Christian Edelmann is Managing Partner for Europe at Oliver Wyman
The June meeting of Eurogroup finance ministers in Luxembourg promised to deliver more clarity on the integration of European banking and capital markets. Instead, it was widely seen as a disappointment.
As this work continues, the lack of progress should not have come as a surprise. In times of geopolitical tension, priorities change.
The war in Ukraine is fueling an already inflationary environment. Economies are struggling to recover from Covid-related supply chain disruptions. As a result, concerns about fiscal stability in (southern) Europe are growing and the European Central Bank is again being challenged to extend its mandate to manage widening sovereign bond spreads.
How bad are things for banks in Europe? On the face of it, the global financial services industry is doing relatively well today and has been growing for several years. He also showed remarkable resilience at the height of the Covid crisis.
But growth and value creation have been resolutely oriented towards new players. In 2012, incumbents accounted for 90% of the total value of the financial services sector. Today, their share is only 65%, according to a recent study by Oliver Wyman. Financial infrastructure and technology companies, or FITs, have begun to replace them, now accounting for 35% of industry value. While leading incumbents have increased their shareholder value by approximately $1.3 billion over the past decade, according to our research, non-incumbents have increased their value by $3 billion.
The vast majority of FIT growth is taking place in the United States and China, where the biggest tech companies are crowding into financial services. Europe lacks true “tech giants” and has therefore experienced more limited value creation so far. While online wallets, digital tokens and the metaverse will eventually gain traction, Europe is once again likely to remain on the sidelines.
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The situation is particularly bad for European incumbent banks. The market value of the top 20 European banks at the end of 2007 was 58% higher than that of the top 20 American players. Now it’s 43% less. The annual profits of some of the largest US banks now exceed the market capitalization of a number of these top 20 banks in 2007.
While the banking union does not provide the hoped-for panacea, what should European banks do to close the value gap?
First, banks should not wait for a perfectly conducive environment for mergers and acquisitions, but rather should work actively with all relevant regulators to achieve better synergies in cross-border mergers and acquisitions. They should challenge national ring-fencing practices in the eurozone, in particular by pushing for cross-border liquidity waivers, which national regulators can grant. In this sense, banks should urge national resolution authorities not to add MREL requirements (minimum requirement for own funds and eligible liabilities) to local subsidiaries of banking groups in addition to the MREL requirements imposed by the Resolution Board unique.
In the longer term, European banks need to question their basic business models. Yes, we have seen several cycles of restructuring and digitization in all European banks since the global financial crisis. But deep down, they are set up in traditional customer-facing silos (such as retail or wholesale banks or wealth management divisions), with the majority of their revenue streams dependent on risk intermediation. While rising rates are now helping these companies, that is not enough to change the fortunes of European banks.
These additional revenues can create additional ammunition to fund a transition to the future, that is, venturing deeper into technology, especially data. Valuable technology services – such as payment, banking/insurance-as-a-service models, or digital assets – achieve revenue multiples of 20-30, while connected data services (such as wallet services , connected ecosystem services for mobility, employment, education, commerce or climate risk data) benefit from multiples of 30 to 40. Traditional risk intermediation firms, on the other hand, have multiples only 10 to 20.
Transitioning into the future will require more than an innovation lab – companies must undergo radical organizational change, transforming these platforms into primary or at least equal reporting lines, with future leaders being groomed into these leadership positions.
Ultimately, it will be up to European banks themselves to reverse the growing gap with US companies. Those who show they can change are likely to find enthusiastic support among investors, regulators and prudential authorities across Europe.