The Covid-19 crisis has significantly changed the market environment for banks

As outlined in our 2019 Lost in Transformation banking study, the market environment was already unfavorable for banks. The Covid-19 crisis has only made it worse. There has been a considerable downgrading of customer creditworthiness and a threat of liquidity shortage in some sectors. These negative effects, particularly the burden on banks’ risk provisions for impending defaults, have been offset and mitigated by measures at the national and European levels, such as guarantees, the participation of public funds, grants, and promotional loans. As the crisis progresses, it can be assumed that an intensification of the real economy’s problems will lead to considerable strain on bank profitability and stability.

The effects of the Covid-19 crisis are visible in the balance sheets of European banks. With Europe falling into a recession in the wake of the Covid-19 crisis, the risk of unpaid loans has risen sharply. For example, at the end of the second quarter of 2020, 36 of the largest European banks had around €317 billion in non-performing loans on their balance sheets. The situation has yet to reach the 2009 level during the financial crisis when non-performing loans were at €444 billion, but the financial markets make it clear that the risk of non-performing loans is increasing. The full extent of the pandemic’s effects are not currently reflected in the banks’ figures – catch-up effects are expected in the next few quarters.

In terms of profitability, the European banking sector was already under considerable pressure before the crisis. Measured in terms of the European banks’ pre-tax profit (EBT), the industry’s performance stagnated the past two years. Since 2017, the banks were able to partially cleanse their balance sheets of legacy assets from the euro crisis and, as a result, have increased their aggregate results 1.5 times since 2013. Since 2019, however, they have been declining slightly for the first time, not least due to further declines in interest margins. Despite the good, albeit somewhat cooled economic conditions, many banks have not successfully developed a sustainable strategy against the oppressive combination of negative interest rates, increasing competitive pressure – especially from FinTechs – and changing customer needs. Compared to the same period the previous year, aggregate EBT slumped by 68 percent in the first half of 2020. The situation is further aggravated by the fact that the banks were unable to increase their net commission income in the first half of the year compared to the past four years.

Even before the Covid-19 crisis, banks often had problems with their business model to operate profitably and sustainably in the challenging market environment. Therefore, it is hardly surprising that the threat of a new banking and financial crisis is still on the agenda of supervisory authorities due to the economic and political environment after the Covid-19 shock. Although the expected massive impact on the banking sector’s stability in the form of a dramatic increase in loan defaults has not yet materialized, banks’ profitability is already under pressure in these difficult times. For some European regions, it is clear that the countries that have been significantly affected by the Covid-19 pandemic also struggled with the most far-reaching economic consequences. The crisis is a negative catalyst for countries that were already economically weakened.

Holistic transformation means establishing NEW Banking - sustainability, efficiency, and growth

To be successful in the long term, banks must focus on three central fields of action. In our view, efficiency, the development of new growth areas, and sustainability should form the core of the banks’ future strategic orientation.

  • It became clear that banks will only achieve the challenging goals of a sustainable cost-income ratio if they sustainably reduce costs and lay a foundation for further growth. They must streamline product portfolios and set up investment strategies.
  • The banks’ task is to significantly expand the earnings situation through structured investments in the coming years to achieve long-term profitability and reduce the cost-income ratio. Focusing on services and products based on a scalable IT architecture is a key success factor to counteract falling interest and commission margins.
  • Banks must consistently exploit their opportunities through new products and a holistic sustainability strategy. The interest in sustainable financial products offers banks another building block for their growth strategy and competitiveness. Customers are increasingly willing to change their bank if it does not offer sustainable products with recognizable added value.

Read more in our Banking Efficiency - simplify for the future study, found below.

About the Study:

Our Banking Efficiency – simplify for the future study and its results are based on the analysis of the annual financial statements of 113 European banks supervised by the ECB since 2013. The sample comprises approximately 70 percent of the aggregated balance sheet totals of the European banking sector as reported by the ECB and non-EU banks. Furthermore, this year’s study is also based on data from 86 semi-annual financial statements for the years 2019 and 2020 to support initial analyses and conclusions on the short-term effects of the Covid-19 crisis on European banks.

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