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
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
13
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: