Is less more? Profitability and consolidation in the European banking sector
Presentation at the CIRSF Annual
International Conference 2019, Lisbon, 4
July
Andrea Enria
Chair of the Supervisory Board of the ECB
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Overview
2
1
2
3
Is overbanking a problem?
Is consolidation a solution?
The profitability of European banks
4 Conclusion
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Overview
3
1
2
3
Is overbanking a problem?
Is consolidation a solution?
The profitability of European banks
4 Conclusion
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1. The profitability of European banks
• Euro area banks have become slightly more profitable…
o Return on equity (RoE) increased from 6.3% in 2017 to 6.7% in 2018
o Main driver: lower impairments
o Core business also improved (net interest income and net fee and
commission income at highest levels since 2015)
8.2% 8.3% 8.1%8.6%
7.5%
8.7% 8.8%
4.7%4.0%
6.3%6.7%
5.4%
7.3%7.9%
-5.9%
-11.1%
1.5%
3.4%
0.2%
5.7%6.6%
-15%
-10%
-5%
0%
5%
10%
2015 2016 2017 2018 2019 2020 2021
Top ROE banks SSM Bottom ROE banks
Realized Forecast
Source: ECB
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1. The profitability of European banks
• …and slightly less cost-efficient
o In 2018, operating expenses slightly increased
Source: ECB
40
45
50
55
60
65
70
75
80
Cost-to-income ratio
Cost-to-income ratio
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1. The profitability of European banks
• But overall, profitability remains
subdued…
o Price-to-book values for most banks
are still below one
o For many banks, their RoE is still below
their cost of equity (CoE)
o Is the recent improvement in
profitability a stable trend?
o Is “Japanification” a risk for the euro
area?
-10%
-5%
0%
5%
10%
15%
20%
0% 5% 10% 15% 20%
RO
E 2
018
COE
ROE above COE
ROE belowCOE
Sources: ECB and ECB calculations
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Overview
7
1
2
3
Is overbanking a problem?
Is consolidation a solution?
The profitability of European banks
4 Conclusion
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2. Is overbanking a problem?
• Overbanking is often put forward as a reason for low profitability
o Banking is a good thing in principle, but you can have too much of a good
thing
o You can also not have enough of a good thing
o The relationship is non-linear and there are many dimensions of
overbanking
Size of banking sector
Welfare
Low profitability
Search for yield
Stability issues
…
Market power
Too big to fail
Lack of finance
…
Euro area?
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2. Is overbanking a problem?
• The first dimension of overbanking: too many banks
o Fierce competition, but only a few banks exit the market
o Non-viable banks have an incentive to price aggressively and take on high risks
in a gamble for resurrection
Sources: S&P Market Intelligence and ECB; data as of end-2018
0%
20%
40%
60%
80%
100%
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50
Cum
ula
tive %
of to
tal assets
Cumulative share of total assets for the largest 50 banks in the Euro Area & United States
EA (ECB) USAUnited States Euro Area
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2. Is overbanking a problem?
• The second dimension of overbanking: the banking sector is too large
compared with other sectors
o Paying excessive wages might drain talented people from other sectors
inefficient allocation of resources
Source: Goldin, C. and Katz, L. (2008), “Transitions: Career and Family Life Cycles of
the Educational Elite”, American Economic Review, Vol. 98, No 2, pp. 363-369
0
10
20
30
40
50
60
70
80
90
100
1970-Cohort 1990-Cohort
Occupation of Harvard Graduates 15 years after graduation
Finance
Medicine & Law
Management
Other
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2. Is overbanking a problem?
• The third dimension of overbanking: the banking sector is too large
compared with other sources of funding
o Bank-based economies perform slightly better
o In crises, however, they suffer more and take longer to recover
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2. Is overbanking a problem?
• The fourth dimension of overbanking: banking assets are too large
o This might imply that the economy is over-indebted
o Arcand et al. show that growth suffers once credit to the private sector exceeds
100% of GDP
Source: Arcand, J.-L., Berkes, E. and Panizza, U. (2015), “Too much Finance?”, Journal of Economic
Growth, Vol. 20, No 2, pp. 105-148
0
20
40
60
80
100
120
140
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Loans to the private sector as a share of GDP
Loans to Private Sector / GDP
Sources: ECB and ECB calculations
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Overview
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1
2
3
Is overbanking a problem?
