Frankfurt Europe’s banks fare poorly in a global comparison. The diagnosis is not new, but what exactly are the reasons for this finding? A new study by the Bearing Point consultancy and the Handelsblatt Research Institute attempts to answer this question.
One of the key findings: European financial institutions are more tightly regulated than their competitors in Asia and the USA, and that puts pressure on returns.
Banks in Europe have to hold more capital to cover unexpected losses compared to the US and Asia. The consequences are particularly evident in two key figures, the ratio of costs to income, known in technical jargon as the cost-income ratio (CIR), and in the return on equity.
According to the study, if European financial institutions had to hold just as little equity as Asian institutions, their average CIR would be 5.8 percentage points lower and the return on equity 2.5 percentage points higher. Compared to the US, the Europeans could reduce the CIR by 2.6 percent and increase the return on equity by 3.4 percent with the same capital requirements.
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However, the advantage for foreign competition has harmful side effects for system stability: “The markets in the USA and Asia bear a significantly higher risk than in Europe,” says the study.
Christian Sewing, head of Deutsche Bank and president of the Association of German Banks, has been complaining for some time that Europe’s banks are disadvantaged compared to their international competitors. “In order to be successful in the long term, we need a regulatory environment that ensures the competitiveness of German and European banks,” emphasized Sewing a few days ago at Deutsche Bank’s virtual New Year’s reception.
Last fall, Sewing complained in a programmatic speech: “In Europe we have done a lot to ensure that banks don’t get any bigger.” Regulation must be fair, and that applies in particular to capital regulations, which do not take sufficient account of European economic structures.
>>Read here: Consolidation in Europe’s banking sector is coming – first nationally, then internationally
But the different costs of regulation are not the main reason for the relative weakness of the Europeans. Bearing Point and the HRI compared the key figures of the 25 largest banks in Europe, the USA and Asia and carried out a modeling that puts them in relation. The biggest differences arise in comparison to Asia in the personnel costs and in the comparison to the USA in the business model
The most important banks in Europe therefore have an average return on equity of 4.6 percent. For banks in Asia and the USA, this benchmark for profitability is almost twice as high at 9.8 percent each. They also earn significantly more in the interest business than their European counterparts.
With a CIR of 53 percent, Asian banks are particularly efficient in comparison. While they have to spend just over 50 cents to earn one euro, it is more than 65 cents in Europe and the USA.
Commission business plays a much larger role in the USA than in Europe and Asia. Due to this advantage in the business model, the US institutions achieve an average CIR of around seven percentage points lower and a return on equity of around three percentage points compared to their European and Asian counterparts.
On average, European banks spend 55 percent and US banks 50 percent of their costs on staff – Asia’s banks significantly less at just 36 percent. If, on the other hand, the same high personnel costs were incurred in Asia as in Europe, the average CIR there would be around 17 percentage points higher and the return on equity around five percentage points lower.
“If the European banks don’t act, they will be further and further left behind by their Asian and American counterparts,” warns Frank Hofele, partner at Bearing Point. In addition to IT investments and leaner business models, the consultant also names mergers and acquisitions as possible measures to increase profitability and efficiency.
Sven Jung from the Handelsblatt Research Institute takes a similar view. There is plenty of potential for consolidation because Europe is overbanked compared to Asia in terms of economic power and population.
However, the US has even more banks per inhabitant than Europe. However, Jung sees this less as an advantage for the Europeans than as an additional opportunity for the Americans. If US banks were quicker or more determined to consolidate, “European banks could be even further left behind in terms of profitability and efficiency.”
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