2020 marked the end of an extraordinary year. Even though banks were not affected to the same extent as other sectors by the impacts of the lockdowns and the associated restrictions on economic activity, they are also feeling the direct and indirect consequences of the pandemic.

Before the coronavirus pandemic, banks were focused on transformation. The most important strategic fields of action were business model alignment, cost reduction programs and pushing digitalization. Due to increasing uncertainty in the markets and among customers, asset quality and risk provisioning again became the focus of banks during the pandemic. Far-reaching support measures by the various state institutions prevented the crisis from escalating in 2020. Despite the significant increase in risk provisioning, the banks achieved noteworthy results that can be attributed on the one hand to the good environment for the capital markets business and on the other hand to the regulatory and monetary policy measures.

The competitive situation in the European banking market remains intense and is characterized by a number of mergers, particularly in Southern Europe. The German market is also seeing an increase in mergers and cooperations as well as cost-cutting programs to increase profitability. On the customer side, there is increased demand for loans due to the pandemic, but at the same time, there is also a record savings rate among private households. As the lockdowns and restrictive measures to combat the pandemic have continued well into 2021 for parts of the economy, such as the suspension of the obligation to file for bankruptcy in the event of insolvency, uncertainty remains in the banking market, which continues to hamper the necessary transformation of banks.

European banks were able to improve their cost base

As emerged from our banking study, "Banking Efficiency - simplify for the future" ,the strict cost-cutting programs of recent years are not the solution for banks' long-term success. To be sustainably fit for the future, overarching digitalization measures such as the transformation and modernization of processes and systems are unavoidable. During the crisis, German banks were able to achieve initial successes in reducing costs through their transformation programs and, at the same time, did not record any high losses in earnings.

German banks are thus on the path to greater efficiency and increased profitability, and there is enormous potential in Germany as well as in the rest of Europe, especially regarding the development of new sources of revenue.

The balance sheet of the COVID-19 crisis

At the beginning of 2020, the transformation to a profitable and sustainable business model was still at the top of the agenda for many banks. That took a back seat, however, with the outbreak of the pandemic. Delays in the transformation process are therefore inevitable due to frequent reprioritizing.

The banking sector did prove last year that it is quite capable of acting even in the short term. The rapid action of the banks and the provision of additional liquidity in the form of loans and deferrals ensured that the beleaguered German economy was supported by financial stability.

In this context, development institutions, in particular, were challenged, as they had to establish new processes within a very short period to implement the various subsidies and bridging aids.

Nonetheless, this does not mean that the banks' long-term and, to a large extent, structural problems are off the table. The pandemic brought this home. It is clear that the digitalization of end-to-end processes has not yet been holistically implemented. Neither has the business model of many banks been adapted to the extent that it can react ad hoc to unforeseen changes in the framework parameters.

ESG as a way out of the earnings spiral

Environmental and social issues have become increasingly important for society in general and financial market players. As a result, socially responsible investing (SRI) has grown significantly in recent years through the consideration of ESG factors and has become a megatrend. Banks are committing themselves to comply with specific minimum standards and principles, and various ESG instruments and securities have emerged that banks actively promote.

External agencies compare the ESG strategies of different banks by analyzing all disclosed ESG information. These ratings represent the risks associated with ESG and have become an important factor in investor decision-making. An above-average rating is an essential element for the success of a company's long-term ESG strategy. Although bank ratings have gained momentum only in recent years, it can already be seen that above-average positive ratings correlate with above-average developments in earnings.

The significant growth of the ESG market in recent years proves that ESG-compliant action is far more than a short-term trend. In the area of sustainability, banks have a crucial role to play, having a direct influence on companies and, ultimately, on social and environmental issues through investments and the provision of funds. It is expected that the ESG market will continue to grow in importance in the coming years.

As a result, companies that do not integrate ESG criteria into their business operations will be at a disadvantage as they will not have access to this new and rapidly growing investor base. That is why it is vital for banks to unify ESG with their strategy to remain profitable and competitive in the long term and increase earnings.

Transformation as the key to sustainable efficiency

Catching up on efficiency remains a key task for European banks. Numerous measures ranging from specialist optimization, IT outsourcing, branch closures and staff reductions have so far failed to move the European banking sector toward a healthy and sustainable business model.

The performers among the banks reacted early and consistently and are extending their competitive edge through massive investments in the modernization of processes and systems. Our experience shows that they are pushing artificial intelligence and robotic process automation (RPA) and more to design and automate processes efficiently and are increasingly implementing standard software as cloud solutions to keep change-the-bank costs at a low level in the long term.

Our recommendation for banks

Transformation is the key to sustainable efficiency. The performers among the banks reacted early and consistently and have extended their competitive edge through massive investments in modernizing processes and systems and integrating ESG factors into their operational activities. By contrast, the laggards among the banks who continue to rely only on cost-cutting programs have not achieved the goals they set.

The message is clear: dare more when it comes to ESG, invest more in IT, and use artificial intelligence and robotic process automation. This will make it possible to design processes efficiently, automate them, and increasingly implement standard software as a cloud solution in order to keep change-the-bank costs at a low level in the long term.

In our view, banks should pursue the NEW approach (sustainability, efficiency, growth) to ensure that the transformation process to a sustainably profitable bank is successful.

About the study

This year's study, "Europe's banks are on the road to recovery with the shift to efficiency and sustainability," is based on an analysis of the financial statements from 2013 to 2020 of 123 European banks supervised by the ECB or national supervisors. The dataset covers over 70 percent of the aggregated total assets of all monetary financial institutions in the European Union. External ratings from independent rating agencies were used for the ESG theme.

You can read the study results and our recommendations for action in the study document, which is available for download.

We hope you enjoy reading it!

 

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