Analytics and information management (AIM)

The European Banking Authority (EBA) has published a speech given by its Executive Director, Adam Farkas at the Deutsche Bundesbank Conference. The speech is entitled “Bank business models – structural changes and their systemic implications”.

In his speech, Mr. Farkas highlighted that it was not the objective of European Banking Authority to suggest that supervisors are empowered to decide on banks’ strategies. The role of supervisors is to assess and challenge business models, but not to control banks’ development of their strategies and the corresponding business model.

The main objective of business model analysis is to allow competent authorities to develop a view on two main areas. Firstly, they should have a view of the current business model of the supervised institution, and its viability. Secondly, they should also understand how the business model may evolve as a result of strategic choices made by the institution and/or the impact of changes to the business environment in which it operates, and therefore, its risks and sustainability;

In Farkas opinion, both views should bring benefits in the form of improved supervisory practices, which in turn should ensure the health of the EU banking system. In addition, he raised several arguments on why banks need to adapt their business models according to the results of the regulators analysis.

Nowadays, the main challenges for banks going forward were low profitability, high non-performing loans and overreliance on the central bank funding. These are all symptoms of weaknesses in their business models. Addressing those weaknesses, banks has to consider several factors, including the macroeconomic developments, regulatory changes, structural adjustments in the financial markets and advance in technology, but that they could respond by revising and changing their business models.

Asset quality is the other major perceived vulnerability for EU banks, especially in the countries that were most affected by the euro area sovereign crisis. In the last years, the banks have picked up the pace in resolving NPLs. Although the trend is clear and promising, on a global level, the non-performing loan ratio in the EU is still the highest among its peers (i.e. US and Japan).

EBAs’ analysis shows a negative correlation between NPL ratios and profitability and shows that banks unable to cope with their non-performing loans will probably struggle to return to profitability.

Farkas also pointed that the first step in the process of banks’ business model adaptation should be fixing their strategy. Banks’ future strategy needs to take into account:

• the potential prolongation of the current low interest rate environment
• the pace of cleaning up of their balance sheets
•  the implementation of Basel prudential rules
• the new resolution framework, as well as the possible future

developments of the Capital Market Union.

In the context of this strategy, banks should also re-assess their risk appetite. The most successful banks need to develop a risk strategy beyond regulatory compliance focusing on the overall business risk management. Besides their risk culture, banks also need to develop their business culture, addressing both their customers as well as their employees.

Adapting banks’ business models is essential for establishing an efficient and, above all, sustainable EU banking sector. To ensure the process does not have negative systemic implications and consequences to depositors, the most vulnerable stakeholders, supervisors will conduct business model analysis in their regular supervisory process. Nonetheless, in adapting business models not all the burden falls on the shoulders of banks. As technology advances and traditional banking models becomes less viable, further efforts are also needed from the official sector.

Deloitte can help you:

• Assess the mission statement of the credit institution
• Assess the role and performance of corporate governance
• Update the respective Risk Appetite Framework (RAF)
• Correlate RAF to your financial projections
• Assess how RAF is communicated to the rest of the organization        in terms of implementation and planning (product design, risk management, regulatory reporting, internal audit framework, stress testing framework, regulatory reporting)