, affecting areas of business that have traditionally buoyed up the profits of financial institutions. Nor will achieving revenue growth be easy. In all likelihood, only by slashing costs, reducing the number of branches and making staff cuts will institutions be able to make a positive contribution to profit and loss. This scenario has dealt a considerable blow to aggregate stock market capitalisations as was seen when the closing bell rang at the end of 2018.
Regulation has not helped. In recent months the individual levels of MREL (minimum requirement for own funds and eligible liabilities), which represent a sizeable burden for small and medium-sized entities that are less accustomed to raising finance on capital markets, have gradually come to light.
On 2 July 2019, the European Banking Authority quantified the aggregate impact of the new Basel III capital adequacy requirements, which mainly affect the larger banks, at Euros 135.1 billion.
In the new environment, with old and new competitors threatening the profitable areas of the bank, and with legacy systems that do require much more than a simple patchwork update, the investments traditional banks need to do are massive. But it would be a mistake to consider that the change is only related to technology.
On the contrary, it is not just, or mainly, about taking advantage of what technology can offer. It is a question of undertaking an integral transformation of the business model of the entities and to rethink their strategy. The key question to respond is how the banks will create and monetise value for their clients and the society as a whole in the future.
This is also a critical point for many European banks: how to position themselves in the marketplace. They should carefully selected their target markets, business and clients and also to decide if they can make this work alone or they should need some partnership and with whom.
Aside from these strategic decisions, there is also the issue of consolidation. Naturally, in the above context, an increase in size can be a means (though not the only one) to achieving efficiency gains and boosting profitability. One should be aware that such gains usually occur after a certain period, and that initially, at a time when the sector is experiencing difficulties, the profit and loss statement (P&L) may be adversely affected. On the other hand, these are mergers that would make sense from an industry perspective and that, given the characteristics and position of the entities, would bring about the creation of solvent, competitive institutions.
Consolidation also raises the question of whether it should be cross-border within Europe or whether domestic integration should prevail.
Although the ECB, among other legitimate voices, has promoted cross-border mergers, there are several reasons why, with exceptions, these have not materialised for banks in the eurozone for some years, even within the scope of the Single Supervisory Mechanism. The main reasons for this are limited expectations of drumming up business and modest profitability, as well as the uncertainties that a merger always brings with it.
On the other hand, regulatory fragmentation clearly persists in such delicate areas as consumer protection, deposit insurance, the insolvency regime, etc. This fragmentation means that banks do not have complete freedom of movement, even within the eurozone.
It is discouraging to think that it has not been possible to make progress in the creation of a European deposit insurance scheme (EDIS), despite the time that has elapsed since the political agreement was reached to build a banking union in the eurozone.
Furthermore, this fragmentation, in the case of a cross-border merger, prevents synergies from being captured as they are in a purely domestic context, so any potential efficiency gains are greatly attenuated by the limited expectation of an increase in turnover. Risks of every type are inherent to the integration process in which cultural, linguistic and other factors also come into play. One might well ask, why such insistence in this regard by the ECB?
For all of the above reasons, and notwithstanding the view that integration processes between credit institutions from different countries can be beneficial, the most prevalent view is that both in markets where financial sector restructuring and consolidation are still pending and in markets where sizeable mergers have already occurred but where other transactions may still be in the offing, the most typical form of consolidation will continue to be, at least for some time, consolidation among domestic entities.
In conclusion, the European financial sector continues to struggle in a highly complex scenario where limited profitability, a new wave of regulation and difficulty in gathering profits through efficiency gains from technological investments (digital transformation) in the short or medium term, create a situation in which the only strategy within reach appears to be cost cutting. There are not many elements that would lead us to believe that the situation is going to improve in the near future.