Brief

Germany's banks 2014

By Walter Sinn and Dr. Wilhelm Schmundt

First published on octubre 21, 2014
min read


Thinking back to the 1970s and 1980s makes German bankers' eyes light up. That was a time when balance sheet growth averaged ten percent year after year, the profits were rolling in and most financial institutes had no trouble earning their cost of capital. The picture has changed beyond all recognition in the wake of globalisation, intense competition, digitalisation, the financial crisis and the sovereign debt crisis, regulation and the difficult economic situation. And there's no improvement in sight. On the contrary, the ongoing structural change – comparable with last century's upheaval in the steel industry – forces banks to engage with a number of challenges that threaten their very future. Yet Germany's banks are not unfamiliar with change. This analysis of the long-term developments in the German banking sector demonstrates just how much the industry has changed over the past four decades. For instance, the number of financial institutes in the market has shrunk by almost 80 percent since 1970. At the same time, their balance sheets have exploded, with the average bank today boasting more than 80 times the assets of a bank in 1970. But the shareholders are seeing little of it. Quite the reverse: net return on equity in the early 1970s was more than four times higher than it is today. In the past three years, not even six percent of banks earned their cost of capital. Costs are some 30 percent over-inflated Contrary to popular opinion, this is not caused by the recent tightening of bank capital requirements. The low returns earned by banks are a long-term development and the result of the fall in net interest and commission income relative to equity and the structurally over-inflated costs. At around 70 percent, the average cost-to-income ratio is now the same as it was in 1970. But just how decisive costs are is shown when we analyse the breakdown of return-on-equity drivers by institute group. Banks with high returns outclass their rivals particularly thanks to their successful management of both costs and risk. Given the restrained growth prospects in Germany and the market entry of new foreign and digital competitors, the focus is again turning to efficiency potential. Banks need to slash their costs by 30 percent on average to generate an appropriate return considering their cost of capital. Business model focusing is a key lever There is major cost-cutting potential to be found in the focusing of business models, an action which is long overdue. Many business segments have to be the right size and offer economies of scale in order to be run profitably nowadays, a situation which will ultimately result in a much wider spread of business models. The market of the future will be divided into Global Universal Banks, Regional Institutes and Specialists who will position themselves based on their own individual competitive advantage such as customer access or economies of scale in their production processes. Besides this, banks need to pull out all the stops to achieve further cost savings. That means, in the first instance, consistent process optimisation and automation extending beyond the production areas. Additional potential lies in the renewal of the fragmented and long-established core banking systems and application landscapes, in the radical streamlining of the branch network – which will see some 11,000 branches close in the next ten years – and in streamlining organisational structures. As a result, around a fifth of jobs in the German banking industry will be at risk.

Thinking back to the 1970s and 1980s makes German bankers' eyes light up. That was a time when balance sheet growth averaged ten percent year after year, the profits were rolling in and most financial institutes had no trouble earning their cost of capital. The picture has changed beyond all recognition in the wake of globalisation, intense competition, digitalisation, the financial crisis and the sovereign debt crisis, regulation and the difficult economic situation. And there's no improvement in sight. On the contrary, the ongoing structural change – comparable with last century's upheaval in the steel industry – forces banks to engage with a number of challenges that threaten their very future.

Yet Germany's banks are not unfamiliar with change. This analysis of the long-term developments in the German banking sector demonstrates just how much the industry has changed over the past four decades. For instance, the number of financial institutes in the market has shrunk by almost 80 percent since 1970. At the same time, their balance sheets have exploded, with the average bank today boasting more than 80 times the assets of a bank in 1970. But the shareholders are seeing little of it. Quite the reverse: net return on equity in the early 1970s was more than four times higher than it is today. In the past three years, not even six percent of banks earned their cost of capital.

Costs are some 30 percent over-inflated

Contrary to popular opinion, this is not caused by the recent tightening of bank capital requirements. The low returns earned by banks are a long-term development and the result of the fall in net interest and commission income relative to equity and the structurally over-inflated costs. At around 70 percent, the average cost-to-income ratio is now the same as it was in 1970. But just how decisive costs are is shown when we analyse the breakdown of return-on-equity drivers by institute group. Banks with high returns outclass their rivals particularly thanks to their successful management of both costs and risk.

Given the restrained growth prospects in Germany and the market entry of new foreign and digital competitors, the focus is again turning to efficiency potential. Banks need to slash their costs by 30 percent on average to generate an appropriate return considering their cost of capital.

Business model focusing is a key lever

There is major cost-cutting potential to be found in the focusing of business models, an action which is long overdue. Many business segments have to be the right size and offer economies of scale in order to be run profitably nowadays, a situation which will ultimately result in a much wider spread of business models. The market of the future will be divided into Global Universal Banks, Regional Institutes and Specialists who will position themselves based on their own individual competitive advantage such as customer access or economies of scale in their production processes.

Besides this, banks need to pull out all the stops to achieve further cost savings. That means, in the first instance, consistent process optimisation and automation extending beyond the production areas. Additional potential lies in the renewal of the fragmented and long-established core banking systems and application landscapes, in the radical streamlining of the branch network – which will see some 11,000 branches close in the next ten years – and in streamlining organisational structures. As a result, around a fifth of jobs in the German banking industry will be at risk.