European bodies renew calls for consolidation of the banking sector

Mergers and the orderly exit of unprofitable banks high on the agenda as the ECB and EBA raise the spectre of “overbanking”

Banking alert | 29 September 2017


Consolidation and downsizing of the banking sector continued to dominate policy discourse this week. Addressing separate activities in London and Madrid, both Danièle Nouy, Chair of the Supervisory Board of the European Central Bank (ECB), and Andrea Enria, Chair of the European Banking Authority (EBA), spoke of the need to continue strengthening supervision and facilitating the cross-border integration of banks as a means to improve the long-term profitability of the industry.

The figures speak for themselves: though banks in the Euro area have indeed begun to decline, dropping by around 20% since 2008, they of course maintain a critical role in the European economy. For comparison’s sake, while total assets of the Euro area banking sector today stand at 280% of GDP, total assets of the banking sector in the US account for just 88% of GDP.   

Whilst prevailing market conditions point towards further shrinking of the banking sector, individual credit institutions are expected to continue facing pressures to reinforce their business models, ramp up digitisation efforts and adapt to regulatory and supervisory realities.

The regulators’ paradigm shift: from avoiding failure to embracing it

Perhaps the most fundamental change to affect the European banking sector since the international financial crisis in 2008 is the approach adopted by regulators to banking failure. Whereas the immediate aftermath of the financial crisis saw national governments shoring up hard-hit banks in a bid to protect consumer confidence in the sector, regulators are now being directed to allow weak banks to fail.

The Single Resolution Mechanism itself was created specifically to cater for an orderly exit of failing banks while significantly reducing the risk of contagion. “We can only draw one conclusion,” said Nouy at the VIII Financial Forum, “banks must be allowed to fail. This is probably the most important thing that can be done to make the market work again.”

Encouraging mergers and acquisitions

Mergers are considered another crucial component of the drive for consolidation. Cross-border mergers in particular are seen to be advantageous because they allow banks to achieve economies of scale, diversify portfolios and improve quality of assets, and enable further integration of the banking union.

Yet, notwithstanding a clear policy stance in favour of cross-border mergers, take-up has decreased rather than increased. Among the reasons for this failure are poor visibility of the impact of incoming regulations on the banking market in the short to medium term, the complexity and uncertainty surrounding mergers, and cultural, linguistic and legal barriers.

Over the coming period, it is reasonable to expect renewed efforts towards making mergers and acquisitions more attractive to banks. Indeed, Enria has called on all involved to “get our act together and try to remove those impediments.”

What does this mean for you?

Without a doubt, Europe’s push towards consolidation and shrinking of the banking sector means local banks must brace themselves for even tougher supervision and enforcement of regulations. The advantage in the face of this new reality is that the procedures and methodologies by which banks are reviewed are laid out transparently in the Supervisory Review and Evaluation Process (SREP), allowing banks to plan ahead.

Strategically, banks must continuously review and strengthen their business model to ensure profitability, resilience and diversification in the face of increasing competition and modest avenues for investment. Operational efficiency will continue to be a major driver for change as banks look to outperform rivals in a leaner and ever more digitised environment. And problematic legacy assets and non-performing exposures are expected to be cleaned off the balance sheet systematically.

How we can help

  • Governance transformation and change management. Assistance in undertaking a current state assessment and formulation of governance, regulatory and risk management transformation plans to ensure compliance with the SREP framework.
  • Business model analysis. Assistance in the preparation of a “business model analysis model and report,” to help you defend and demonstrate the viability and sustainability of your business model and strategy to the regulator.
  • Regulatory submissions. Diagnostic on existing ICAAP and ILAAP processes, as well as assistance in the preparation of ICAAP and ILAAP reports and Recovery Plans (BRRD).
  • NPL reduction plan. Assistance in the preparation of NPL reduction plans in line with Banking Rule 09 and ECB guidance on NPLs.
  • On-site inspection credit risk readiness. Assistance in achieving readiness to undergo either a full-scope or a targeted AQR-type assessment in line with the ECB AQR methodology.
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