June 30, 2015
In a very interesting study by A.T. Kearney called the 2015 Retail Banking Radar - they tracked nearly 100 retail banks and retail banking divisions in 24 European markets. Forty-six banks are in 13 Western European markets: Austria, Belgium, Denmark, France, Germany, Italy, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, and the United Kingdom. (The Nordics and Benelux are clustered to obtain meaningful regional samples.). Fifty-one banks are in 11 Eastern European countries, clustered into four markets: Central Europe (the Czech Republic, Hungary, Slovakia, and Slovenia), Southeastern Europe (Bosnia and Herzegovina, Bulgaria, Croatia, Romania, and Serbia), Poland, and Turkey. This study is done year after year.
According to the study, retail banking sector in Europe mirrored macroeconomic conditions in 2014, with modest recovery. Despite lower interest rates, personal deposits rose for the fifth consecutive year, by more than 2 percent. Loan volumes, on the other hand, were almost flat, increasingly slightly by 0.5 percent, as both individuals and companies remained reluctant to commit to significant investments. Profitability continued its upward trajectory, with profits per customer increasing to €155, but that was mostly a result of a continued decline in risk provisions from 2012's historical highs. Profit margins remain more than 25 percent below pre-crisis levels. While Europe's retail banking sector has likely moved on from its lows—decreased incomes, high risk provisions, and low profits—the heights of 2007 are not yet in sight.
Two interesting developments are worth highlighting when looking in more detail into retail banking performance in Europe in 2014, (1) one related to revenue generation and (2) the other to cost efficiency.
First, regarding revenues, retail banks' incomes remained almost flat (rising only 0.4 percent), mostly driven by net interest income growth. Banks continue to struggle to increase fee revenues, which remain at less than 30 percent of total income. Slow economic growth and lower interest rates are part of the story, but these trends also point to the fact that banks are taking too long to adjust their business models.
Most of the indicators, especially those related to income generation and cost efficiency, remain at levels close to or lower than last year's, highlighting the difficulties most European banks face in improving the fundamentals of their existing business model.
Branch network rationalizations and headcount reductions in many markets did not necessarily bring higher cost efficiency. Some may argue that headcount reductions, branch network rationalizations, and efforts to become digital- and customer-centric require retail banks to commit significant near-term investments in personnel severance, real estate refurbishment, and technology, and that the potential benefits will be arriving in the coming years. Although true, we believe that many European retail banks need to move forward with structural changes on both their business and operating models if they want to become more efficient and compete with agile and cost-efficient new challengers.
According to this detailed A.T. Kearney study, Retail banks in Spain and in the Nordics remain champions of cost efficiency, with cost-to-income ratios below 50 percent and operating costs per customer below €325. Banks in countries such as Switzerland or Italy compensate their expensive cost structure with a banking model capable of extracting the most out of their customers. Institutions in large European markets such as Germany, Austria, and France, on the other hand, have cost-to-income ratios well above 60 percent, not only due to their relatively heavy cost structures but also due to their struggles increasing income per customer. This only reinforces the view that cost efficiency is not about cost cutting alone, but must include the development of a profitable and sustainable banking model, where income improvement and operational efficiency go hand in hand.
Risk provisions relative to total income. After peaking at almost 24 percent of total income in 2012, risk provisions have declined sharply, and were 14 percent in 2014, close to pre-crisis levels. Retail banks have progressed back to near normal after a couple of years of balance sheet cleanup. The creation of national "bad banks" and significant loan impairments, following the asset quality review and stress tests conducted by the ECB, have been the most common practices used. However, in some hard-hit regions such as Southern Europe (Italy, Spain, and Portugal) and Eastern European (namely, Hungary, Romania, and Slovenia), provision levels remain near or even above 30 percent. In the event of potential economic stagnation across Europe that increases unemployment, or exchange-rate fluctuations in Eastern Europe, caution remains advisable, even if European retail banks seem better prepared now with stricter risk policies and predictive models.
The report observed that there is an urgent need for structural changes in retail banking models that would enable banks not only to improve cost efficiency but also increase topline results.
About the content of this article - This article is totally based on the study published by A.T. Kearney consulting and research group and is available for public access here.
This article is written by Andreas Pratz, Daniela Chikova, Pedro Castro, Peter Hewlett and Roberto Freddi.