French retail banks need to close branches and slash costs

French retail banks will have to significantly reduce their costs to compensate for their drop in income, according to a new study. The increased cost of risk also means that many retail banks will need to upgrade their “outdated” business models.

Over the course of the summer, some of Europe's biggest lenders have been revealing the extent of the coronavirus pandemic's impact on their businesses. Germany's Deutsche Bank, Britain’s Barclays and Spain's Banco Santander all reported a big jump in loan-loss charges in the second quarter, as the companies they bank for struggle to repay debts, and unemployment rises across the regions in which they operate.

According to a report from management consulting firm Alvarez & Marsal, French retail banks are far from safe too. The research branded the business model of most retail banks as “outdated” and warned that without drastic changes, the recent Covid-19 crisis and the world’s flagging economic performance could see them financially pressured. 

The title of Alvarez & Marsal's study, ‘Retail banking, a business model at the end of its rope?’ may be in the interrogative form, its conclusions leave little room for doubt. The consulting firm specialised in business transformation and restructuring believes that the traditional business model of French retail banks is facing a structural decline, and as a result, they will therefore have to implement drastic savings measures in the coming years.

The report warns banks that they are currently facing a “scissor effect”, with a drop in their income accompanied by an increase in the cost of risk – mainly on the back of the Covid-19 crisis. It also suggested that retail banks would “suffer a drop in operating income of €10.6 billion in a moderate crisis scenario. Meanwhile, banks are likely to have to absorb an 8% drop in net banking income and a 200% increase in the cost of risk.

To deal with this situation, Alvarez & Marsal’s report puts forward that savings could be realised via the closure of branches, which could lead to a reduction in costs of around €5 billion. The move is defendable because the role of the bank is becoming increasingly less relevant for customers in its current format amid the rapid adoption of digital banking services – a process likely to accelerate even faster rate than before the pandemic. 

This cost-cutting strategy is likely to be followed by banks across Europe, as suggested by research from fellow consultancy Kearney which was released earlier in 2020. Kearney’s research said that as many as 40,000 branches (25% of all branches in Europe today) could close across the continent in the next three years.

The digitisation of certain services, enabling physical services to be covered by technology, can lead to an additional saving of €3 billion in France. However, Alvarez & Marsal also warned that in “a sensitive social context” priority must be given to reducing external spending, which currently represents 40% of retail bank spending.

Long-term decline

The news comes shortly after news emerged that Australia’s major banks saw a decline of more than 40% in their profits for the first half of this year, compared to the same period last year. Analysis by KPMG attributed the plunge to Covid-19 repercussions among other factors.

The recent pandemic is not the only factor sparking the decline of retail banking in France, however. According to the research, over the past five years, the cost/income ratio of retail banks in France has structurally deteriorated, dropping from 66% in 2014 to 70% in 2019. The reasons are old and well identified.

First of all, persistently low interest rates have been weighing on net interest margins for many years following the last financial crisis. Meanwhile, competition has increased in the sector, in particular with the development of neo-banks and online banking, eating into the market share of long-term incumbents. Financial institutions are also faced with an increasingly burdensome regulatory environment.