European banks continue to transform to meet standards

19 November 2017 5 min. read

The European banking sector has slowly worked its way out of the fallout from the financial crisis, with regulatory oversight and scrutiny continuing. As new directives are installed to stave off the possibility of a new financial crisis, banks continue to find themselves in a period of transformation to cut costs and to meet stringent requirements. Transformations around non-performing loans remain key areas of concern, particularly for Southern European banks.

The financial crisis saw banks across the globe buckle, with some entering into administration, while a large number required emergency nationalisation to prevent a potential catastrophic failure of the financial system. In the years since the crisis, banks, particularly in Europe, have come under increased scrutiny, with various requirements placed on them in terms of capital buffers and risk mitigation.

In a new report from Oliver Wyman, the financial and management consulting arm of Marsh & McLennan Companies, the current status of restructuring efforts to buffer the banking system from various risks is considered, as well as the wider impact of the new rules on the banking system as a whole in Europe. The report, titled ‘Beyond Restructuring: the New Agenda’, is based on industry data and the firm’s own analysis.

Average tier 1 capital bank return in Europe

The financial crisis has a relatively strong influence on the capital return on capital for EU banks. Most banks in the region continue to have returns below their respective hurdle rates, although actual declines are now few and far between – with 2016 the average return standing at 4.4% down from 5.2% the year previous.

The increase in returns, in part, reflects that EU-based banks are getting on top of their respective restructuring programmes, with increased focus on shutting down ‘unprofitable lines of business, clean up the balance sheet of non-performing assets, and meet the higher capital requirements and liquidity ratios.’ Increases in rates, meanwhile, while much anticipated by institutions, may not result in increased profit. Respondents continue to face challenges as increased competition from banks, increased price transparency and increased risk of default (particularly among consumer products in the UK) affect profitability.

Management focus at major European banks

In terms of where tier 1 banks are in their respective restructuring journeys, various responses were returned by respondents. The current status of cost initiatives remains a major open question for many EU-based banks, although a large number too have set it as a major focus with plans in place, and in-execution at a relatively large proportion of institutions.

In terms of the top organisational leaders, the result is skewed slightly towards digital re-engineering, although the ‘traditional approach’ remains on the cards at many of the institutions surveyed. When it comes to the ‘top balance sheet and capital priorities’, varies options are deployed, including a large proportion that leverage ‘planning & management of financial resources’, changes to ‘booking model’ and ‘ring-fencing/RRP/Brexit’ planning. Finally, when it comes to M&A activity, around two fifths are not interested, close to 20% are engaged in further divestment, while much of the remainder is out for “bolt-on” acquisitions and ‘active targeting’.

NPL ratio per country

Balance sheets

One area in which respondents remain active is dealing with non-performing loans (NPLs) on their balance sheets – many of which are hangovers from the financial crisis. Italy has one of Europe’s largest pool of such loans, at 15.3% of the loan book, although much of South East Europe remains relatively impacted by such loans – particularly Greece. North West Europe, meanwhile, has a relatively strong performance in terms of NPLs on their balance sheet.

The firm notes that one of the major drivers for clearing NPLs is tied to their respective type, with asset bubble related loans, particularly for real estate, easier to clear than loans to SMEs and corporates, particularly if they subsist in a climate of low growth. Financial institutions in high NPL regions are likely to continue to focus on clearing their NPLs through various avenues in the coming years as part of their, relatively, prolonged restructuring period.

Wholesale markets business line

Aside from managing and restructuring NPLs, institutions are also looking to exit various business lines, particularly if they fall outside the remit of the institution’s core. Around 25% of revenue from the ‘credit and securitised products’ line has been exited from wholesale markets since 2009, totalling around €3.4 billion, while exit from equities has netted around €3 billion.

Consolidation and concentration are an additional way in which banks are managing their respective transformations, although such implementation has decreased in recent years – while being relatively regionally dependent, concentration having increased particularly in Greece and Spain.