CRISIS AVERTED BUT PROBLEMS REMAIN: EUROPEAN BANKS FACE UPHILL BATTLE FOR PROFITABLE GROWTH

Ten years after the start of the global financial crisis, more than a quarter of European banks are still at high risk of failing while many others struggle to find a profitable business model

London – 4 Sept. 2017 – In August 2007, the global financial crisis kicked off and shook the banking sector to its core. Today, European banks seem to have rebounded when viewed through recent stress tests by regulators, in light of higher capital buffers the banks have erected. In reality, 10 years on, many European banks remain in a difficult situation. Bain & Company’s 2017 Health Check of the Banking System finds that banks in Europe still have challenges to overcome. More than a quarter of banks appear to be high-risk, and need to take urgent action to ensure survival. Others struggle with a weak balance sheet, while some need to radically rethink their business models to remain competitive.

However, the past decade has also shown that any bank at any point along the spectrum can return to good health, through a proven formula, if the regulators, board and senior executive team have the commitment to carry out the hard decisions required over three to five years.

“A troubled bank is not necessarily doomed to fail,” said João Soares, partner at Bain and creator of the Health Check. “The journey back to good health is long and getting there requires some very difficult decisions, but we have seen that it is possible to take action and return to growth.”

The Health Check provides a uniquely integrated view, combining data from balance sheets and income statements. Bain calculates a score for each bank, based on data from financial providers such as SNL Financial and Moody’s with banks’ own financial statements, placing it in one of four categories:

• Winners. Some 38 percent of banks have attained this strong position. Scandinavian, Belgian and Dutch banks figure prominently in this group, outperforming on virtually all financial indicators.
• Weaker business model. Banks in this quadrant continue to represent just under 17 percent of the total. What may surprise some observers is the number of UK and German banks, including names that used to be references for good health, struggling to find a viable business model. Virtually all the large German names fall into this category, as their profitability and efficiency sit at a level comparable to their Greek counterparts.
• Weaker balance sheet. Some 17 percent of banks have a priority to fix weak balance sheets, compared to 21 percent in 2013. Over the years, banks in this quadrant have shown vulnerabilities not yet fully reflected in their profit and loss statements. A leading Spanish lender, for instance, moved from this quadrant to the quadrant of “highest concern” in just two years.
• Highest concern. Of the total base, 28 percent of banks flash a high-risk signal, up from 26 percent in 2013. Banks in Italy, Greece, Portugal and Spain form the bulk of this quadrant and have become a breed apart in continued distress.

The cost of inertia is striking, with investors rewarding the winners with a 1.31 price-to-book ratio, and punishing the high-concern banks with a 0.31 price-to-book. Equity markets also seem to reward banks with weak balance sheets slightly higher, at 0.72, than banks with weak in-year profitability and efficiency, at 0.60.

“Management teams need to have the clarity of thought and courage to make difficult decisions and regain control of their company," said Mr. Soares. “We have identified four distinct actions which are ‘must-haves’ for troubled banks to get back on track. Addressing the problem areas of the balance sheet and re-igniting growth around the new profit pools have the highest impact.”

The path to winning

The experiences of banks that managed to move from the lowest-scoring quadrant to the winners’ quadrant illustrate the path that can be taken:

1. Significant shrinkage of the balance sheet. Winning banks reduced their risk-weighted assets by about 50 percent, their gross loan amounts by between 25 percent and 30 percent, and their problem loans by 70 percent to 75 percent.
2. Growing revenue by improving customer loyalty and advocacy for the new digital world. Net interest margin as a share of risk-weighted assets more than doubled. This occurred after the winning banks embarked on an ambitious reassessment of the markets in which they operate, for their retail and business segments. They discarded legacy bets and focused on new profit pools.
3. Adjusting the cost base to reinvest in new activities. Winning banks pursue cost reductions through zero-based redesign programs. This differs from traditional budgeting processes by examining all expenses for each new period, not just incremental expenditures in obvious areas.
4. Changes to the mix of funding. Winning banks’ deposit levels rose by 20 percent to 25 percent, while they reduced wholesale funding by between 70 percent and 80 percent. Reduced dependency on wholesale funding marked a major departure from the previous make-up of the balance sheets.

With relatively new and ever-increasing regulatory frameworks from the European authorities taking hold, including the Supervisory Review and Evaluation Process, and greater scrutiny of nonperforming exposures, European banks cannot afford to ignore any of the data that signal vulnerable areas in the institution. Taking an integrated view is essential for understanding how to return to robust health. The good news: even troubled banks are not doomed to fail if the right actions are taken.

To request a copy of the report or schedule an interview with João Soares, please contact Aliza Medina at aliza.medina@bain.com or +44 207 969 6480.

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