Andrea Enria: Is less more? Profitability and ... · 1. The profitability of European banks • But...

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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www.bankingsupervision.europa.eu ©

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




4 Conclusion

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www.bankingsupervision.europa.eu © 4

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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• …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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• 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




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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• 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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• 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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• 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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• 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




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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• 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


Consolidation through mergers and acquisitions (M&A)

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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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• 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)


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What can be done?


• 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

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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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Andrea Enria: Is less more? Profitability and ... · 1. The profitability of European banks • But...

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