Europe’s banks must reform to combat the rise of challengers
Christian Edelmann is managing partner for Europe at Oliver Wyman
June’s Eurogroup gathering of finance ministers in Luxembourg promised to offer more clarity on integrating European banking and capital markets. Instead, it was widely seen as a disappointment.
While that work continues, the lack of progress shouldn’t have come as a surprise. In times of geopolitical tensions, priorities change.
The war in Ukraine is feeding an already inflationary environment. Economies are struggling to recover from Covid-related supply chain disruptions. As a result, concerns over fiscal stability in (southern) Europe are growing, and the European Central Bank again is challenged to stretch its mandate to manage the widening of sovereign bond spreads.
How bad are things for banks in Europe? At first sight, the global financial services sector is in relatively good shape today, and has been growing for the past several years. It has also shown remarkable resilience during the peak of the Covid crisis.
But growth and value creation have been skewed decidedly towards new players. In 2012, incumbent firms accounted for 90% of the total value of the financial services industry. Today their share is just 65%, according to recent Oliver Wyman research. Financial infrastructure and technology companies, or FITs, have begun to replace them, now accounting for 35% of the industry’s value. While the top incumbent firms have increased their shareholder value by about $1.3tn over the past decade, according to our research, the non-incumbents have increased their value by $3tn.
The vast majority of the FIT growth is taking place in the US and China, where the biggest technology firms there are piling into financial services. Europe lacks true “tech giants” and hence has seen more limited value creation thus far. As online wallets, digital tokens and the metaverse will eventually gain further ground, Europe is again at risk of standing on the sidelines.
The situation is especially bad for Europe’s incumbent banks. The market value of the top 20 banks in Europe at the end of 2007 was 58% greater than the top 20 US players. Now it is 43% less. Annual profits at some of the largest US banks now exceed the market capitalisation of a number of those banks in the top 20 back in 2007.
With the banking union not delivering the hoped-for panacea, what should European banks now do to address the value gap?
First, banks should not wait for the perfectly conducive environment for M&A, but rather should work actively with all involved regulators to achieve better synergies in cross-border M&A. They should challenge domestic ring-fencing practices in the Eurozone — in particular, by pushing for cross-border liquidity waivers, which national regulators can grant. Along those lines, banks should push domestic resolution authorities not to add MREL (minimum requirement for own funds and eligible liabilities) requirements to local subsidiaries of banking groups on top of the MREL requirements made by the Single Resolution Board.
Longer-term, European banks need to challenge their core business models. Yes, we have seen various rounds of restructuring and digitisation at all European banks since the global financial crisis. But at their heart, they are set up across traditional client-oriented silos (such as retail or wholesale banks or wealth management divisions), with the majority of their revenue streams reliant on risk intermediation. While rising rates now help these businesses, this is not enough to change the fortune of European banks.
These incremental revenues can create additional ammunition to finance a transition into the future — that is, to venture more deeply into technology, particularly data. Value technology services — such as payment, banking/insurance-as-a-service models or digital assets — are getting earnings multiples of 20 to 30, while connected data services (such as wallet services, connected ecosystem services for mobility, employment, education, commerce, or climate risk data) enjoy multiples of 30 to 40. Traditional risk intermediation businesses, by contrast, have multiples of just 10 to 20.
Transitioning to the future will require more than an innovation lab — companies must undergo sweeping organisational change, turning these platforms into primary or at least equal reporting lines, with future leaders being groomed in these leadership positions.
In the end, it will be up to European banks themselves to reverse the widening gap with US firms. Those that show they can change are likely to find eager support among investors, regulators and prudential authorities across Europe.