Imagine your entire industry and the world around it are being reshaped. Would you rather be an integral part of the process or a passive bystander?
That, essentially, is the situation confronting European banks today.
The industry faces challenges and opportunities on many fronts, from the pandemic recovery and growing competition from tech companies to the role of banks in the long-term existential threats of climate change and changes to financial infrastructure. In all, the equivalent of 25% of current bank revenue is in play within the next few years.
There are two ways the narrative could play out. In one scenario, banks are, to quote the musical Hamilton, 'in the room where it happens'. They join with policymakers and businesses in setting the agenda to solve the biggest issues facing Europe’s economy. By getting out on the front foot, banks renew their sense of purpose, ensure their ongoing relevance, grow the bottom line, and reap reputational benefits from their newfound vim and vigour.
In the other scenario, banks fail to step up and instead let others lead. Gradually, they are pushed into a diminished role by a combination of public policy measures and new competition that results in decreasing relevance, shrinking market share and a backlash from stakeholders.
One way or the other, Europe’s banks can expect to undergo a transformation in the years ahead. They can ensure a better outcome by taking bold, collaborative action now in five important areas.
1. Banks must solidify their role as financial first responders
As the pandemic period ends, it will fall on banks to help unwind emergency government lending programmes while minimizing insolvencies and the number of 'zombie' companies weighing down the economy. Banks need to create and deliver standardized approaches across the industry, with government buy-in at every step. Banks and other private-sector financial providers may need to invest in equity-like instruments to prop up otherwise viable companies that are carrying too much debt. A successful glidepath out of emergency loan support would ensure that peak bank losses do not reach the worst predictions, saving at least €40 billion.
2. Banks must carve out a new role in providing credit to companies
The European Union’s €750 billion Next Generation fund is being rolled out over the next two years and the Capital Markets Union (CMU) is finally emerging with its shift to market-based financing. The Next Generation fund amounts to 16% of outstanding loans to nonfinancial corporations in the European Union. The CMU has the potential to drive market-based financing of corporates from 25% to 50%. Banks have an opportunity to become trusted advisers, channel different forms of capital, and help clients navigate the new, broader range of financing options. The alternative is to be viewed as begrudging and unequal partners of these public initiatives.
3. Banks have to compete in new ways as finance becomes embedded in customer-first services
The pandemic has accelerated changes in the way banking products are delivered, moving them closer than ever to customers’ point of need. Payments, lending and other banking products are increasingly being delivered in ecosystems that serve a wider set of customer requirements. If banks can’t create new ecosystems themselves, they can serve as providers of finance to existing networks. If they do nothing, banks will see more market share shifting to fintechs and big tech companies.
4. Banks must deliver system-wide improvements to Europe’s financial infrastructure
For example, central bank digital currencies (CBDCs) are one major initiative that banks need to influence for the better. These currencies could be truly disruptive, with €10–€25 billion of bank revenue at risk if CBDCs attract just 20% of total deposits. The banking system needs to take a collaborative approach, engaging with policy-makers and regulators and with each other to identify and deliver system-wide improvements. Payments and financial crime initiatives are already underway, and further initiatives can deliver a more resilient and efficient system.
5. The last and biggest challenge is the transition to a net-zero-carbon economy
In Europe alone, €1.5 trillion to €2 trillion needs to be invested in green initiatives, more than twice the size of the Next Generation fund. Banks have pledged to reach net-zero carbon emissions across their lending portfolios by 2050, yet their commitments are running far ahead of the transition in the real economy. To hit their targets, they will need to be proactive in initiating green projects. Conflicts between climate goals and financial returns may need to be managed, but if banks don’t take the initiative, a combination of boutique advisers and specialists, data companies and private equity funds will bridge the gap; banks will have put their credibility on the line and failed.
If banks can rise to these challenges, it will reinforce customer trust and their central position in the economy. If they don’t, they are likely to be coerced into supporting the public agenda anyway – without the benefits of helping to shape the plan, or the halo effect from being seen as proactive problem solvers.
Embracing change, however difficult it might be, is the best way for banks not only to avoid being sidelined in coming years but, perhaps, to thrive.