Groupama AM sees the European banking sector as stronger and better able to meet the coming new challenges

28/09/2017

BCE

In a more favourable overall economic environment, European banking establishments have been pursuing healthier balance sheets and a significant improvement in profits since the beginning of this year. Patrick Goux, Banking Analyst at Groupama Asset Management, presents the prospects for the banking sector and the structural changes that it now faces.

 

GOUX patrick
[Patrick Goux, Analyste Banques]
The banking sector is more robust today. A combination of factors has enabled banks to strengthen their balance sheets since 2007.

First, the improved resilience of the sector is now sustained by reinforced supervision that is increasingly well coordinated at European level. “the single supervisory mechanism established for banks in the eurozone has the great advantage of being independent of national political powers,” is the analysis of Patrick Goux.

Fundamentals reinforced by the single supervisory mechanism and by the regulations implemented since 2007

Second, the prudential regulations initiated after the crisis of 2007 have significantly increased the ability of banks to resist potential shocks. “Basel III has led to improved solvency of the banks, both in quality and quantity, and has also raised the levels of their liquidity reserves. Also, their asset/liability position has been stabilized by improved cashflow matching,” he explains.

Moreover, “banks are continuing to reinforce their fundamentals,” because of the continuing “toughening” of regulations. “Basel III will not be in full force until 2019,” and the work of the Basel Committee is advancing towards “Basel IV”, the term commonly adopted by the major market players to denote the final, deep-reaching version of Basel III. The approach adopted by the European Union in this context has been pragmatic, with a progressive implementation of “Basel IV”. “In the run-up to Basel IV, banks are continuing to strengthen their balance sheets and are applying a more prudent dividends policy.

However, the quality of the assets held by banks is still causing problems in some European countries.
“In the Italian banking sector, questionable assets still count for almost 15% of total bank assets. And the process of bringing this ratio down was always going to be slow, not only in Italy but also in Greece and Portugal.” So, for the last year, the European authorities have stepped into action to accelerate the resorption of this fragility. The stress tests and audits conducted by the ECB have obliged the most fragile players to considerably bolster their reserves in 2016 and therefore to recapitalize. The European authorities also accepted the injection of public money in Italy to speed up this stabilization process, as was the case with Monte Paschi, without even obliging senior debt holders to accept a proportion of the losses. Finally,” Since the beginning of the year, the markets have been prompt to support the recapitalization of banks considered to be in a less critical situation.”

Reduction in risk liability and improvements in results

The profitability level of the European banking sector, expressed in terms of ROE, remains below the levels recorded before the crisis of 2007. However, 2017 has been marked by an improvement in results, despite the continued pressure on profit margins induced by the levels of interest rates.

This recovery in profits is due to the improved overall economic environment in Europe, which has led to more dynamic volumes of business. “We are also witnessing a decrease in reserves in 2017 in all European countries, including Italy. The series of massive reserves established by banks up to 2016 to cover bad loans or for dispute settlement now seems to be behind us, with the critical pressures being released over the last few years.”

In particular, the Groupama Asset Management team is anticipating an acceleration in profit growth for banking institutions in Southern Europe, sustained by the fall in the cost of risk and the stabilization of interest rates.

Meeting new challenges

Although the banking sector is more robust overall, it must now also manage the twin challenges of digital transformation and energy transition, with their impacts at both structural and societal level. Technological advances are revolutionizing the nature of client relations, with resulting lowering of admission barriers, a potentially more volatile client base and pressure on income levels. Banks are facing new competition in the sector, such as FinTech or digital leaders, especially the GAFA giants, which have many advantages, including agility, digital expertise, processing capacity and data optimization.

“The major challenge for the traditional players in the sector is not only to keep up to date technologically but also to imagine the most efficient model of partnership with the new players. A ‘cultural revolution’ – at technological, human and managerial levels – will have to be launched in the banks in order to rethink client relations. More than ever, the client is the key to the sector’s offer of services while now also enjoying greater freedom in determining the mode of interacting with the bank,” explains Patrick Goux.

Finally, banks are at the heart of the energy transition challenge. Climate change is causing new risks for the sector. Although the exposure of French banks to the physical risks of climate change is relatively low, the risks of the transition cannot be ignored. “French banks provide finance for sectors of activity where players are directly exposed to the transition risks, for example the transport, automotive and utilities sectors,” concludes Patrick Goux.

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