The banks are facing the perfect storm!
When the outgoing head of the ECB cut the key deposit rate again to -0.50% last September, many were quick to point to the swan song of an admittedly successful European central banker as a harbinger of new troubles for the European banking industry.
Negative interest rates mean, oversimplified, lower interest income (interest income averages 60% -65% of core income and has a catalytic effect on the return on equity), and therefore, among other things, a higher cost-to-earnings ratio (key business efficiency index). Strange as it may sound, there have long been banks in Scandinavia, most recently in Switzerland, but also elsewhere that offer negative lending rates. Jyske Bank e.g. (Denmark’s third largest bank) offers ten year mortgages at -0.50%, ie it pays you 0.50% per annum to get a loan from it.
Of course, the negative interest rate regime (which is probably not a short-term parenthesis, but came to stay) is not the only serious threat to the income of European banks (not excluding domestic ones). New regulatory requirements, the signs of an impending economic downturn, the impending trade war between East and West, the disruptive forces of applied business models are exacerbating the anxiety of management, shareholders and potential investors that the worst is yet to come.
The consequence of all this is the fact that European banks, which are mainly affected by the above, are valued significantly lower than the American, but also by many corresponding, both developed and emerging markets (average share price to book value of European banks: 0.65 , American: 1.35).
In the Greek reality, the negative (for income) development of low interest rates comes to accompany the extensive, in recent years, leverage of bank balance sheets (sales and securitization of loan portfolios) carried out in an attempt to overcome the huge and unresolved problem of serviced exposures, which directly threatens the capital adequacy of banks.
It is obvious that in our country, the wind of tectonic changes in the international capital markets has not yet blown strong. Greek bond yields are at historic lows, mainly due to political stability following the July 2019 elections, but also a number of particularly positive developments in the economy (upgrades to the country’s credit rating, asset protection scheme, tax cuts, start of emblematic investments and privatizations, etc.). Deposit interest rates have followed a similar downward trend (currently averaging 0.26%) but not those of loans, which are significantly higher than European. Heavily injured, in the process of recovery, Domestic banking sector is trying to recover by not currently following the international trend in lending rates. At the same time, commission income remains low, but the solution to the problem is not the horizontal imposition of charges on all types of transactions (which also reflects negatively on the social dimension of their role), but smarter options, such as increasing commission income, e.g. , development of consulting services, asset management, bank insurance, trade support, issuance / agency of mutual funds and other structured financial instruments, stock exchange activities, further activity in the foreign exchange markets, etc.
But the equation of sustainable and sustainable organic growth includes two factors, revenue and cost. In this area (cost), domestic banks still have a long way to go to reach equilibrium. Costly voluntary staff outflows have largely exhausted their potential and administrations will now have to use more ingenious and effective ways to reduce the disproportionately high operating costs of banks.
In this battle, the creation and operation of a grid of common platforms (ATM networks, card issuing and transaction acceptance infrastructures, contact centers, regulatory compliance and generally non-differentiating functions that deviate from their core business), the use of emerging technologies and digital transformation ( introduction of artificial intelligence in advanced metadata analysis for better risk management but also in other key activities, block chain technology, cloud services, etc.) which are fundamental components of modern business models, can drastically reduce operating costs and to make banks incomparably more efficient.
In a macroeconomic environment full of threats and powerful challenges, banks are called upon to face, in addition to all these, additional enemies from their own ecosystem.
Financial technology companies (known as FinTechs), Big techs (Amazon, Facebook, Google, Apple, etc.), digital banks and other challenger banks are a strong and dangerous “internal” enemy for traditional banks. . Given their strong comparative advantages (low operating costs, very competitive product and service charges, promptness and speed of service, strong state-of-the-art technological infrastructure, access to huge databases, freedom from the burdens of non-performing loans and forecast needs, etc.). ) are, without a doubt, a present and clear threat to future profitability, but in the long run perhaps also to the viability of traditional banks in their present form. An insurmountable need but also a strategic one-way is the adjustment and restructuring of the business models of operation and organic development of the traditional banks, which must necessarily take seriously the new and emerging financial market conditions internationally. With the return on equity (ROE) at just 2.89% for the first half of 2019 (compared to the also relatively low 6.86% across Europe) the impasse is a given.
With this perfect storm not just visible but in full swing, the saying “either we change now or we sink” could not be more relevant.
- Mr. Elias E. Xirouchakis is Deputy Chief Executive Officer of the Financial Stability Fund.