Newsroom

• Industry optimistically aiming for return on equity (ROE) increase of 1.6% this year but thats still a long way from covering the cost of capital
• More bankers expect pay to fall in 2015
• 41% of universal banks to sell assets as the model comes under pressure

A combination of low growth, continued restructuring and renewed pessimism about the economic outlook in Europe means that bankers see further staff cuts as inevitable. However, they are hopeful that the banks will be able to deliver marginally improved ROE (+1.6%) and that they should be able to increase lending to business this year, in particular to SMEs, according to EYs European Banking Barometer .

The European Banking Barometer comprises interviews with 226 senior bankers across 11 markets: Austria, Belgium, France, Germany, Italy, the Netherlands, the Nordics, Poland, Spain, Switzerland and the UK. In each market the respondents represent financial institutions covering at least 50% of banking assets. 1

Steven Lewis, EYs Global Banking & Capital Markets Lead Analyst, says:

Bankers optimism about the European economy has evaporated, and with it, their hopes for a return to strong growth. Staff costs account for just over half the industrys operating costs, and so against this background, and the pressure being put on banks by regulators and shareholders, the expectation of further job losses is sadly realistic.

ROE expectations look overoptimistic

Bankers expectations for cost reduction and revenue growth look more positive than last year. Costs are expected to fall by an average of 1.57% more than three times the cost reduction expected last year and revenue growth is expected to average 3.46%, which also exceeds last years predictions. The respondents hope this will deliver a 1.6% improvement in ROE, but EY analysis shows that it would only improve average ROE by 0.8%.

Lewis says: Improving ROE for the European banks is proving difficult. Whereas the US banks are now delivering 12.15% return, even growth of 1.6%, which would bring average ROE to 4.35 % is looking unlikely in Europe. This highlights the real issue here how far the European banks are from covering their cost of capital, which averages 9.4%.

EY analysis suggests that European banks would need to reduce costs by 21% and grow revenues simultaneously by 15% just to achieve their average cost of capital (9.4%). To illustrate how far from this European banks are: banks in Austria are expecting to cut costs the most, and they are not expecting to cut costs by more than 6%; banks in the Netherlands are expecting to increase revenue the most, and they are expecting on average to grow revenues by 5%.

Reduced optimism for growth hits expectations for pay

Remuneration has been an area of intensifying regulatory and investor focus. This year fewer banks now expect pay to rise, and more expect overall pay to fall than last year. Notably, although 5% expected aggregate pay to increase by more than 8% in 2014, none do this year, but 7% expect pay to fall by 8% or more.

However, with just 16% of European respondents seeing the development of new remuneration systems as a key priority, any cut in pay has to be seen as a response to market pressure and continued low growth rather than an attempt to structurally transform incentives across the industry.

The pace of job losses is set to increase everywhere other than in the UK

The pace of job cuts is expected to rise in 2015 to levels last seen in 2013. Staff costs remain about 54% of the sectors operating costs. With the industry anticipating further restructuring and requiring additional cost reduction to achieve profitability targets, further job losses remain inevitable. Forty-three percent of bankers expect headcount to fall this year. The greatest losses are expected in the Nordics, Italy and Austria. The UK is the only market where more hiring than firing is anticipated.

Lending to SMEs to increase but construction and real estate to struggle to borrow

Despite a weaker economic outlook, bankers do expect their business lending policies to loosen across most sectors. SMEs in particular should benefit, with more than half of respondents saying they expect to be less risk averse when lending to the SMEs.

Transport, financial services, construction and commercial real estate, however, will continue to face increasingly restrictive lending policies as banks continue to derisk their balance sheets and reduce exposure to riskier sectors. The construction and real estate sectors will be particularly badly hit in Austria, France and Italy, and the only country in which banks expect to be able to lend more freely to real estate is the UK.

Restructuring is expected to gather pace this year

Sixty-nine percent of respondents are considering their options in terms of restructuring, be that selling assets, buying assets or forming partnerships or joint ventures, in comparison to 55% last year. Interest in partnerships or joint ventures has increased the most, jumping from 24% in 2014 to 34% in 2015.

Bankers in Belgium and the UK are keenest to buy, bankers in France are keenest to sell and bankers in Germany, The Netherlands, Switzerland and the Nordics are most interested in exploring partnerships.

The structural reform agenda is emerging as a key driver of this activity with 41% of universal banks expecting to sell assets, compared to 33% of corporate and investment banks and just 20% of retail banks.

Lewis says: Restructuring in the banking sector had slowed ahead of the AQR and stress test but, now that the exercise is over, both weaker growth and structural reform are forcing banks to seriously reconsider the viability of some business units. In particular, we may start to see concrete evidence of the effects of the structural reform agenda on the universal banking model.

Its clear that alliances and partnerships are going to be the preferred form of inorganic growth, in a large part due to Basel III rules. Interest in creating partnerships in North America has doubled as banks seek to increase their exposure to the USs economic recovery.

1 In Austria, 31% of total assets are represented.

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