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GLOBAL INVESTOR 1.14 — 18 Banking today Even as banking continues to cope with the aftermath of the financial crisis, completely new competition is arising. Disruptive innovation through FinTech start-ups questions the banks’ value chain. Christine Schmid Co-Head Global Equity & Credit Research +41 44 334 56 43 christine.schmid@credit-suisse.com Key figures of European banks 2013 2009 2007 MARKET CAPITALIZATION NET INCOME EQUITY RoE in % in billion in billion in % 100 EUR 1,748.48 bn 20 EUR 349.00 bn 62 EUR 1,083.72 bn From 2007 until the trough in 2009, banks lost a staggering 80% of their market capitalization and only recovered to just over 60% as of end-2013. 106 48 16 2013 profitability was impacted by the cleanup mode that banks were in, anticipating the asset quality review and European Central Bank stress test. 702 801 1,063 The impact of Basel III regulation is that equity has risen by 51%. Thus high return on equity (RoE) numbers are more difficult to achieve. 15.1 6.0 1.5 With an RoE of 1.5% (down 90% in recent years), banks seem to have become utilities. The low RoE is partially due to low profitability but also higher equity. Photos: Getty Images Europe, Ulrik Tofte/Getty Images, Steven Puetzer/Getty Images, Andrzej Podulka/Getty Images Source: Credit Suisse coverage, company data
GLOBAL INVESTOR 1.14 — 19 The last seven years have been a rollercoaster ride for European banks, driven by the aftermath of the financial crisis, stricter regulatory rules and, last but not least, the Eurozone breakup concerns. From end-2007 until 9 March 2009, European banks lost a staggering 80% of their market capitalization. Remarkably, it recovered to reach roughly 60% of its original size by 2014. But in terms of relative market weight and importance, the banking sector never recouped. Down from 20% market weight in 2007, its share remained at 13%. This could change if the European economy recovers. Banks are a direct proxy for indicating expected eco nomic development. But economic development also depends highly on banks and their lending capacity. In Europe, where the capital market is less mature, bank lending constitutes roughly 70% of company financing; for small and medium-sized enterprises (SMEs) 100%. Thus, no longerterm economic recovery can occur without expanding lending in Europe, where up to 70% of the jobs are provided by SMEs. But banks are still in deleveraging mode (see Figure 1), shrinking their balance sheets to meet stricter capital and leverage ratio requirements. The aggregated equity position of European banks has increased by 51% since 2007 as a reflection of stricter capital rules. The equity position, and with it the capital ratio, has constantly improved over the last few years, but the balance sheet size has remained largely unchanged. Driven by European Central Bank (ECB) liquidity measures, the banks engaged in sovereign debt carry trades. With zero risk weight imposed by regulators on sovereign debt, the capital ratio was not affected. The 2014 ECB stress test seeks to change this delusive incentive. 2014 lost in transition? 2014 is a transition year for European banks as the ECB conducts a harmonized asset quality review and subsequent stress tests later this year. In anticipation of these events, various banks have raised capital, revalued their assets and continued to divest assets. This illustrates how, even seven years after the financial crisis, European banks still lack a proper capital level under more severe economic conditions. Capital market and securitization gaining importance Tight capitalization and ongoing regulatory pressure are limiting bank lending and the economy. The Eurozone urgently needs to revive securitization as well as develop its capital market facilities to foster economic growth. At the same time, banks will go through a phase of radical changes – be it their business models, their value chain or the channels used. Banks offer high potential going forward, but only if they adjust their business models and communication channels Banking is the global industry expected to change most in the coming years as a result of client demand and cost pressure combined with technological development. Despite cost constraints and regulatory pressure, European banks need to find ways to serve their 01_European economic growth difficult to achieve as no support from lending Lending in Europe is in negative territory as banks continue to deleverage, driven by the pending asset quality review and stress test by the European Central Bank. Simplified rules for securitization as well as concerted actions to support capital market growth are needed to foster economic growth. Source: Datastream, Credit Suisse/IDC % YoY 15 10 5 0 –5 –10 2000 2002 2004 2006 2008 2010 2012 2014 USA Eurozone FinTech According to Cisco, the number of mobile-connected devices will exceed the world population by the end of 2014. This rapid pace of accelerating technology interaction affects both our daily lives and, increasingly, the financial industry. The term “FinTech” addresses this convergence of financial services with technology. Big Data analytics, cloud computing, mobile solutions and social media have also become essential in banking. This is driven by changing customer behavior as well as by new profit pools and the entry of new digital competitors such as retailers, mobile phone operators, IT giants and start-ups. 32% of banking revenues at risk from new digital competitors by 2020 They challenge existing business models and have the potential to disrupt the industry. In a world of growing regulatory requirements that must be implemented constantly, we think it is crucial that banks develop innovative technology to deal with these new challengers, while also improving efficiency. Financial centers have also recognized the benefits of closer interaction between banks and start-ups. Over the last three years, New York and London have adopted so-called FinTech innovation labs that aim to facilitate their collaboration. This is a good opportunity to foster innovation among banks while providing IT entrepreneurs with contacts in the financial industry. In our view, other financial centers are likely to pick up similar projects to strengthen their banks’ competitiveness.
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