Is consolidation a solution?
The profitability of European banks
4 Conclusion
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3. Is consolidation a solution?
• Euro area banks have deleveraged
• In doing so, they relied mostly on reducing assets and less on increasing capital
• They also mostly reduced assets abroad
Consolidation through deleveraging
Source: ECB
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3. Is consolidation a solution?
• Compared with other jurisdictions, only
a few banks exited the market in the
euro area
• Many banks were bailed out and kept
alive due to a lack of European crisis
management tools
• The Single Resolution Mechanism is
thus an important step in the right
direction
Consolidation through failure
0
50
100
150
200
2008 2009 2010 2011 2012
Banks resolved in the EU and the United States
EU United States
Source: FDIC and Open Economics. Pagano,
Marco, et al. Is Europe Overbanked?, No. 4.
Reports of the Advisory Scientific Committee,
European Systemic Risk Board, 2014.
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• Economies of scale and scope banks might become more efficient and more profitable (the empirical evidence is mixed, however)
• Opportunity to scale up technological innovation
• After a crisis, consolidation can help to mop up excess capacity
Benefits of M&A
• Governance issues are amplified
• Challenge of integrating cultures, IT systems and other structures
Costs and challenges of M&A
16
3. Is consolidation a solution?
Consolidation through mergers and acquisitions (M&A)
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3. Is consolidation a solution?
Additional benefits of cross-border M&A
• Banks could diversify their portfolios across borders become more resilient
• The sovereign-bank nexus would be weakened
• Private risk-sharing would improve the entire banking system would
become more stable
Consumption risk-sharing in the euro area and its channels: % of shock smoothing
Source: ECB (2018), Financial integration in Europe, May
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3. Is consolidation a solution?
• In Europe, M&A activity has been on a downward trend for some time
o The few deals we see are mostly domestic (which is already a step in the
right direction)…
o …and among smaller institutions
What do we see in terms of M&A?
Sources: Dealogic and ECB calculations
0
20
40
60
80
100
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Bank M&As in the euro area - number of transactions
inward non-EU
outward non-EU
inward EU
outward EU
cross-border
domestic
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Why is there so little consolidation?
• The banking union should facilitate consolidation and cross-border M&A
o There is a level supervisory playing field across the euro area
o The ECB takes a neutral stance towards M&A; we assess each project put
forward by banks purely on technical grounds
o Regulatory uncertainty now coming to an end with the completion of the
reform process
• But the market remains fragmented…
o Countries are still ring-fencing liquidity and capital at the national level
limited benefits from being a cross-border bank
o Despite the single rulebook, the regulatory framework remains fragmented
(as do tax and insolvency laws, for instance)
• …and uncertainty is still high
o e.g. about bank valuations (e.g. non-performing loan ratios still high in many
countries)
3. Is consolidation a solution?
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What can be done?
3. Is consolidation a solution?
• Make ring-fencing obsolete by improving risk management and
introducing pan-European safety nets
o The agreement on the backstop for the Single Resolution Fund was an
important step
o But we also need a European deposit insurance scheme (EDIS) to create
more trust and lessen the need for ring-fencing
o Make intragroup financial support agreements part of banks’ recovery plans
• Continue harmonising the regulatory framework
• Continue cleaning up banks’ balance sheets
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Overview
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1
2
3
Is overbanking a problem?
Is consolidation a solution?
The profitability of European banks
4 Conclusion
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4. Conclusion
• The optimal size of banking sector is hard to gauge
o It seems clear, though, that the European banking sector is still too large
o So there is a need for consolidation
• However, this is not about:
o Creating ever-larger banks; it’s about more efficient banks. The banking
sector needs to be diverse
o Policymakers determining the structure of the banking sector; ultimately,
that is up to market forces
o Seeing only cross-border mergers. They would certainly be a sign of a truly
European banking market. But also in a truly European market, domestic
mergers might make sense from a cost-efficiency viewpoint
To conclude:
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