Citius, altius, fortius. Germany's banks are currently making huge efforts to live up to the Olympic motto of "faster, higher, stronger". They are digitalizing, closing branches, cutting costs and reorganizing their distribution. Yet none of this is helping to alleviate the constant slump in returns among the steadily decreasing number of banks. In 2017, the average return on equity after tax was just 2.0 per cent, and only one bank in twelve was able to earn its cost of equity.
In addition to the relentlessly fierce competition and the regulator’s demands for higher capitalization ratios, the primary reason is the persistently low interest rate policy of the European Central Bank (ECB). As a ratio of equity, net interest income declined by almost 2 percentage points to 16.9 percent in 2017. Net commission income, the perpetual beacon of hope, failed to offset this decline. Moreover, little movement can be seen on the cost side, despite all recent efforts, with the cost-income ratio consequently having last risen by only 3 percentage points to 72 per cent - the yield trap is snapping shut.
Direct banks and automotive banks showing above-average returns
However, a number of institution groups are standing out from the crowd. As in previous years, it was above all the direct banks and the automobile banks that again managed to generate above-average returns in 2017. The cooperative credit institutions and savings banks can also boast good returns if the equity-enhancing loan loss provisions are deducted from expenses in accordance with Section 340g German Commercial Code (HGB). But even in this case, the sector's return on equity still lies below the cost of equity.
The effects of the banks' feeble returns are feeding through to investors, as revealed in Bain’s global comparison of stock returns in various industries. For Europe's credit institutions, this rate has shrunk to -9 percent in the past twelve months. An analysis of the drivers of equity returns reveals what is currently lacking most of all – trust. The multiples are in decline.
Exploiting potentials and expanding partnerships
Faced with these weak returns, banks - whether listed or not – must act, in three ways at once. First, they must step up their efforts to leverage the full potential of their business models. Second, faced with the disruptive forces of digitalization they have no other choice than to explore the possibility of partnerships more than ever before. And last but not least, they must give greater consideration to the issue of mergers.