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Economy ENG Eurozone

Market focus: European Banks from resilience to consolidation

– Most European Banks are resilient to the economic fallout from the Coronavirus crisis as they enter into the crisis with significantly improved solvency indicators, compared to a decade ago.
– However, this resilience masks structural weaknesses which translate into lower performance and market valuations amid persistent banking fragmentation alongside national markets within Europe
– The Banking sector in Europe seems ripe for another wave of consolidation. The big question is whether regulators are also ready for that. The ECB seems to welcome this process but the challenge comes from other market regulators.

Key takeways

  • Most European Banks are resilient to the economic fallout from the Coronavirus crisis as they enter into the crisis with significantly improved solvency indicators, compared to a decade ago.
  • However, this resilience masks structural weaknesses which translate into lower performance and market valuations amid persistent banking fragmentation alongside national markets within Europe
  • The Banking sector in Europe seems ripe for another wave of consolidation. The big question is whether regulators are also ready for that. The ECB seems to welcome this process but the challenge comes from other market regulators.

Detailed analysis

Bank-based economies

European countries remain bank-based economies. The Banking sector provide two thirds of the financing to the economy as opposed to the United States where the proportion is the opposite.

The strong dependence of European economies on banks is further evident in the financing mix of non-financial corporations. For example, in 2018, SMEs received 47% of their financing from bank loans and only 12% from equity (the latter being raised on the capital marketsas identified in the SAFE report). The importance of bank financing is a specific characteristic of the bank-based European economy and can be compared with economies that are more market-based. 

European Banking Federation

Research by S&P Global shows that although financial integration in the Eurozone has made some progress over the last few years, it remains lower to the level achieved prior to the 2008 financial crisis. The prospect of an integrated Capital Markets Union (CMU) in Europe remains elusive. The Banking Union forged following the Eurozone sovereign crisis is still incomplete as it lacks a mutualised European Deposits insurance Scheme (EDIS) , due to a longstanding opposition of Germany and other Northern EU countries to this project. Recently, Berlin lifted its cast-iron opposition to such a scheme but it remains to be seen when it will be implemented and under which conditions. In the meantime, the responsibility for Banking supervision in the Eurozone has been transferred to the European Central Bank, at least for the systemically important institutions, with national banking supervisors in charge of implementing the policies and guidelines decided at the EMU level within their jurisdictions, alongside direct responsibility for the supervision of smaller credit institutions.

Uneven banking concentration

The total assets held by the five largest banks in the Eurozone – three French Banks, one Spanish bank and one German bank – represented around 25% of the Bloc’s total banking assets. In comparison, the 5 largest banks hold around 45% of total banking assets in the United States and around two thirds in the United Kingdom and Japan.

Looking at the concentration of the banking sector country by country in 16 European countries based on data from the ECB (13 Eurozone and 3 non-Eurozone countries), we can isolate three clusters in terms of banking concentration. A cluster with concentrating banking industry, with the 5 largest banks active in the country representing above 65% – 70% of total banking assets. This cluster comprises small or medium-sized countries like Greece, Finland, Portugal and Slovakia alongside bigger ones like Spain where tthe banking sector has undergone a significant consolidation following the 2008 financial crisis, Belgium and the Netherland. The second cluster is comprised of large Eurozone countries such as France and Italy as well as smaller countries such as Ireland, Sweden and Poland. Banking concentration is around 50%. Italy joined this group starting from a low concentration but the financial crisis and the Euro sovereign crisis led to a consolidation of the Italian banking sector.

Lacklustre Performance amid low interest rates compounded by the coronavirus crisis

A split of Banks ROE by bands in different European countries shows that some important baking markets like Germany combine low concentration with low profitability. In most European countries, the ROE in the banking sector is geared toward the lower end. Based on data provided by the ECB, we have compiled a chart that gives a helicopter view of Banks profitability by ROE quantile as of end 2019. The size of each ROE quantile or band represents the assets under management by the banks with the related ROE, in proportion of the total banking assets in the considered country,

We can see from this chart that in Western Europe most of the Banks fall in the three lower quantiles in terms of profitability. Overall, the average profitability of the banking industry is low in Greece, Ireland and Luxembourg. But above all, Germany stands out as the country with the worse profitability with 60% of the banking sector’s assets managed by Banks with an ROE lower than 5%. This is related to two main raisons. First, it reflects the fragmentation of the German Banking sector as already discussed above. Second, it reflects the difficulty faced by Germany’s two largest Banks with very different cultures, namely Deutsche Bank and Commerzbank, to restructure their business models and to improve their profitability in a meaningful manner, more than a decade after the Great Financial Crisis of 2008. In other Western European countries, most banks displayed an ROE comprised between 5% and 10%, with a larger subpar performance concentration in Italy.

Remark: The sum of the quantiles across all the ROE bands does not always equal 100 due to data omissions

Performance of the major European banks and prospect for consolidation

Looking at market-based valuation of the Major European Banks, it is clear that there is a substantial difference with their US counterparts. On July 8, they exhibited a Price/Book ratio that was standing on average at 0.4. The two Swiss banks UBS and Credit Suisse showed much higher P/B ratios while the two largest German banks, Deutsche Bank (DB) and Commerzbank displayed Price/Book ratios at around 0.2. In sheer contrast, most US banks exhibited P/B ratios above 0.8, with the exception of Citigroup, Capital Group and Wells Fargo. Given their low Price/Book ratios, some European Banks like the two German largest banks or French Societe Generale might be perceived as ideal targets for an unsolicited take-over. But potential acquirers will have to get past all the regulatory and political hurdles that this process would involve, not to mention getting the visa from the European Union’s Competition watchdog headed by the formidable Margrethe Vestager. Previous European domestic mega-mergers attempts such as BNPP-SG or DB-Commerzbank failed partly because they were perceived to stifle competition on narrow overcrowded domestic markets. It remains to be seen if intra-European cross-border mergers will get a better chance to be approved.

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