European banks: seeking stability in an uncertain world
Published October, 2016 |Growth and competitiveness Print
Eight years after the global financial crisis, European banks are still trying to sort themselves out. The industry is in a funk, and profoundly pessimistic about its prospects. Only 52% of bank executives we surveyed expect their own institution's financial performance to improve this year, according to European Banking Barometer, an annual survey of banker sentiment conducted by EY. That marks the lowest confidence level since 2012, the peak of the Eurozone debt fiasco, with a net score of 29% – a clear dip in the last four years.
European banks are struggling to figure out what they want to be, and the process has been messy. We've seen management shakeups, job cuts and retrenchment. Since September 2008, eight of Europe’s largest banks have furloughed some 100,000 employees. In Italy, banks are saddled with about €360 billion in bad loans.
Throughout Europe, banks are scaling back their operations and curbing their ambitions. The medicine they've imposed has been harsh and the patient has been slow to respond.
Banks are still straining to produce single-digit returns on equity (ROE), a far cry from the halcyon pre-crisis days when their ROE routinely exceeded 15%. Based on the banks' own forecasts for revenue growth and cost reductions, we expect average ROE for all European banks to grow by just 0.47 percentage points in 2016. For the banks to reach their self-declared goal of 12% ROE, they will have to either cut costs by another 30% or grow their revenues by 20%.
These are tall orders. But there is a way forward for European banks.
It involves making hard choices and setting clear priorities. Banks need to move beyond an agenda focused on enterprise protection and control to one that drives growth.
Certainly, the environment is challenging. Banks face tough new regulations and capital requirements. Compliance and legal costs have skyrocketed. At the same time, interest rates are at historic lows, crimping profit margins. Economic growth is anemic throughout Europe, damping demand for loans and other banking services. On the economic front, things may get worse before they better, as Europe grapples with the fallout from Britain's decision to leave the European Union.
Big banks, meanwhile, must contend with nimble FinTech start-ups and other new entrants that operate without the burdensome overhead of bricks-and-mortar branches. These new firms often have a better grasp on the needs of consumers, especially younger ones, who prefer to do their banking on their smartphones. As big banks seek to counter these new rivals with their own innovations, they bump up against not only their own high cost structures but also their legacy IT systems, many of which were created for a different era, and for a different kind of customer.
There are a few bright spots, areas where banks see the potential for growth.
Among the 250 bank executives, 57% have a positive outlook for private banking and wealth management (see Figure 2). They're also relatively upbeat about corporate banking, retail banking and mergers and acquisitions (M&A) advice. Some bankers even express guarded optimism about lending. Common equity Tier 1 capital ratios are strong, up by an average of 70 basis points from last year, meaning banks are in a better position to make loans – if the demand is there from borrowers.
There's a lesson in these numbers. To really lift themselves out of their funk, big banks need to decide what they want to be. In the immediate aftermath of the crisis, executives were generally quick to acknowledge the failure of their all-things-to-all-people strategy, but they've been relatively slow to take the bold steps necessary to focus their business.
In fact, most banks have been preoccupied with avoiding risks, rather than seizing opportunities. Among the bankers we surveyed, 70% ranked risk and regulation as their top priority. In the current regulatory climate, that kind of emphasis is prudent and understandable. But it's not a recipe for growth.
Neither is the area that bankers identify as their second most pressing priority: cutting costs. Europe's biggest banks are still shedding assets and eliminating jobs. And more cuts are coming. In fact, the pace is likely to accelerate. In the EY survey, 54% of bankers expect headcount to fall in 2016, compared with 43% who made that prediction for 2015.
Cost-cutting, while often necessary, is not a strategy for long-term growth.
In most cases, the easy and obvious reductions have already been made. Banks should now be making cost-cutting decisions with something more in mind than immediate efficiencies and profits. They should evaluate costs in the context of their entire ecosystems, as part of an overall strategic plan. Even as banks trim costs, they should be investing in new and innovative ways to deliver services.
To rekindle growth, banks can either expand their share of a market or they can widen their "share of wallet," i.e., get more of an individual customer's business.
Banks have begun to narrow their focus to those business lines and geographies where they believe they have a competitive advantage. That's a good start, but it's not enough. Banks can still do a better job of serving their customers, particularly their retail customers.
In some respects, banks win high marks from their customers. Depositors trust banks to keep their money and data safe. If I put €10,000 in the bank today, I'm confident it will be there, plus perhaps a miniscule amount of interest, when I go to withdraw it a year from now. I also trust that my bank will keep my financial affairs private.
Where banks do less well is in managing the relationship with the customer. If there's been suspicious activity on my credit card, I expect my bank to notify me immediately, which is what usually happens. But I also expect to get a new card right away, not to have to wait five days for a new one to come in the mail. By the same token, when I apply for a mortgage I don't want to have to fill in reams of forms that ask for redundant information. FinTech start-ups get this concept; many of the big banks don't.
The one-size-fits-all approach to customers rarely works, but neither does overly rigid customer segmentation.
It's too simplistic to assume, as some banks have done, that all customers under the age of 35 want to bank only online, or that all customers over the age of 50 want to do all their banking in a branch. Customers now expect more personalized service.
Banks can improve their customer service and much else by investing wisely in technology. Even in a cost-conscious environment, they should be spending on IT that can automate many of the routine, labor-intensive tasks of banking, like processing those mortgage applications and compiling data for regulators.
One area where banks shouldn't skimp is cybersecurity. A serious data breach can cause not only financial loss, but even greater – and perhaps irreparable – damage to a bank's reputation. Banks caught up in the Libor and foreign exchange scandals have learned the hard way how challenging it can be to recover from a blow to an institution's reputation. As stated above, customers generally trust banks to keep their data safe. But that could change in hurry in the case of a major incident. Bankers understand this. Among the bankers surveyed, 56% rank investing in cybersecurity as one of their top priorities, up from 47% two years ago.
Banks don't need to do everything themselves, especially when it comes to technology.
Rather than building their own mobile apps, for example, some banks are partnering with FinTechs that already have apps that customers like. In our survey, 23% of the bankers said they expected to collaborate with a FinTech company this year.
Banks can pool their resources in ways that save costs for everyone – without impeding competition or attracting the scorn of regulators. One possibility for this kind of collaboration involves “know your customer” (KYC) rules, the regulations that require each bank to ascertain that their clients are who they say they are. Rather than every bank individually maintaining an in-house KYC department, there's a good case to be made for setting up a consortium that would centrally vet customers, much the way credit bureaus assess the financial soundness of potential borrowers.
As banks invest in technology, either on their own or in partnership with others, they will run into two major obstacles.
One is legacy systems that were built to keep data centrally stored, not to make it widely and instantly available on customers' tablets and smartphones. Getting new customer-facing applications to work with old inward-looking systems is a major challenge.
The other issue is legacy people. Even as banks lay off thousands of employees, they're finding that the ones who remain don't necessarily have the right set of skills. Banks will have to attract workers, especially millennials, who understand both technology and finance. For the most part, talented young people don't perceive banks as exciting, innovative places to work.
So banks have a tough road ahead. With the right people, the right strategy and the right technology, banks can eventually reach their goal of 12% ROE. And they can get there without imposing additional draconian cost cuts or setting unrealistically aggressive revenue targets. They can attain that 12% ROE target with a judicious combination of approaches, for example, a further 10% reduction in costs and a 6% increase in revenues. But first banks have to firmly decide what they want to be. They must decide which markets they want to invest in, which businesses they want to focus on and what kinds of customers they want to serve. Until they get those things right, they'll continue to struggle.
For more information, please go to: European Banking Barometer