Europe’s banks have had a tough ride over the past decade. Their market value is still down by more than two-thirds from the peak before the global ﬁnancial crisis.
European banks are falling behind on both sides of the ledger. Not only has revenue growth been weak — cost structures also remain a major burden. U.S. banks boasted a cost/income ratio roughly 15 percentage points better than their European counterparts in 2021, according to Oliver Wyman research. About 80% of that gap was attributable to support function costs: U.S. banks are getting more out of their technology than European banks.
Only one-ﬁfth of the gap was due to higher front-office payout ratios last year. But if revenue and cost trends persist, European banks soon will struggle to keep up with Americans on comp as well.
Granted, some of the malaise is due to negative interest rates, which have taken a major toll on European banks.
Regulation and its implementation, or the lack thereof at the European layer, is another important factor. Both the Banking Union and the Capital Markets Union are key ingredients for creating a simpler and ultimately more level playing ﬁeld across Europe, which also would help foster well-needed consolidation. European banks also have a point when they argue there is no truly holistic view on regulation across the Basel regulatory framework and the full prudential regulatory agenda. This includes all supervisory tools such as the Supervisory Review and Evaluation Process (SREP) and its drivers, as well as the Asset Quality Review and stress testing. Better understanding of how these regulations and tools systematically impact the business model of typical European bank is critical.
But what if that day of “regulatory panacea” never comes? In this moment of political populism, growing nationalism, and ﬁery polarization, it has been difficult for European leaders to make progress on regulatory initiatives. For example, the CMU was absent in the President of the European Commission’s state of the union address, which sets out her top priorities.
If banks want to get out of their malaise, they will likely have to do it for themselves, and swiftly. It requires nothing less than radical transformation.
Most banking CEOs will argue they have been in constant transformation over the last decade. But they have reacted far too slowly and too gradually. They have tried to preserve what made them successful historically, and then tried to layer on new capabilities largely on legacy infrastructure that in most cases dates to the 1970s and ’80s.
Banks haven’t leveraged the value of the data they have. And most important, they haven’t sufficiently appreciated how the process of value creation has shifted. Historically, banks created value by managing pools of risks —and they extracted so much money out of it that they even oﬀered ancillary services such as custody or payments for free or at cost. They didn’t realize the value opportunity that specialist providers have tapped into over the last decade.
If banks want to close the gap in the near term, they will likely have to do it for themselves.
Banks need to organize business units around data and customer lines — but so far, none has truly done this. The quickest successes would come from simple improvements such as using data to help customers make better spending decisions. In an extreme scenario, one could imagine a ring-fenced setup in which managing the balance sheet stays in a regulated entity while customer-focused platforms that serve all manner of customer needs sit outside it. It might sound farfetched, but radical thinking is required.
An example of such a customer-focused platform could be related to climate transition. Indeed, this is one area in which the European political and regulatory environment can become an advantage. Europe is further along the political, societal and regulatory journey than the United States. Banks have a chance to finance and advise corporates along this journey and, on the flip side, distribute such assets to institutional investors who are urgently looking to beef up their climate-friendly investment track records.
These aren’t quick fixes; they require major transformations that demand leadership courage and investment budgets. Most firms don’t have those budgets and may have to think about selling assets to finance this critical transition, painful though that may be. But they need to be bold. Incrementalism will not do the job.