More Action Needed on European Bank Profitability

IMF Blog, August 30, 2017

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European banking has made considerable progress: banks have built up capital, regulation is stronger and supervision has been enhanced.
Profitability remains weak, posing risks for financial stability.
In a sample of more than 170 large European lenders with combined assets of $35 trillion:
- roughly half generated a weak return on equity in 2016,
- banks representing only 15 percent of assets generated a healthy return on equity, defined as more than 10 percent.
Weak profitability is also shown in a low return on assets for domestic banks in many European countries.
Drivers of weak returns reflect varying combinations of low income, high costs, or provisions needed to build buffers against non-performing assets.
Almost three-quarters of these banks in our sample, by assets, had weak returns on equity in 2016, compared with less than 40 percent for internationally focused peers.

The economic upturn in Europe should boost profitability as interest rates rise, loan-loss provisions fall, and lending opportunities increase.
The October 2016 Global Financial Stability Report found that a cyclical recovery is unlikely to be enough to fully restore bank profitability.
Why low profitability is a threat:
- Consistently unprofitable banks are unable to build up reserves against unexpected losses and often find it difficult to raise capital in times of need.
- Weak returns limit banks’ ability to expand lending.
- Weak returns may induce banks to drive up returns by taking greater risks.

Profitability problems reflect both weak business models and structural features of banking systems.
The IMF’s April 2017 Global Financial Stability Report discusses structural challenges, including over-banking.
Over-banking (no common definition) refers here to a set of structural factors that affects profitability across the system; causes vary by country and no single aspect explains profitability concerns across countries.
Other structural challenges:
- A large proportion of savings, cooperative, policy banks (such as development banks), and state-owned institutions can reduce the profitability of other banks in the system.
- Problems in resolving non-performing loans (for example, lengthy foreclosure times) delay disposal of non-performing assets and act as a drag on profitability.

Individual banks:
- Continue restructuring businesses for higher returns.
- Invest in technology to increase efficiency.
Supervisors:
- Assess business-model sustainability and ensure banks do not respond to profitability pressures by taking excessive risks.
- Ensure banks adopt ambitious, time-bound strategies for the disposal of bad assets.
Authorities in over-banked systems:
- Encourage consolidation among small and medium-sized banks, combined with governance reforms where needed.
- Consolidation can mean small or mid-sized banks combine forces to become stronger, not just making large banks bigger.
In systems with significant asset quality challenges:
- Consider targeted asset quality reviews for banks that have not undergone such an exercise.
- Regulators should resolve unviable institutions to remove excess capacity from banking systems.
Cross-border and legal framework actions:
- Further harmonizing national supervisory practices and legal frameworks across countries should enhance banks’ effectiveness.
- Measures are needed to fully resolve the burden of non-performing assets.
- Completing the regulatory reform agenda is vital to ensure weaknesses are addressed and uncertainty is reduced.

Banks’ efforts to adapt business models to changing regulatory and market challenges are necessary but may not be sufficient.
Policy actions to improve system structures can foster conditions for banks to generate sufficient profitability with acceptable risk, making them both safer and better able to support the economy.

Source: More Action Needed on European Bank Profitability, John Caparusso, Rohit Goel, Will Kerry, August 30, 2017.

Für die Ertragsstärke der europäischen Banken muss mehr getan werden
- Für die Ertragsstärke der europäischen Banken muss mehr getan werden (Markdown version)
- Für die Ertragsstärke der europäischen Banken muss mehr getan werden (PDF)