Bain study on the situation of Germany's credit institutions

German banks face a yawning earnings gap of 25 billion Euros

• Returns are coming under pressure from low interest rates, digitalization and regulation
• Improvements in capitalization are compounding the profitability problem
• The gap between the most and the least profitable banks is widening
• The savings efforts of past years have achieved very little
• Initial forecast of earnings development through 2025 reveals a need to cut costs by 30 percent
• Bain predicts average return on equity of 5 percent after tax

Munich – 24 November 2015 – Banks in Germany continue to face an uphill climb, thanks to a challenging operating environment. Despite a slight improvement in earnings, less than 6 percent of credit institutions are managing to earn their cost of equity. A gaping hole of 5.6 percentage points has opened up between the average return on equity generated in 2014 – 2.1 percent – and the cost of equity – 7.7 percent. In other words, banks need additional net profit to the tune of € 25 billion if they are to fulfill their claims made to their shareholders. This is the conclusion of Bain & Company's latest study, Germany's banks in 2015 – the 25 billion earnings gap.

"The earnings gap at German banks is particularly striking, and the background conditions are not going to get any better," cautions Walter Sinn, head of Bain & Company Germany. "Banks that want to remain successful in the future need to adopt a counterstrategy now and rework their business model."

Such measures will also necessitate a radical reduction in the banks' cost base of € 84 billion over the next ten years. Cost reductions of 30 percent are possible.

"Local credit institutions need to become far more focused, streamlined and profitable," adds Dr. Wilhelm Schmundt, Bain partner and banking specialist.  "And by far the most effective levers for cutting costs are personnel costs."

This means a further reduction in jobs, which will have to be achieved through changes in business models, automation and digitalization of business processes, a reduction in organizational complexity and greater outsourcing. The required personnel cutbacks of 125,000 jobs by 2025 will be aided by the age structure of bank employees, and achieved through natural fluctuation, semi-retirement schemes and early retirement programs. Bain also estimates that an additional 115,000 positions can be outsourced to service providers and service companies.

A long way off from fulfilling their own claims

The enormous profitability differences within the banking sector underscore the importance of cost discipline. The gap between the most and the least profitable banks has widened immensely. In 2014, the 360 most profitable banks (the top 20 percent) generated return on equity of 4.9 percent compared with a mere 1.7 percent generated by the 360 weakest institutions (the bottom 20 percent).

"The profitable institutions are increasingly extending their lead over their rivals," said Sinn. "A selection process is clearly under way in the market."

This is also evidenced in a comparison between the institution groups. The cooperative central clearing institutions generated after-tax return on equity in 2014 of 10.0 percent and ranked among the top three in the league table alongside the direct banks (9.8 percent) and the automobile banks (8.1 percent). The mid-field was dominated by the specialist banks, the credit cooperatives, the big banks, banks mandated with special tasks, the Landesbanks, mortgage banks and savings banks, each with ROEs of between 1.8 and 4.2 percent. Bottom of the league were building societies together with private banks and asset managers.

Despite last year seeing the first increase in total assets since 2011 – an increase of three percent to 7.64 trillion euros – the number of banks operating in Germany has fallen from 1,843 in 2013 to a new low of only 1,786 in 2015.

Schmundt claims that "if the consolidation process continues at the same speed as in the last 20 years, in ten years' time the number of banks will have contracted by a further 550."

In 2014 a total of 1,100 branches were closed. This nevertheless leaves a further 30,800 branches nationwide. According to the Bain forecast, a total of 11,000 branches will fall victim to the changes in the business models. The number of employees fell last year by 5,000 to 625,000. In the last five years, 22,000 jobs in the banking sector have already been cut.

ROE can be doubled by slashing costs

For the first time, Bain has also analyzed how the profitability of German banks will develop over the next ten years. Key factors here are higher capitalization, rising risk costs and an inflation-induced cost spiral, each of which will have additionally negative repercussions for business results. At the same time, however, relief will be felt from higher interest income and commission income. If banks succeed at radically cutting costs, the earnings gap expected for 2025 of 25 billion euros can be at least halved. Return on equity in the German banking sector would then more than double – from 2.1 percent today to 4.9 percent.

Sinn concludes: "Despite all the efforts undertaken, the profitability of banks in Germany will remain on average below the cost of capital. The consequence will be fierce competition. Further consolidation is unavoidable."

Media contact
Leila Kunstmann-Seik, Bain & Company Germany, Inc., Karlspatz 1, 80335 München  Email: leila.kunstmann-seik@bain.com, Tel.: +49 (0)89 5123 1246, Mobile: +49 (0)151 5801 1246

About the study

The analysis of developments on the German banking market uses data from the Deutsche Bundesbank and the European Central Bank as well as the databases of Bankscope and Hoppenstedt. They form the basis for the detailed analysis of the balance sheet and P&L structures of around 1,800 credit institutions in Germany. Additional use was made of internal benchmark and market models which are being constantly developed in a large number of transformation and cost reduction projects. The forecast of the future earnings gap is the result of a scenario analysis, which was based on current market data from Bloomberg alongside historical time series. For our examination of the consolidation trends, data from national central banks, the Bank for International Settlements and the World Bank were used. The study also drew on results from comprehensive surveys and studies recently carried out by Bain in the banking sector.